Economic Slump Underlines Concerns About McCain Advisers

By Jonathan Weisman
Washington Post Staff Writer
Wednesday, April 2, 2008

One of them helped deregulate the financial services industries in the 1990s, and now sits in the corporate suites of Swiss banking giant UBS, which yesterday announced $19 billion in investment losses tied to the crumbling U.S. real estate market.

The other pushed one of the most aggressive and controversial mergers of the technology boom, then was sacked by the disenchanted board of Hewlett-Packard.

Former senator Phil Gramm, with his aw-shucks Texas drawl, may at first blush have little in common with Carly Fiorina, the telegenic former chief executive of Hewlett-Packard. But they share a bond: Both are leading economic advisers of Sen. John McCain (Ariz.), the presumptive Republican nominee for president, and both have reputations as the kind of aggressive capitalists that may be sliding from favor as the nation's economy edges toward recession.

Democratic opponents are already plotting attacks on two advocates of what Robert Reich, a former Clinton labor secretary, described as "dog eat dog capitalism," an economic philosophy that works well when the economy is on the upswing but may not play so well in a trough. "McCain is counting on people having very short memories and not connecting some pretty obvious dots here," said Jared Bernstein, an economist at the Economic Policy Institute, summing up a growing liberal critique of McCain's economic team.

To economists across the political spectrum, much of the criticism is unfair oversimplification. But even some advisers close to McCain said they wonder if such lightning-rod public figures should be so closely identified with his candidacy. "I, for one, have thought about it a lot," said one McCain adviser, who spoke on the condition of anonymity. "And that's all I will say."

The spiraling crisis in the credit and housing markets has kept Gramm in focus, fairly or not. His employer, UBS, revealed yesterday that investment losses tied to the U.S. housing market reached $37 billion over the last six months. For the last three months, UBS posted a $12 billion loss.

Gramm, UBS's vice chairman, said yesterday he was "totally unaware" of his bank's massive holdings of securities tied to subprime mortgages, but, he added, "I'm confident we'll recover."

More to the point may be Gramm's aggressive efforts when he was chairman of the Senate Banking Committee to deregulate the banking and financial services industry. That culminated in passage in 1999 of a sweeping financial services law that tore down the Depression-era Glass-Steagall wall separating regulated commercial banks from largely unregulated investment banks. And little regulation was put in to replace it.

"We are here today to repeal Glass-Steagall, because we have learned that government is not the answer," Gramm declared at the time. "We have learned that freedom and competition are the answers. We have learned that we promote economic growth and we promote stability by having competition and freedom."

To many liberal economists, Gramm's efforts set the stage for the current crisis. Lending by noncommercial banks has soared, to about 70 percent of total lending. Investment banks, including Bear Stearns, grew too large to be allowed to fail. And, said James K. Galbraith, a University of Texas economist, investment banks helped create the exotic financial instruments that turned subprime mortgages into tradable securities.

"Phil Gramm's career was as the most aggressive advocate of every predatory and rapacious element that the financial sector has," Galbraith said. "He's a sorcerer's apprentice of instability and disaster in the financial system."

Gramm denied the charge, saying financial services deregulation has mitigated the impact of the credit crisis by giving investment and commercial banks a broader business foundation to withstand the downturn. The commercial bank J.P. Morgan Chase could not have swooped in to salvage Bear Stearns without deregulation, he said.

"People who want greater involvement in the markets always see in any crisis the need to expand government control," he said. "That always happens."

Gramm has some unlikely defenders. Robert Litan, a Brookings Institution economist who advised the Clinton administration on financial industry deregulation, said that if anything, the crisis might have been mitigated if Gramm had gotten more of his way when he opposed the Community Reinvestment Act in the 1990s.

Gramm maintained that the act, which allowed regulators to review a bank's record on lending to the poor before approving financial industry mergers, allowed advocacy groups to effectively blackmail banks into making risky loans in poor communities. But the Clinton administration prevailed in saving the CRA.

"If they wanted a merger approval, they had to show they were making a conscious effort to make loans to subprime borrowers," Litan said. "If the CRA had not been so aggressively pushed, it is conceivable things would not be quite as bad. People have to be honest about that."

Gramm, as a former Senate colleague, has an older, deeper connection to McCain, but Fiorina may soon be more closely identified with him. Since McCain installed her last month at the Republican National Committee, the once-high-flying chief executive has held conference calls, made near-daily television appearances and become the face of McCain's economic team.

"John McCain understood the positive role of government in incenting and motivating innovation," Fiorina said yesterday in an interview, recalling their first meeting in 2000.

But until recently, Fiorina's claim to fame was 5 1/2 rocky years at Hewlett-Packard, where she battled the company's founding families to push forward with a $19 billion purchase of Compaq Computer in 2002, then failed to create the profitable computer giant she had promised. In February 2005, she was publicly ousted by HP's board, but not before she ordered the first of a series of leak investigations that would spin into a highly publicized scandal.

Alarmed by leaks of boardroom deliberations to reporters covering the technology industry, HP authorized investigations that would ultimately involve private investigators lying to phone companies to obtain personal phone records, bogus e-mails to reporters complete with tracer software to track forwarding, even a plan to infiltrate newsrooms with spies posing as clerical workers and cleaners.

Those efforts were tied most directly to Hewlett-Packard's former chairwoman, Patricia C. Dunn, but in her 2006 memoir, Fiorina wrote that she had ordered the first investigation a month before her ouster following a Wall Street Journal report on an impending corporate reorganization.

Fiorina said yesterday that all she had done was ask the company's outside legal counsel, Larry W. Sonsini, to interview all of the board members about the leaks, a process that took two weeks. She regretted using the term "investigation" in her book.

"It is factually inaccurate to connect me to the spying scandal at HP," she said.

As for the Compaq merger, Fiorina said she has been more than vindicated for her aggressive management.

"The results have validated the wisdom of the decision and the timing of the move," she said.

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