Why Is Alan Greenspan’s Lawyer Still Controlling the Federal Reserve?
There’s been a sharp focus on Janet Yellen’s Chairmanship role at the Federal Reserve, and rightly so. She’s the first female Chair and she actually cares about inequality. But what is missing from virtually all Fed watching, except for this piece by Jesse Eisinger, is any recognition of how the Alan Greenspan-appointed staff at the Fed still retains substantial control of the institution through the high-level staff who were promoted into their roles by Greenspan.
Ideological drag is inevitable in any institution. But Greenspan cast an especially long shadow, running the Fed from 1987–2006 and organizing the culture of bank regulators for an entire generation. Most of his people are cycling out naturally. The entire Board of Governors of Greenspan’s era is gone, replaced by mostly Obama appointees. But there are two specific staffers retaining significant fiefdoms there who are Greenspan holdovers; the first is General Counsel Scott Alvarez, who has a team of 55 lawyers working for him that analyze everything from legal guidance to legislative changes to supervisory actions to regulations (such as those on swipe fees, insurance capital requirements, or capital surcharges to large banks). The second is Michelle Smith, who runs the office of public affairs.
Alvarez is the more significant hold-out, he’s so powerful that he is sometimes called the “power behind the throne.”
I’m reminded of this because Alvarez is now testifying in the AIG trial. While there’s been a lot of attention focused on Bernanke, Paulson, and Geithner, Alvarez is a very significant witness. His testimony took up the first three days of the trial, and he made key legal determinations about the authority of the Fed to put equity into AIG, to structure loans, and to handle the AIG board itself.
It’s a bit difficult to give you a sense of how Alvarez testified, because while there are some ‘gotcha’ moments between the plaintiff’s lawyer David Boies and Alvarez as witness, they don’t really resonate unless you can grasp some reasonably technical determinations in their courtroom context.
That said, Alvarez seems to have operated like Ronald Reagan during Iran-Contra, saying “I don’t know” or “I don’t recall” nearly every chance he could when Boies was asking him questions. On just one day, it was 36 “I don’t know”s and 17 “I don’t recall”s, often in response to simple questions. Alvarez disputed the meaning of the world “purchase” and the word “attempt.” This wasn’t because there was complicated context — the judge admonished him several times for not answering questions. Often he would say “I don’t know” and then Boies would read back his own words in deposition contradicting him.
This was in stark contrast to the liquid smooth answers he gave when the government attorney was asking him complex questions about statutory interpretations.
Behavior like this matters because Alvarez was — along with Tom Baxter of the New York Fed — the main legal architect behind the Fed’s extraordinary lending facilities. He probably was the one who made the call that the Fed could buy equity in AIG, and restructure the company to funnel cash to counterparties like Goldman Sachs. So the judge’s polite admonitions to Alvarez for refusing to answer questions and for changing his story are remarkable.
Here’s one example, where he and Boies go back and forth on whether there were legal reasons for the Fed to hold equity in AIG. Alvarez disputes the term “legal reasons”, until Boies shows that Alvarez had in his earlier deposition used the term “legal reasons.”
Q. My question is, have you, since your deposition, had any discussions about this testimony or the subject matter of it with anyone?
A. I — I have not — let’s see. I’m not sure how to answer that question.
Q. Yes or no or I don’t remember.
MR. AUSTIN: Your Honor, we object on the grounds of attorney-client privilege and work product privilege.
THE COURT: Well, much like the discussion we had yesterday, I don’t want the witness to testify about any legal advice he may have received or requested in meetings with counsel. But if we’re talking about fact information and explanations for why his testimony may be different today than it was in his deposition, I think we should hear about that.
This isn’t the first time Alvarez pulled this rhetorical trick. He also disputes Boies characterization that AIG at one point sought to get access to the discount window, arguing about the meaning of the word “attempt”. AIG didn’t formally apply officially to become a primary dealer, he notes. Perhaps there were conversations about that, but he Alvarez says he wasn’t aware of them. Then Boies shows him his own testimony in deposition in which he says AIG attempted to get access to the discount window. He admits, sullenly, he agrees that this is his testimony, but then implies that was a slightly different question (it wasn’t).
Over three days, Alvarez made it difficult to get any useful information about what happened and when. He pretended to be unaware of key aspects of what the Fed was doing, such as attempting to broker an investment in Morgan Stanley from cash rich investors or sovereign wealth funds. Among other things, he denied knowledge of or disputed that:
- Investment grade collateral is considered better than non-investment grade collateral by financial markets.
- The Fed opening the discount window to investment banks kept those investment banks in business.
- Morgan Stanley ever had “severe liquidity problems.”
- Goldman and Morgan Stanley were given emergency waivers to become bank holding companies because any delay would endanger their health as going concerns.
- AIG’s interest rate was substantially higher than other financial institutions received at the time under 13(3) authority.
- AIG sought access to Fed lending facilities prior to its bailout.
- Investment banks given access to Fed lending had better access to Fed lending than AIG.
He also made absurd characterizations, like saying that the emergency waiver granted to Morgan Stanley to become a bank holding company was done only because the Fed had comprehensively examined the firm and found it “well-managed.” This examination, which normally takes a year, was in this case done in two days.
There was even a moment when Alvarez says that when he agreed in a deposition with Hank Paulson’s statement that the Fed bore no risk in its loan to AIG because of the collateral, he only meant that in the context of his role as the Fed’s lawyer. Did he personally believe that the Fed bore no risk? Mumble mumble, mumble, followed by “I don’t know.”
It was maddening just reading it. Alvarez normally gets away with this, because the structure of Congressional oversight and its five minute cross-examination limits makes it impossible for anyone to truly trap someone this skilled. Boies however had all day, he also is a very skilled lawyer, and the judge was perceptive and increasingly irritated. Judge Wheeler overruled every objection by the government, and sustained every objection by the plaintiff. You can see why. Here’s just one example of Alvarez’s answers.
Q: Would you agree as a general proposition that the market generally considers investment-grade debt securities safer than non-investment-grade debt securities?
A: I don’t know.
Q: Now, when the Federal Reserve told Congress and other agencies that the September 22 AIG credit facility was fully secured, the Federal Reserve understood that what Congress and the other federal agencies were interested in was whether there was a risk to taxpayers, correct?
A. No. I don’t think that’s right.
Q. You don’t? So, you think that when Chairman Bernanke went up to the Hill to testify about whether the AIG credit facility was fully secured, Congress wasn’t interested and Chairman Bernanke didn’t think Congress was interested in whether there was a risk to the taxpayers?
A. So, I think —
Q. Is that your testimony? Yes, no, or I don’t know.
A. Could you rephrase the question?
In other words, Alvarez is a very skilled hostile witness. He disputes big questions, like whether a Treasury bond is riskier than a mortgage-backed securities, and little questions, like whether an AIG term sheet was “incorporated” or “referred to” in Fed Board of Governor meeting minutes. In most contexts, his tactics would work. But faced with lawyer David Boies, a legal team with millions in resources, and a knowledgeable Judge like Tom Wheeler, it isn’t. Wheeler is constantly directing Alvarez to answer questions, and wondering why his memory keeps being ‘refreshed’ (ie. a polite term for changing his story from his deposition to the trial).
Boies was trying to establish a couple of core ideas. One, AIG was treated disproportionately badly compared to other entities, like Morgan Stanley and Goldman Sachs. And two, the Fed did not have the authority to inject equity into AIG.
On the first point, Boies pretty well won. He showed that the interest rate to AIG was punitive and much higher than to every other entity that sought Fed loans. In no other case did the Fed try to take equity. He also showed that Morgan Stanley had borrowed tends of billions from the Fed through its 13(3) facilities while AIG was begging for similar credit lines (which the Fed refused). Alvarez glumly noted he did not know or did not recall what Morgan Stanley was borrowing when making key decisions about Morgan Stanley’s and/or AIG’s future.
On the second point, the Fed’s authority is in deep dispute, but it’s clearly true that Alvarez did not put down on in any formal memo that the Fed could or could not take equity. It was certainly a legally dubious proposition.
New York Fed General Counsel Tom Baxter had sent Alvarez an email saying that the Fed couldn’t inject equity. In addition, there were slides that Alvarez saw that were prepared for a committee of regulators saying that. Bernanke even said that equity was not an available tool when testifying to the Financial Crisis Inquiry Commission. There’s even a memo from Alvarez’s deputy saying that the Fed cannot hold full voting rights of AIG stock in trust for the Treasury, on which Alvarez writes “Not clear why we should have the first part. Politically sensitive.” The firm’s outside lawyers at Wachtell, Lipton, Rosen, and Katz wrote that Alvarez had “nixed the idea” of holding AIG’s equity. But there was some evidence, notes in margins of paper, that the Fed did think that holding equity was fine as long as the Treasury took responsibility for losses in a trust.
Boies got a lot out of this testimony, as will probably become clear in the trial. But what I find more interesting than the trial outcome is what this testimony says about the culture of the Federal Reserve itself. Alvarez has done as much as anyone to keep Alan Greenspan’s deregulatory culture alive in the face of a more regulatory minded Federal Reserve board. Alvarez’s approach is ideological in nature.
I went back and read his testimony before the Financial Crisis Inquiry Commission, which was the body tasked by Congress to find out why the crisis happened. Alvarez discusses his background, the financial system, and his essential philosophy.
As a staff lawyer at the Fed since the early 1980s, Alvarez participated in significant deregulatory changes in the banking sector. It was the decades at which Alvarez was at the Fed where, through decisions big and small, Glass-Steagall was pulled down via loopholes for derivatives, waivers for acquisitions, and allowances for commercial banks to engage in investment banking activities. All of these shifts required acquiesance or active complicity by the bank regulators, including and especially the Federal Reserve and the OCC. Alvarez was in the thick of all of this. It’s literally all he knows.
For example, Alvarez helped draft the law formally eliminating Glass-Steagall, The Gramm-Leach-Bliley Act. He alludes to helping Citigroup merge with Travelers, which prompted the statutory shift. What’s more interesting than what he did is how he sees his actions today. After all, a lot of people in hindsight acknowledge they erred. Not Alvarez. He argues that the repeal of Glass-Steagall had nothing to do with the crisis.
His evidence? Well he claims that Lehman and Bear were the primary culprits in the housing crisis, and that neither entity took advantage of the end of Glass-Steagall. By contrast, those banks that did take advantage of it, such as JP Morgan and Bank of America, well they “did rather well.” These banks were “not the cause of the crisis” and they were “not a casualty, either.” He talks about sick dog Citigroup, and says that we shouldn’t refer to “Citi as if it failed. It hasn’t. It survived, unlike Bear Stearns, unlike Lehman, unlike WaMu, Wachovia, etc.” He speaks as if Citi had no support from the government whatsoever. It was a remarkable performance, reminiscent of what French diplomat Talleyrand once said about the Bourbons, “They had learned nothing and forgotten nothing.”
Obviously the end of Glass-Steagall in 1999 was more of a formality than anything else. American Depression-era banking regulations had been chipped away since the 1960s, with an accelerated deregulatory mindset taking off just as Alvarez’s career began to flourish in the 1980s. But to Alvarez, the removal of the speed bumps in the U.S. financial system is simply irrelevant to the series of crises we’ve been experiencing since the 1970s. They are perhaps just acts of God.
For instance, when asked why the crisis occurred, Alvarez uses standard talking points you may have heard elsewhere. The financial system was more fragile than we realized. It was simply due to a global savings glut. Investors stopped doing due diligence. It was just a big crisis of confidence. Everyone was responsible. Yada yada.
Alvarez is completely unapologetic about the Federal Reserve refusing to use its authority to stop false and deceptive practices in the mortgage market prior to the crisis. He doesn’t mention the linkages of mortgage-backed securities to the financial system via derivatives, the gaming of the capital markets, or problems with banker compensation that reward short-term gains while socializing losses. Alvarez’s arguments reflect a pure and unadulterated deregulatory mindset bequeathed to the central bank by Alan Greenspan.
So what does all this mean? Well there’s a lot of chatter about how the Fed could be reformed with the right set of Governors on the Fed board, or a new New York Federal Reserve President. And that’s true as far as it goes. But Alvarez creates special problems for Yellen, and the Fed.
Alvarez is a regulatory specialist who controls the bulk of the legal expertise in the Fed, whereas Yellen is a macroeconomist who doesn’t know regulations that well. Alvarez’s institutional opponent is Fed Governor Dan Tarullo, and Tarullo as a single Governor doesn’t have the resources to fight the entire Fed legal staff. So Alvarez is likely to continue to win. In other words, what Yellen really needs to do to put her stamp on the Fed is to fire Alvarez and replace him with someone who actually sees the legal mandate of the Fed in the context of the institution’s recent failures. Alvarez is simply too wedded to Greenspan’s legacy to do so; he is incapable of recognizing the needs of today’s Fed.
Today the big buzzword is ‘macro-prudential tools’, which basically means using regulatory tools to ensure that big banks and capital markets don’t adversely destabilize the economy. This is different than normal safety and soundness regulation, which is to look at the practices and balance sheets of individual banks. It’s somewhere between institution-by-institution banking regulation and the broad credit controls of World War II, where the Fed takes a direct interest in organizing credit to specific sectors to prevent inflation or prevent problems. No one knows what it means in today’s context. But unless you have people dedicated to regulating the system, ‘macro-prudential tool’ will never mean anything. Alvarez just isn’t going to let it.
This kind of personnel move has worked. Until 2012, the Office of Comptroller of the Currency was a horrific bank regulatory agency, largely because of its former General Counsel, Julie Williams. She was responsible for a whole series of regulatory determinations in the 1980s and 1990s that effectively deregulated derivatives and eliminated Glass-Steagall long before the statutory changes.
One of the first things new OCC chief Tom Curry did a few years ago was fire Williams, and despite the outcry, lo and behold, the OCC is actually a credible regulatory agency again. Alvarez is the Julie Williams role of the Fed. He’s a career civil servant, he’s served at the Fed for decades, and he’s exceedingly bright. This is not a man out to make a quick buck. But he is someone who has been at the Fed long past his time, and what we are seeing with the AIG trial is that Alvarez won’t let the Fed modernize and reform itself away from its deregulatory Greenspan-infused past. Because what he’s really good at, what he’s spent his whole life doing, is making sure it can’t.