INTRODUCTION
James (Jim) Wright, Jr., became Speaker of the House of Representatives in 1987. I will examine the following puzzles: How did the two worst control frauds recruit him as an ally? Why did he remain loyal to them even after it became clear that doing so would have disastrous consequences for his constituents, the nation, and his party?
Why did he, after striving for decades to become Speaker, continue to support the control frauds, even though doing so cost him his life’s ambition and his reputation?
How did three control frauds and a real estate developer, each of whom voted for Ronald Reagan in 1980, get Wright, a populist Democrat, to champion wealthy GOP frauds despite the warnings of fellow Democrats?
Wright’s actions on behalf of the control frauds had enormous direct
consequences: they were decisive in forcing him to resign in disgrace from the House, and because they delayed the closure of dozens of (mostly Texas) control frauds, they led to billions of dollars in additional costs to the taxpayers.
The indirect consequences were even greater. The Speaker’s support for the control frauds helped elect George Bush to the presidency in 1988. The clumsy
interventions of members of Congress on behalf of the frauds obscured the Reagan- Bush administration’s contributions to the control frauds’ success and the creation of the debacle. Wright’s actions proved critical in causing Gray’s successor to appease Charles Keating. That, in turn, led to the worst failure of a financial institution in U.S.
history, to the S&L debacle becoming a political scandal, to the resignation in disgrace of Gray’s successor, to the termination of the Bank Board, and to an ethics
investigation of the Keating Five by a reluctant Senate. The Speaker’s intervention was a “hinge event” that changed a wide range of policies.
Wright’s actions fit the classic definition of tragedy. He was not an intrinsically evil man or a fool. He did not know initially that the people he was aiding were control frauds. His tragic flaws were ambition and hubris. His driving ambition was to become Speaker of the House, and he had to be a champion fund-raiser in order to achieve it. Wright’s pride and domineering personality led to him to surround himself with yes-men and to disdain warnings.
Studying how the frauds enlisted him to their cause is vital. First, they did it relatively easily. The political system remains vulnerable to similar enlistments, and elected officials should study the case of Jim Wright to learn how to avoid
subornation by future control frauds. Second, Wright’s actions—and the responses by
his colleagues, the Reagan administration, and the regulators—are important to the development of a coherent theory of how elected officials and regulators behave.
Scholars use public-choice theory to devise a “just so” story that purports to explain government officials’ actions after the fact, but public-choice theory could not have predicted the behavior described here. A theory that relies on ad hoc and
contradictory assumptions about behavior is not useful. Studying how government officials act during hinge events is important if scholars are to develop tenable theories.
Since John Barry had the immense good fortune to accompany Wright for months and to all manner of meetings for a behind-the-scenes book on the Speaker, our
ability to understand Wright’s actions is made much easier. Barry wrote a lengthy book, The Ambition and the Power (1989), filled with anecdotes. We are even more fortunate because Barry became a partisan defender of the Speaker. As Barry
emphasizes, the Speaker was comfortable only with yes-men. If Barry had not come to identify so completely with him, the Speaker never would have been so open.
Barry’s book provides the Speaker’s contemporaneous defense of his actions on behalf of the control frauds.1
The House ethics investigation of the Speaker and the Senate ethics investigation of the Keating Five also permit a rich study of the Speaker’s actions on behalf of the Texas control frauds and his later aid to Keating. The Senate investigation immunized Keating’s chief political fixer, Jim Grogan, who set up Keating’s 1988 meeting with Senator Glenn and Speaker Wright and attended the decisive meeting later that day with Bank Board chairman Wall at which Keating, by playing the Speaker card, induced Wall to appease him. Grogan’s testimony about the Speaker is unusually credible because he was, clearly, wholly sympathetic to the Speaker and Keating, yet his testimony damned both.
I participated in the critical 1987 meeting with Speaker Wright and attempted to cope with his interventions on behalf of the Texas control frauds in 1986 and 1987.
This meant that I dealt directly with all of the executive-branch and legislative officials involved. I led the Bank Board’s eventual criticism of the Speaker. This adds to the richness of the case study but adds a risk of bias.
A FRIEND IN NEED IS A FRIEND INDEED
The first irony is that it was a very clever Republican political ploy that made it easy for the Texas control frauds to enlist Jim Wright in their cause. The second irony is that the issues involved had nothing to do with S&Ls. In 1984 the Republicans gained control of the Senate. President Reagan was enormously popular. The Republicans
had been in the minority in the House for the bulk of the last fifty years. Being the minority power in the House is inherently unsatisfying, but the Republicans felt that the Democrats had gone out of their way to make their lives unpleasant. The
Republicans began to believe that a historic realignment was taking shape, one that could restore them to majority control of the House. They were eager to hasten the process.
In 1985 Jim Wright was House majority leader and Thomas “Tip” O’Neill was Speaker. O’Neill was in ill health, and it was clear that he would soon retire. The
Speaker can be the second-most powerful elected official in the United States because House rules place far more power in the Speaker’s hands than the Senate rules vest in the Senate majority leader. Jim Wright would soon be Speaker, and his ambition to be a powerful Speaker was widely known.
The president appointed Representative Sam Hall, who represented a district around 100 miles east of Wright’s, to the federal judiciary. The congressman was a Democrat, so appointing him to the judiciary removed the advantage of incumbency that the Democrats would have otherwise had in that district. When a vacancy occurs in the House, there is a special election to choose a successor. Republicans planned to humiliate Majority Leader Wright in this special election. If he could not get a
Democrat elected in his own backyard, he would not be a credible Speaker. The Republicans hoped to deny him the speakership and publicize the realignment of the country along Republican lines (Jackson 1988, 265; O’Shea 1991, 167–169).
Texas was fertile political ground for the Republicans. Former governor John Connally had switched parties to become a Republican, and the state was becoming more conservative while the Democratic Party was becoming more liberal. The Republican Party and its supporters had far richer coffers than the Democrats, and poured large sums into the special election. In a special election, candidates have less time to develop name recognition with the voters, which maximizes the importance of existing name recognition and expensive political advertising on television (as
Governor Schwarzenegger’s huge victory proves). The Republican candidate was a well-known former collegiate football hero.
The Democrats sought with equal fervor to elect their candidate, Jim Chapman (Jackson 1988, 264–267). Representative Tony Coelho, chairman of the Democratic Congressional Campaign Committee (DCCC), urgently raised funds for Chapman. As Jim O’Shea, the journalist who wrote a book about Vernon Savings, explained, the Chapman election created the “ideal opportunity to curry favor” (1991, 167–169).
Thomas Gaubert seized the opportunity even though he had voted for Reagan in 1980 (Jackson 1988, 263). He was the principal owner of a Texas S&L named Independent
American. He had looted the S&L so badly that it was deeply insolvent, and the Bank Board had removed him from control through a consent agreement. The law
permitted the DCCC to make only a small contribution to Chapman. Gaubert created a single-candidate political action committee (PAC) to fund Chapman’s campaign.
I decided to make a difference. I formed the PAC, I raised the money. I raised every dime that went into the PAC. I called everybody I knew. (Washington Post, May 5, 1988)
Within three months, Gaubert’s PAC raised $100,920. He explained the pitch he used to raise funds:
I don’t know why you’re not involved in their [politician’s] business; they’re involved in our [expletive] business every day…. The donations give you access…. They give you a chance to have a forum when you have a problem. (ibid.)
The S&L insiders who made these PAC contributions were an infamous collection of the worst Texas S&L control frauds, including Don Dixon of Vernon Savings (a Republican), John Harrell of Commodore Savings, and Ed McBirney of Sunbelt Savings (ibid.; O’Shea 1991, 167–169). In his even more graphic pitch to these criminal S&L owners, Gaubert cited his experiences with Bank Board supervision:
Look what the SOB is doing to me and you’re going to be next. If we don’t get the Nazi [expletive] bastards out of here they’re going to destroy the whole industry. (Washington Post, May 5, 1988)
The “SOB,” of course, was Gray. Worse, these S&Ls frequently made illegal campaign contributions by directing their employees to make contributions and then reimbursing them the funds (Jackson 1988, 274–275; O’Shea 1991, 203–207). The same S&Ls gave about $200,000 to the DCCC from early 1985 to mid-1986
(Washington Post, May 5, 1988). Don Dixon explained, “It was the responsibility of Vernon Savings to grease the wheels of political America” (O’Shea 1991, 206). In fact, Gaubert’s entire PAC was probably illegal because it gave far more money to Chapman than permitted, unless it was wholly independent of the DCCC, which it was not (Jackson 1988, 266). Gaubert’s ability to convince so many S&Ls to
contribute to his PAC is particularly impressive given that S&L regulation was not at issue in the special election.
Chapman very narrowly won the election. Wright became the Speaker, and Coelho became the House Democratic Whip thanks to his fund-raising successes. Gaubert, now a hero, became close to both Wright and Coelho. Gaubert and the control frauds had shown great sophistication in their strategy and tactics. He had found a situation that was absolutely critical to the party and to Coelho and Wright personally. He came in at their hour of greatest need and he delivered.
The scariest part of this recruitment was that the control frauds did it for about
$100,000, a pittance. The insolvency of Independent American under Gaubert grew at
the rate of about $1 million every working day, so it took Gaubert only a few minutes to lose a sum equivalent to the $5,000 that Independent American provided to that
$100,000 contribution. My standard joke was that the frauds’ highest return on investment always came from their political contributions.
In addition to helping two prominent and rising politicians at the time of their greatest need, Gaubert’s contributions had four other important effects. The first one is so basic that we tend to forget it. To Jim Wright, these were not control frauds, but legitimate businessmen. The S&Ls and their owners had apparent legitimacy: control fraud is so effective because it hides behind a false front. The contributions aided the Democratic Party, not just individual officials, so the party was now indebted to the Texas control frauds.
The frauds asked nothing in return for their contributions; this is why it was useful that S&L regulation was not at issue in the election. This made it appear that the
contributors belonged to that ideal group, those who support politicians financially because they believe in their policies.
The fourth characteristic was that there were no rival contributions to offset the political debt owed to Gaubert and the control frauds. Political scientists have theorized that political contributions are less influential than the public suspects because they often offset one another. If both the trade association representing the big banks and the rival association representing the small banks contribute to a politician, neither has decisive leverage on issues in which the two groups have
opposing interests. The Bank Board, of course, could not make political contributions.
The control frauds maximized their political leverage, therefore, on issues in which they opposed the Bank Board, and they opposed the Gray Bank Board on everything.
Gaubert’s clever (albeit illegal) tactics defeated the clever Republican ploy designed to prevent Jim Wright from becoming Speaker. Wright and Coelho came out of the special election with increased power and reputations, poised to become the top leaders of the House. Gaubert’s confederation of control frauds made it possible.
What elected official would not be intensely grateful in such circumstances?
THOMAS GAUBERT
Wright and the Democratic Party rewarded Gaubert by appointing him finance chairman of the DCCC; his ambition was to become chairman of the Democratic National Committee (Jackson 1988, 263). Successful presidential candidates traditionally appoint the party chair to the cabinet or a plum ambassadorial post.
The Bank Board had forced Gaubert out of day-to-day control of Independent
American in late 1984. By mid-1985, it was seeking a “removal and prohibition” order to keep him from ever reentering the industry. He knew that the Dallas fraud task
force was planning to indict him. The S&L he owned was deeply insolvent; its new management, appointed by the FHLB-Dallas, was preparing a huge lawsuit against him. He realized that his wealth and his ambitions for higher political office were doomed unless the Bank Board released him from the removal-and-prohibition order and he regained control of Independent American. Gaubert had ample incentive to cultivate political support during the 1985 special election (U.S. House Conduct Committee 1989, 241).
Gaubert was cultivating fertile ground that had already been furrowed. Gray’s proposed rules on growth and direct investments in 1984 had galvanized the control frauds in Texas and California. In 1984 Durward Curlee, a former senior Texas League official, formed a group, comprising the worst Texas S&Ls, to oppose
reregulation (O’Shea 1991, 102, 165–167). The group met monthly to plot its strategy.
Its primary focus was on lobbying the Texas congressional delegation. The Texas delegation was numerous and disproportionately powerful. Senators Phil Gramm (Republican) and Lloyd Bensten and Representative Jim Wright (Democrats) were its leaders. In 1986 Senator Gramm recommended that Curlee be named to the Bank Board (National Thrift News, May 26, 1986). He would have been as disastrous an appointment as Lee Henkel. The fact that the administration appointed Keating’s choice instead of a prominent Republican senator’s candidate indicates how extraordinary Keating’s influence was with the White House.
1986: A YEAR OF CRISIS FOR THE CONTROL FRAUDS AND THE BANK BOARD
By 1986 the control frauds were desperate to remove Gray and reverse his initiatives.
Texas and California control frauds were the most desperate. A series of hammer blows fell on them. The growth rule was beginning to bite. Deprived of growth, the Ponzis would die.
The Bank Board dramatically increased its human resources, particularly in Texas.
The FHLB-Dallas hired more than 100 new examiners, and the Bank Board temporarily reassigned 250 examiners from other districts to Texas.
The Bank Board’s leadership was greatly improved. Adding Joe Selby in Dallas and Mike Patriarca in San Francisco immediately injected vigor into the agency. The FHLBSF had already been a leader in closing problem S&Ls under the leadership of its president James Cirona and its vigorous supervisor, Charles Deardorff; now it targeted the control frauds and took over record numbers of them. Selby faced a far
greater crisis than Patriarca, so it took the FHLB-Dallas much longer to begin removing its control frauds.
Taking over the control frauds, however, required the FSLIC to spend its critically limited funds. By late 1986, the FSLIC had very little money left.
In 1986 the Bank Board and the administration proposed to recapitalize the FSLIC (i.e., give it a loan so it would have more cash to close the control frauds). The
control frauds understood that the FSLIC “recap” would provide the funds to close them down. As Taggart, the former CDSL commissioner, explained in his August 4, 1986, letter urging Donald Regan to fire Gray:
[Gray’s actions] are likely to have a very adverse impact on the ability of our Party to raise needed campaign funds in the upcoming elections. Many who have been very supportive of the Administration are involved with savings and loan associations which are being closed by the FHLBB….
It is felt by many in the industry that the 250 extra federal examiners on temporary duty in Texas are poised awaiting passage of the Recapitalization Bill…. If approved, sufficient funds will then be available to the FSLIC to … close down associations…. It is then anticipated that a substantial number of these “loaned” examiners will be transferred to California…. [T]hose who are typically targeted for removal or takeover are sole shareholder associations … [which] are highly profitable and which have experienced substantial growth over the past three to five years. (U.S. House Banking Committee 1989, 3:630, 634)
The Bank Board was getting far more stringent, i.e., by eliminating most of the creative regulatory accounting principles. The regulators were also receiving
additional powers. The classification-of-assets rule became effective January 1, 1986.
Upon Selby’s arrival in May 1986 through the remainder of that year, the FHLB-Dallas issued over 100 supervisory actions (U.S. House Conduct Committee 1989, 256).
Enforcement actions, liability suits against directors and officers, and criminal investigations were all expanding rapidly.
Texas commercial real estate was in massive oversupply due to several things: the 1981 Tax Act, perverse (e.g., fraudulent) incentives for continuing to make ADC loans in the face of a glut, and the crash of oil prices. Passage of the 1986 Tax Reform Act and the crack down on the Texas S&L control frauds punctured the Texas real estate bubble.
The final straw came when the FHLB-Dallas put the first massive Texas control fraud, Western Savings in Gatesville, into the Management Consignment Program (MCP). It was a $2 billion S&L riddled with fraud, and it eventually cost the taxpayers over $1 billion. It was clear that the new Texas MCP managers, as their counterparts had done with failed California S&Ls, would expose massive losses and pervasive fraud once they took control and removed the insiders. It was equally certain that a wave of criminal referrals and lawsuits would follow. The Texas control frauds had reason to be worried: Dallas, uniquely, had a special financial-fraud task force of 100
professionals created to respond to the wave of frauds.
Texas had more control frauds than any other state. If the FSLIC recap passed, Gray and Selby would destroy the livelihoods and reputations of hundreds of control fraud insiders and defaulting borrowers. Thousands of noncriminal S&L executives also hated Gray. The S&L League reflected its membership’s overwhelming enmity for him. The industry hated reregulation. It was in a panic about stringent supervision by regulators recruited from the Office of the Comptroller of the Currency because of their demonstrated toughness. The industry had fought for over fifty years to prevent the grant of any meaningful discretion to examiners. The classification-of-assets rule now gave examiners substantial discretion. This is the context in which the
administration introduced the FSLIC recap bill.
1986: FSLIC RECAP
A BASTARDIZED PLAN EXPOSES THE BANK BOARD TO EXTORTION
The mechanics of the proposed recapitalization of the FSLIC are complex, and
unnecessary for understanding the struggle over the bill. It is enough to know that the administration placed two absolute constraints on the plan and that those constraints were sure to cause severe problems. First, the Treasury Department would not kick in a penny to help the FSLIC. That was a bedrock administration demand—end of story.
All the money had to come from the industry. Second, not a penny of the money spent could be “scored” for budgetary purposes as a federal expenditure; in other words, the whole plan had to be “off budget.”
The goals were, first, to prevent the S&L crisis from becoming an issue the
Democrats could use in the 1988 presidential election, and, second, to give the FSLIC a modest increase in funds for closing more of the worst control frauds. The FSLIC recap brilliantly accomplished the first goal, but for wholly unforeseen reasons. The idea was to stave off the FSLIC’s collapse. Government accountants were in the process of (properly) declaring the FSLIC insolvent. A nationwide run was still a possibility if the public panicked, and that could have doomed George Bush’s
electoral chances. No one foresaw that the control frauds would hand George Bush a priceless political gift by enlisting Speaker Wright to help kill the FSLIC recap.
The recap failed to achieve the second goal for equally unforeseen reasons. The control frauds and the league combined to prevent passage of the FSLIC recap bill during Gray’s tenure. Gray, therefore, never received any additional funds to close more control frauds. Gray’s successor, Danny Wall, chose not to use the modest