Ted Cruz just named Phil Gramm his economic advisor. Here’s Gramm’s economic legacy.

If it's true that a man can be judged by the company he keeps, what are we to make of the appointment of former Sen. Phil Gramm as economic advisor to the presidential campaign of Ted Cruz?

The short answer is that they're cut very much from the same economic cloth, which makes sense if one is advising the other. Here's a longer answer.

Cruz made the appointment Friday, when he collected Gramm's endorsement of his quest for the presidency. He cited Gramm's role as an opponent of the healthcare reform measures proposed in the 1990s by President Bill Clinton, as well as Gramm's record as a professor of economics at Texas A&M University before becoming a U.S. representative in 1979 and moving up to the Senate in 1985. He retired from Congress in 2002.

The distinguishing feature of Gramm's career in public service is hostility to regulation in almost every form. "Gramm, with his Southerner's mistrust of big government, believes that markets, left to their own devices, eventually will find the most efficient way of bringing together buyers and sellers," wrote former Securities and Exchange Chairman Arthur Levitt in his memoir, "Take on the Street." "'Unless the waters are crimson with the blood of investors,' he exclaimed in one meeting, with a finger in my chest, 'I don't want you embarking on any regulatory flights of fancy.'" 

Gramm left a long record as a dedicated financial deregulator on Capitol Hill, with much of his effort aimed at freeing up trading in derivatives. That's why he's often identified as one of the godfathers of the 2008 financial crisis, which was spurred in part by banks' imprudent trading and investing in these extremely complex financial instruments.

Gramm's previous stint as a presidential campaign advisor ended inauspiciously. That was in 2008, when he served as co-chairman of John McCain's presidential run. 

Gramm's most notable moment in that position came on July 10, 2008, when he dismissed the developing economic crisis as "a mental recession" in an interview -- and video -- released by the conservative Washington Times. "We've never been more dominant," he said. "We've never had more natural advantages than we have today. We've sort of become a nation of whiners." McCain immediately disavowed the remarks, and a few days later Gramm stepped down as his campaign co-chairman.

Gramm's remarks bristle with irony. In the first place, his sunny outlook then contrasts sharply with the frighteningly gloomy depiction of America's condition today that is a core feature of the Cruz campaign. That's even more striking, given that Gramm's reassuring assessment came just as the economic crisis was heating up. The investment bank Bear Stearns had failed just three months before, and the collapse of Lehman Bros,. which set off the crisis in earnest, would occur two months almost to the day after the interview was published -- not a terrific testament to Gramm's economic perspicacity.

Gramm played a key role in legislation that expanded the influence of the Commodity Futures Trading Commission over the objections and at the expense of the Securities and Exchange Commission when his wife, Wendy Lee Gramm, was the CFTC chair, a position she held from 1988 to 1993. Toward the end of her tenure, the agency exempted Enron's energy-swap derivatives from regulation. According to the watchdog group Public Citizen, her husband was one of the leading recipients of Enron campaign contributions in Congress, having collected nearly $100,000 since 1989. Five weeks after leaving the CFTC, Public Citizen reported, she joined the board of Enron, which paid her between $915,000 and $1.85 million in compensation from 1993 to 2001, when the company collapsed.

Enron was a beneficiary of measures Phil Gramm pushed at the Senate, where he served as chairman of the Senate Banking Committee in 1999-2001. The most important such measure was the Commodity Futures Modernization Act of 2000, which ensured that over-the-counter, or OTC, financial derivatives would remain almost entirely unregulated and which was signed into law by President Bill Clinton in December 2000, just before he left the White House.

The instruments' potential for disaster was well understood by some regulators, notably Brooksley Born, who had been appointed CFTC chair in 1996 by Clinton. Born produced a recommendation to bring the instruments under her agency's oversight, but it was shot down by SEC Chairman Arthur Levitt, Treasury Secretary Robert Rubin, and Federal Reserve Chairman Alan Greenspan.

Gramm, among others in Congress, was determined to make sure no regulation was possible. With Sen. Richard Lugar (R-Ind.) and Rep. Thomas Ewing (R-Ill.), he introduced the CFMA. It sailed through the House and then ran into a roadblock in the Senate: Phil Gramm, who demanded that its deregulatory provisions be strengthened. The bill stalled but resurfaced after the 2000 presidential election -- this time bearing what became known as the "Enron loophole," which effectively exempted Enron's energy trading from regulation. 

Thanks to the 2000 act, according to 2010 congressional testimony by Michael Greenberger of the University of Maryland law school, the "multi-trillion-dollar OTC derivatives market was removed from almost all pertinent federal and state enforcement to which trading markets had been subject since the New Deal.... In effect, almost no law applied to this market."

What was the harvest? "It is now almost universally accepted," Greenberger said, that the unregulated derivatives market "helped foment a mortgage crisis, then a credit crisis, and finally a 'once-in-a-century' systemic financial crisis."

In op-ed columns for the Wall Street Journal and other public statements, Gramm has condemned the Dodd-Frank Act for producing a "failed recovery" in banking and advocated giving every American "the right to decide not to participate in Obamacare," which of course would destroy the Affordable Care Act. These positions show Gramm's intellectual compatibility with Cruz, and there's nothing particularly wrong or illegal about them. Though it's hard to avoid thinking that many investors might hope that government would step in as their protector well before their blood is running in the waters.

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