So Friday night, I leave on HBO after a preview of Cowboys and Aliens… Film looks great, but big mistake for not hitting the power button after the preview was over…

Eyes blood shot and in the final sentences of my graduate thesis, I look up. There’s Bill Maher sitting with three guests representing the nation’s political spectrum.

I shake my head when FreedomWorks’ Matt Kippe struggles to explain his Tea Party’s stance on spending prior to TARP. I roll my eyes when Republican Margaret Hoover can’t get any numbers right on the national debt…

And then, the real prize…

Representing the Democrat brand is Eliot Spitzer, a former Wall Street regulator, turned New York Governor, turned john, turned TV host, turned unemployed talking head.

And while defending the President and praising Bill Clinton for leaving a surplus (at the peak of another financial bubble… he leaves that part out), Spitzer blames Bush for the current debt problem…

Of course.

Forget that we’re 30 months into Obama’s first term and $4 trillion deeper in debt.

No… According to Client Number 9, our current crisis is the result of Bush giving America “the deregulatory craziness that led us over the cliff.” My eyebrows rise. I stop typing. I lean in.
Moments later, Spitzer tells the other panelists something even more perplexing… He is an “old school Democrat” because he knows and “believes in facts.”

Irony abounds. The mind reels. Spitzer is rewriting history and fueling the greatest myth of the financial crisis.

Now I’m no Bush apologist, believe me… but W is not responsible for “deregulatory craziness.” And the debate ends quickly when you know the facts and don’t make them up to fit your talking points.

The Web of Myth

Spitzer’s trapped in a myth for two reasons: First, the deregulatory efforts that fueled the financial downturn came in two Acts passed in 1999 and 2000, before George W. Bush entered office. This can’t be disputed because Bill Clinton’s handwriting is on the Financial Services Modernization Act of 1999 (FSMA) and the Commodity Futures Modernization Act of 2000 (CFMA).

Bill Clinton is not George Bush… and George Bush is not Bill Clinton. One is a Democrat, and the other a Republican… One has an affinity for cigars; the other, a preternatural ability to mispronounce words.

Glass-Steagall (The Banking Act of 1933) largely banned proprietary trading by Wall Street banks with only a few exemptions 80 years ago. But the FSMA repealed Glass-Steagall provisions and allowed banks to invest their own money in whatever they wanted: Other banks… risky loans…credit swaps… skulls… probably arms trading… I mean really, who even knows anymore? We’re still finding these things out as we sort the carnage of balance statements.

The CFMA on the other hand guaranteed that the government would not regulate derivatives, those pesky financial instruments that helped sink Lehman Brothers, Bear Stearns, AIG, Citigroup and a slew of hedge funds and financial institutions. That bill was a different monster brought forth by champions of the mid-90s.

In 1997 Clinton’s ex-Treasury secretary, Robert Rubin and super friends Alan Greenspan and Larry Summers, led the charge against Brooksley Born to prevent the Commodities Futures Trading Commission (CFTC) from monitoring derivatives markets. Greenspan eventually won a bitter war of words. Born left the CFTC in 1999, shipped out of Washington on a rail. Meanwhile, as Time magazine put it, Rubin and his team went on to “Save the World” during the Asian and Latin American crises.

So, isn’t it ironic that 10 years later, while Rubin was the Chairman of the Board at Citigroup, the company lost more than $50 billion on subprime derivatives trades? And now Citigroup represents the third largest individual bailout and loan guarantee in U.S. history at $280 billion?

I suppose you have to save the world, before you can destroy it. Still, Rubin went on to pocket $126 million in eight years… which is a fitting, yet average, payday for a former Goldman Sachs Co-chair.
But according to Eliot Spitzer, all of this is the sole fault of George Bush… because… Spitzer needed to set up Maher for a punch line about the Tea Party?

The “deregulation” that put the brick on the pedal on the car on the road that accelerated off the cliff? These Acts were signed by Bill Clinton and had overwhelming support from a bipartisan Congress…
And the argument could end there.

But that’s just part one of the George W. Deregulation myth… It’s the second part where Spitzer really gets it wrong. And here is what is so incredibly bizarre about Democrats constantly claiming that Bush’s deregulatory practices sank the economy.

Prior to the Swiss cheese that is the Dodd-Frank Act, the biggest regulatory effort in 70 years occurred under Bush in the passage of the Sarbanes Oxley Act. Now say what you want about Sarbanes Oxley, and then I’ll go even further. It was a terrible, costly, backward-looking piece of regulation that was designed in haste to reduce illicit accounting practices at public companies… And it failed miserably.

One of the principle problems during the crisis were illicit off-balance accounting practices at Lehman, Bear, and Citigroup (among others), which allowed companies to turn massive debts into report footnotes and shield their derivative exposures and leverage from the markets and their own investors. Sarbanes Oxley should have prevented these practices… but auditors never held companies accountable and the regulation never addressed the off-balance accounting standards that had been a part of nearly every crisis dating back to the early 1990s.

But failure or not, Sarbanes Oxley was not a “deregulatory effort.” In fact, SOX and Eliot Spitzer himself were the two greatest agents of Wall Street regulation since Roosevelt.

Before Eliot Spitzer became New York’s 54th governor, he was Eliot Spitzer, Attorney General and Sheriff of Wall Street. He himself was a part of the biggest litigation effort in the nation’s financial history, so his argument is dismissed by his own actions. Spitzer made a name for himself by tackling Wall Street firms under the 1921 Martin Act. This antifraud statute is so ambiguous that the state government didn’t even require Spitzer to demonstrate criminal intent before investigating stock inflation schemes. Anyone was guilty before being investigated.

Spitzer rose to fame as an aggressive regulatory champion, one who legally bludgeoned costly settlements out of numerous firms and shelled stock prices in the process. Specifically, he targeted Wall Street’s bread-and-butter business of underwriting initial public offerings. There was a craze of those in the Dotcom Era, right around the time that Bill Clinton was giving America those surpluses. But Spitzer’s efforts years later, combined with SOX, has made it far less enterprising and far more expensive to underwrite IPOs…

And as a result, we’ve had fewer IPOs than in the pre-Bush years on the backs of these efforts. Still neither can be called “deregulation.”

The only time during Bush’s tenure that we can actually say markets were “deregulated” was in 2004 when the SEC lifted the cap on how much leverage a bank can use. At the time, the SEC was being run by William Donaldson, a former Nixon adviser who is actually older than the Security Exchange Commission itself…

Though people blame Bush for his SEC’s decision, and it is damning, that’s practically impossible because no one at the SEC has had any clue what they doing for 80 years… Plus, the person who earns the most blame, according to Dylan Rattigan of all people, is Henry Paulson for leading efforts to make this possible for a decade…

But while SOX and Spitzer took an axe to the Wall Street IPO engine and drove off business to London, Spitzer’s actions and government intervention diverted Wall Street capital from stocks to the housing sector.

But deregulation hasn’t been the housing market’s problem in the past decade and a half. It’s been overregulated toward damn near centralized planning. Three decades of government tinkering (Fannie and Freddie, the Community Reinvestment Act, Tax Subsidies for Second Mortgages) placed incredible pressures and perverse incentives on lenders to reduce loan standards and increase credit availability.

But make that factual argument and Barney Frank will step out of an alternative universe and brand you a liar… In a Democrat’s world, this is the fault of Bush’s deregulatory blood lust.

I’m not even sure if Spitzer or half the people who voted for any of these bills know what “deregulation” actually means anymore. Deregulation should be defined as the elimination of government barriers to entry in a sector… not forcing banks to make loans through wishful social engineering. The Bush Administration, if anything, helped fueled government stimulation in the housing markets.

And what’s worse, the Obama administration recently pushed initiatives to drive increased lending to under-qualified buyers… again. What is the definition of insanity, by the way?

The new administration that blames Bush for deregulation doesn’t see the lesson from government involvement in the private housing sector… It thinks government can fix this… it’s doubling down on failed policies.

I’ve spent three years of my life investigating the root causes of this financial crisis. A Lexus worth of student loans says that I’m not here just trying to get a degree because I’m a glutton for academia… When the world melted down around me in New York in 2008, I had no clue what had happened. So I checked into grad school and wrapped my head around the past 20 years of this economic drama … Tonight, I’m submitting my thesis on the impacts of the housing crisis on public policy and corporate leadership.

My research dates all the way back to the New Community Reinvestment Act of 1995 and the Taxpayer Relief Act of 1997… Two more faulty, centralized initiatives under President Clinton that helped fuel Wall Street speculation while two other bills predating Bush deregulated the behavior of banks… The 2004 increase in leverage standards was the final gallon of gas on a bonfire built in the Clinton years as a strong wind created by crippled IPO operations and government mandates stoked the flames of crisis…

So, if I get anything out of this experience, let it be that I can tell you with full confidence that “Bush is responsible for this deregulatory craziness” is the most inaccurate thing I’ve heard out of a former politician’s mouth since… well… Friday morning.

But, then again… I’m not on TV, and Spitzer is. So his version will live on… Why let facts get in the way of a successful talking point?

Regards,

Garrett Baldwin
for Whiskey & Gunpowder

Client Number 9 And The Myth of Deregulation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Let’s recall the olden days of electric power, for example. Your local utility company probably ran the whole show by virtue of a government-granted license. In other words, the utility company was a monopoly, but it also had the obligation to serve every entity that required its services. (At the consumer and customer end of things, the final demand for power is called the "load.")

Under that arrangement, the local electric utility owned and operated the generating station just outside of town, or certainly within the region where you lived, and it owned and maintained the transmission towers that led from the powerhouses to the load. That utility company also owned the substations where the high-voltage power was stepped down into the street grid, of which it owned the poles and wires. And your friendly local electric utility company probably even owned the usage meter on the side of your house.

There was also a state regulatory agency, probably called the "Public Utilities Commission" or something similar. The PUC reviewed whatever documents the well-connected attorneys for the utility company placed before it, and almost always rubberstamped whatever the utility company requested.

Thus did the PUC set the rates you were charged, according to the revenue needs of the utility company. And really, when you think back, about the only part of the electric grid over which you had any individual say may have been the wiring inside your home (subject to the local electric code, of course) and the wattage of the light bulb in your bedroom.

Things Have Changed

Things are certainly different now, aren’t they? If you live in or near a major urban market area, you probably receive frequent notices in the mail containing offers from companies of which you have never heard offering to sell you utility services such as "renewable" electricity. If you have read your local newspaper business section over the years, you have probably noticed that the utility company has sold its generating stations to some third party, again a firm of which you have never heard. And you may have seen that the utility company has sold the transmission towers to some other entity whose name you cannot recognize. The local utility may still maintain the street grid, but then again, maybe not. Every month, you may still receive a bill from the old utility company. But your bill probably contains all sorts of charges broken out for fuel or basic generating costs, plus transmission, and perhaps a "delivery" charge payable to companies with strange names, as well as a myriad of taxes and local fees. What is going on?

Welcome to Deregulation and Competition

Welcome to the world of free market energy competition. This intellectual paradigm took root in U.S. public policy in a big way in the late 1970s. One of the leading lights of this movement was the economist Alfred Kahn of Cornell University, who earned his stripes as chairman of the New York Public Service Commission (New York’s PUC), and later as chairman of the federal Civil Aeronautics Board in 1977-1978 under President Jimmy Carter. It was Commissioner Kahn who set a national example with airline deregulation and increased competition with his efforts to deregulate airlines.

Deregulation is a political process in which the government removes or simplifies restrictions on businesses in order to encourage increased efficiency in the operation of market mechanisms. In other words, goes the rationale, deregulation means that fewer and simpler regulations will yield an increased level of competitiveness, with higher productivity, more efficiency and overall lower prices. Deregulation is not a uniquely American idea, by the way. During the past three decades, the concept has been applied, with varying degrees of success, in nations as diverse as Australia and Japan, the United Kingdom and Argentina, the European Union and even post-Soviet Russia.

Alfred Kahn’s initial focus on airline deregulation spread to other parts of the economy as well, particularly in the realm of transportation, such as railroads and motor freight trucking. The initial results were that under deregulation, literally hundreds of railroads and many thousands of trucking companies either went out of business or were forced by circumstances to combine with other firms via bankruptcy, asset sales and other forms of merger. And the results also included a large number of new entrants to the marketplace, to include companies like Federal Express (now FedEx), whose ubiquitous trucks would never have seen the light of day under the old, heavily regulated transportation system.

Living in a Different World

To make a long story short, by the 1990s, deregulation was occurring in the arenas of utility services, as well. This is when the old-time utility companies began to transform by selling off assets such as generating plants, transmission lines, wholesale distribution networks and even the "final mile" of distribution wires, if not the meter on the side of your house. If the name on your local utility bill looks like the familiar one with which you grew up, it may well be because some third party bought the right to use that name. From the standpoint of who owns what, you are now living in a different world.

I am using the story of deregulation in general, and what has happened to your old and faithful electric utility company in particular, to illustrate the point of how much and how dramatically things have changed on the other side of the light switch. I could tell a somewhat similar story about your natural gas utility, or the water utility company. Most people do not know or appreciate the scope of this change, and I want to use this discussion to lay some foundation that leads into the remainder of this article. This major transformation in the structure of the energy markets in the U.S., courtesy of the deregulation philosophy and the associated decoupling of different phases of generation, transmission and distribution to load, gives us at Outstanding Investments an opportunity that I will present later on.

Transmission and Transportation

In the energy delivery industry, and certainly in the electricity and natural gas sectors, the transmission system has become a critical market-enabling mechanism. That is, transmission functions in much the same way as the interstate highway system, if not as those oceangoing freighter ships that bring foreign-made goods to U.S. shores.

Think about that last analogy of the oceangoing ships. What makes a factory in China truly competitive with a factory in the U.S. that can make a similar product? Does a Chinese injection mold operator have a better education than an American injection mold operator? Maybe not, but then again, consider how much TV the American worker has probably watched over the years. Or is it those proverbial "Every Day Low" sweatshop wages that they pay in China? OK, we are getting closer to an answer. Or perhaps it is because the Chinese factory spews a toxic brew into the adjacent air and water, in such a manner that would get the U.S. factory padlocked and its managers frog walked by the bunny cops down to the local jailhouse. Yes, of course, this matters in the broad scheme of things.

These Chinese competitive advantages, and many more that you could recite, do matter to one degree or another. But my view is that what truly makes Chinese factories competitive is the ability to transport the goods so cheaply across the Pacific Ocean, in containers that are then rapidly unloaded and shipped, via "deregulated" rail and truck, almost to the point of sale. Cheap transport effectively puts the factory in China right next to the factory in the U.S.

Transmission and Corridors

It is the same thing with energy transmission as with oceangoing transportation. A well-managed transmission system is the key to enabling robust and competitive energy markets that offer customers choice, savings and related benefits.

Do you recall how we began this article? We looked back to the olden days when the utility company owned the power plant just outside of town. This is probably no longer the case where you live. So do you really know from where comes your electricity?

If you live in California, some of your electricity may come from New Mexico, if not British Columbia. If you live in Ohio, some of your electricity may come from Ontario, or even Quebec. If you live in New Jersey, some of your electricity may come from a plant in western Maryland. Or consider that one of the largest generators of wind-powered electricity in the U.S., for example, is Florida Power and Light, and many of its windmills are located in – are you ready? – North Dakota. Last time I looked, Florida is a long way from North Dakota.

What makes this all possible is the creation of long-distance transmission corridors, over which electric power is moved, or "wheeled," from one region to another. No, the North Dakota electricity does not go all the way to Florida. But the North Dakota electricity might go to Illinois, and electricity from Illinois might go to Alabama, and electricity from Alabama might power homes in Florida. How do you calculate the electricity rates for Florida consumers, and who should get paid how much at each step of the way along the transmission corridor? It gets complicated in a hurry.

And why is FPL building windmills in North Dakota? For starters, it is just too hard to build new power plants in Florida, both despite and because of the fast-growing population, which adds more load and demands more and more electricity each year. Think about it. What community in Florida wants a new large power plant with a tall stack and thousands of rail cars passing by, hauling coal to the facility? And what electricity consumers in Florida want to pay what it costs to run a natural gas-fired power turbine just to generate base load electricity? "Not in my backyard," goes the cry.

Or consider what happens to aging power plants, such as the pulverized coal units with the 600-foot-tall smokestacks of the old-fashioned utility company, when these industrial behemoths are ready for retirement. Can anyone, even the local electric utility company, consider replacing an older plant if it is located near an urban or near-suburban core? As a rule, many among the locals cannot wait to hear that some plant operator wants to decommission an old coal-burner near the city. "Goodbye and good riddance" is the typical sentiment. And nobody wants a new power plant to get built nearby, either, so the tendency is for power generators is to construct new generating facilities out in rural areas far from the urban NIMBYs and their lawsuits.

But developing energy facilities far from load centers requires construction of transmission lines over transmission corridors. Whether it is a new, higher-tech version of the old coal-burner or windmills out on the High Plains (or maybe even a new nuclear plant, one of these days), the problem of transmitting that power along a new transmission corridor from generation site to place of load is instantly presented. And just to add another layer of perplexity to the process, which comes first – building the generation or building the transmission? If you thought that building a new power plant in any one location was tough going, just try building a transmission line that crosses many jurisdictions, each filled with its local species of NIMBYs.

In the arena of renewable energy sources, one critical issue for wind farm construction is that installed capacity in some regions is outstripping producers’ ability to move the wind power from relatively remote areas to load centers in other areas. This affects market prices in a significant way, because the cost of installing and upgrading transmission lines to deliver the generation must be factored into the final consumer price.

Transmission constraints in West Texas, for example, have negatively impacted operations of numerous wind farms in that area. Thus, wind power generation in that region has been routinely curtailed to prevent overloading the local transmission system. This has resulted in losses of many millions of dollars per year of electric power sales. Texas generators and regulators are addressing the situation by upgrading existing facilities and constructing additional transmission facilities for high-voltage power.

Looking for Solutions

New Mexico has similar problems and has recently adopted its own solution. That state enacted legislation that will create the New Mexico Renewable Energy Transmission Authority, a quasi-governmental agency that will plan, finance, acquire and build power lines and energy storage projects. The Authority will have power to designate transmission corridors and to negotiate with other entities on the establishment of interstate corridors. It will be able to use eminent domain authority to help get projects built.

Another state, Wyoming, also has a transmission authority that likewise is intended to help transmit and export electricity produced by state’s energy resources.

The Role of Transmission

The points to keep in mind are that transmission is a critical link, and, in fact, may well be THE critical link, to enable competition between local and distant producers.

Now, can we make some money out of this? In the next article, we will apply some of these principles to growing our principal.

Until we meet again…
Byron W. King

April 13, 2007

Corridors of Power was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.