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John McCain's Presidential Campaign and the Keating Five: A Fresh Look at a Dead Scandal

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In 1989 John McCain's political career was in jeopardy as his popularity plummeted during the course of the Senate Ethics Committee investigation into his meeting with bank regulators on behalf of Charles Keating, an icon of the Savings & Loan scandal whose corrupt business practices cost American taxpayers an estimated $2.6 billion.  McCain emerged unscathed from the investigation, and is now competing for the presidency with an advertisement campaign that portrays him as a GOP maverick who is tough on Wall Street, and committed to divorcing private interests from politics.  

John McCain chided Barack Obama for breaking a promise by opting out of public campaign financing in the primaries, however, decided a short time later to do the same to remain competitive in the presidential race.  As private donations flood into the McCain campaign, the influences donors have had on McCain's policies have already raised eyebrows.  The banking, and real estate industry have spent lavish amounts on the McCain campaign, and connections of donors to the sub-prime mortgage crisis are widespread.  

The Senate Ethics Committee exonerated John McCain in 1991 from any wrongdoing in the Keating affair; however, he was found to have practiced questionable judgment.  Did John McCain learn a lesson from his involvement in the Savings & Loan debacle to become the anti-corruption stalwart that his campaign portrays him to be?  Or does John McCain still practice questionable judgment when it comes to his campaign contributors, and, if so, what could this mean for the U.S. economy?

The Savings & Loan debacle of the 1980s was one of the worst economic crises in the country's history; it caused the recession of the early -90s, an enormous deficit in the federal budget, and cost taxpayers an estimated $300 billion.  The deregulation of the banking industry in the early 1980s allowed financial institutions to use federally insured deposits for previously prohibited high-risk investments.  Loopholes created by deregulation were manipulated by loosely knit networks of industry high-flyers who used their savings and loans as personal piggy banks, and left taxpayers responsible for paying back the depositors.  Bank regulators found that the majority of thrift failures in the S&L debacle, over 1,000 institutions, were the direct result of management misconduct, insider abuse, and outright fraud.

A key factor that contributed to the Savings & Loan debacle was political interference with bank regulators whose recommended actions against troubled institutions were consistently ignored.  Corrupt S&L executives were frequent contributors to political campaigns, and used their political influence to stall the efforts of regulators, and continue their operations despite insolvency, which dramatically increased the cost of the eventual bailout.  Charles Keating was a prominent figure in the S&L debacle.  His CA based Lincoln S&L utilized banking techniques that were common throughout thrifts involved in the S&L debacle.  The scandal that was coined the Keating 5 was emblematic of the political pressure that prevented bank examiners from doing their job, and exacerbated the crisis to monumental proportions.

Charles Keating was the founder of the Cincinnati, OH law firm Keating, Muething and Klekamp, which handled security work for Marvin Warner, and Home State Savings, responsible for another costly securities fraud case in the S&L debacle.  In 1972, he left law to work for Carl Linder's conglomerate, American Financial Corporation, and, in 1976, moved to Phoenix, AZ, and bought the homebuilding division of Linder's empire, which he renamed American Continental Corporation.  In 1984, he bought the CA based Lincoln Savings & Loan, and within 3 years involved the thrift with large investments in junk bonds, real estate projects, and other high risk ventures that benefited the American Continental Corporation.  In 1986, San Francisco bank examiners noticed serious discrepancies in the financial records of Lincoln S&L.  The political strings Charles Keating pulled in an effort to prevent a serious investigation resulted in the Keating 5 scandal.         
Charles Keating was a large donor to political campaigns, and supported over 36 state and national candidates in their run for public office.  He frequently used his political connections to influence legislation, and to prevent the Bank Board from adopting regulations that would harm his assets.  In March 1987, Senators John McCain (R-AZ), Dennis DeConcini (D-AZ), Alan Cranston (D-CA), and John Glenn (D-OH), all benefactors of Keating's campaign contributions, held a highly unusual meeting in DeConcini's office with the Chairman of the Bank Board, Edwin Gray, to inquire about the bank examination of Lincoln S&L.  

Edwin Gray recounted in an interview for The Big Fix by James Ring Adams that the Senators offered to help him with his concern that Lincoln wasn't making enough home loans if he removed a proposed Bank Board regulation that would limit loans on undeveloped land, which Keating had a large investment in.  The offer confused Gray who had avoided direct involvement with Lincoln, and he referred the Senators to the examiners from the San Francisco Home Loan Bank who were in charge of the investigation.  The Senators, joined by Donald Riegle (D-MI) to become the Keating 5, met with bank examiners in April to grill them about their investigation into Lincoln S&L.  The meeting ended when bank regulators made clear that Lincoln's financial problems were beyond repair, and a criminal referral was being sent to the Justice Department.

In 1987, shortly after the meeting with the Senators, the examiners concluded their investigation, and sent their recommendation to the Bank Board that Lincoln S&L be placed in receivership.  However, for two years the recommendations of the examiners, and their criminal referral disappeared.  The thrift continued to operate with enormous losses.  The Bank Board finally took over Lincoln S&L in 1989; by that time the cost of the bailout had increased to $2.6 billion.  Charles Keating was later indicted, and, in 1993, was convicted on 73 counts of racketeering and fraud, which carried a maximum penalty of 505 years.  In 1996, Keating was granted a retrial, but opted instead for a plea bargain where most charges were dropped, and Keating was released for time already served.  He spent a total of 4 years in prison.

The Senate Ethics Committee launched their investigation into allegations that the Keating 5 interfered with bank regulators in exchange for political contributions, in 1989, as Lincoln's collapse hit the press.  John McCain received a total of $112,000 in campaign contributions from Charles Keating between 1981-7, which helped him secure 2 terms in the House of Representatives, and a Senate seat in 1986.  He, also, reportedly vacationed with Keating in the Bahamas.  However, the Committee's special counsel recommended that charges against McCain be dismissed, because his meeting with bank regulators did not directly correlate to political contributions, and he did not pursue the matter after the April '87 meeting.  

The Committee stated that McCain had practiced questionable judgment, however, exonerated him from any official wrongdoing, and focused instead on the actions of Senator Alan Cranston whose lobbying work for Charles Keating was directly linked to campaign contributions.  The Senate Ethics Committee investigation lasted two years, and was widely criticized for stalling in taking action against Cranston.  Many were pushing for the case against Cranston to be brought to the Senate for censure, a public show of disapproval on the Senate floor for a colleague's misconduct.  However, Cranston vigorously defended his actions as no different than other members of Congress, and threatened to reopen the case against the 4 exonerated members of the Keating 5 if he was subjected to a censure.  He was issued a formal reprimand in 1991, a less severe action.

The parallels between the sub-prime mortgage crises and the S&L scandal are unsettling, and involve many of the same accounting techniques, which have resulted in numerous fraud cases in the real estate and mortgage industry.  Reports have yet to surface about political interference with investigations into lending institutions involved in the sub-prime crisis.  However, with cases like SEC investigator Gary Aguirre who was abruptly fired when he tried to act on an alleged insider trading scam that involved Pequot Capital, and a top executive at Morgan Stanley, it can be expected as a common practice on Capital Hill.  Given some of the connections John McCain's campaign contributors have to the sub-prime mortgage crisis, questions should be raised about the level of political influence John McCain would feel it appropriate to exert for his supporters if he was elected to the top position in the executive branch.  

The collapse of Bear Stearns, one of the largest global investment banks, and securities and brokerage firms, was due to the total loss of value in two sub-prime mortgage hedge funds.  In an effort to avoid the market crash that would result if Bear Stearns was declared insolvent, the Federal Reserve, with help from the Treasury Department, issued an emergency loan to Bear Stearns, and arranged for its merger with JPMorgan Chase.  Experts in the industry maintain that Bear Stearns collapse was more a result of rumors about liquidity problems than an unfixable financial situation.  However, Bear Stearns was subjected to numerous class action lawsuits that charged the firm had committed fraud.  The SEC settled their fraud charges with Bear Stearns; however, two managers of the collapsed hedge funds were indicted on 9 counts of conspiracy and fraud.

Thomas M. Flexner was a Senior Manager, and Vice Chairman of Bear Stearns.  He oversaw the bank's commercial real-estate activities, and led the Financial Buyers Group, which provided special financing, and advice on buyouts, and private equity funds.  He was, also, an avid political contributor while at Bear Stearns, and spent over $100,000 of his personal funds in campaign contributions since 2000, and was a bundler for Chris Dodd (D-CT), Chairman of the Senate Committee on Banking, Housing, and Urban Affairs.  In addition to generous donations to the Democratic National Committee, and the campaigns of Hillary Clinton, and Barack Obama, Flexner has donated the maximum amount possible to John McCain's campaign in the primaries, and for the presidency.  Flexner emerged unscathed by the collapse of Bear Stearns, and allegations of fraud, and now serves as the Global Head of Real Estate for Citi Institutional Clients Group where he is responsible for their commercial real estate activity, including investment and finance.           

McCain was forced to distance himself from his former campaign co-chairman, and chief economic advisor, former Senator Phil Gramm, due to his calloused remarks about the sub-prime mortgage crisis that many claim he had a direct role in creating.  The sub-prime market crisis has been linked to the Gramm-Leach-Bliley Act of 1999, legislation sponsored by Gramm, which repealed provisions in the Glass-Steagall Act, enacted in the midst of the Great Depression, that paved the way for the formation of major financial conglomerates of banks, security firms, and insurance companies.  Phil Gramm was the Chairman of the Senate Committee on Banking, Housing, and Urban Affairs until he left the Senate in 2002. He has gone on to serve as the Vice Chairman of the Swiss investment bank, UBS, and in 2008 disclosed that he worked as a lobbyist for UBS, and attempted to influence legislation related to the sub-prime mortgage crisis while he simultaneously worked on McCain's campaign.  

Gramm formerly resigned from the campaign in July, 2 months after the McCain campaign's public purge of staff with conflicts of interest, however, his economic advice remains influential. In a Sept. 14 Washington Post article with the headline "A Nation of Exaggerators"-, one of McCain's current economic advisers, Donald Luskin, stated that he agreed with Gramm's "mental recession"- comment, and felt that the gloomy outlook even McCain has adopted is uncalled for. Despite McCain's staff shake-up in May, his campaign is still riddled with staff who have lobbied on behalf of financial institutions  connected to the sub-prime mortgage crisis. McCain's campaign manager, Rick Davis, responsible for drafting the campaign's conflict of interest policy, made headlines in mid Sept. for the continued monthly fee of $15,000 mortgage giant Freddie Mac paid to his lobbying firm Davis Manafort Inc. Newsweek reported that Davis had personally approached Freddie Mac in 2006 to arrange for a new consulting agreement that would allow payments to his firm to continue. Deputy Campaign Manager, Christian Ferry, is, also, a consultant for Davis Manafort.        
John McCain's political career was saved when he was exonerated from any wrongdoing at the end of the Senate Ethics Committee investigation into the Keating 5 affair.  McCain maintained during the investigation that he met with bank regulators to inquire about a complaint that was being made by a major employer of his constituency. He maintained that he did not attempt to do any favors, or anything otherwise inappropriate, for Charles Keating, and that his actions were consistent with his responsibilities as a Senator. However, the Senate Ethics Committee found that McCain had practiced questionable judgment in participating in the meetings.  

As the sub-prime mortgage crisis continues to unfold, one has to ask whether John McCain's questionable judgment will persist. Will John McCain, as Commander in Chief, be able to distinguish between appropriate and inappropriate actions that are done on behalf of campaign contributors? In March 2008, John McCain made headlines, and distinguished himself from his Democratic contenders, by stating that he would reject U.S. aid as an option for dealing with the mortgage crisis. However, in early Sept., John McCain voiced his support for the bailout legislation of mortgage giants Freddie Mac and Fannie Mae as an unfortunate, but necessary step. The legislation saved the firms, and allowed them to continue to operate by issuing them a still to be determined credit line funded by taxpayers that will serve as a liquidity backdrop to prevent insolvency. Is this an early indication that McCain is willing to do political favors for an industry that is supporting his run for presidency? If so, what will the cost be this time?  


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