Eagle on the Street

by Coll, Steve; Vise, David A. ;

  As the SEC’s chief economist, Jarrell was working feverishly to develop studies “proving” that the fears Shad had expressed in his landmark “Leveraging of America” speech were unfounded. Shad had departed from his previous public statements and sounded warnings about the potentially disastrous long-term consequences of debt-driven corporate takeovers. Since then, during meetings in Shad’s office, in the commission’s hallways, and at every available opportunity, Jarrell had pushed the SEC chairman to rethink the views he expressed in New York—views Jarrell had characterized as “B.S.” when he marked up an early draft of Shad’s speech with a red pen. It wasn’t clear how deep Shad’s skepticism about takeovers ran, since the merger boom in 1984 was providing clear benefits to stockholders, the group Shad saw as the commission’s most important constituency. Indeed, takeovers had been a driving force behind the great bull market in stocks that in little more than two years had taken the Dow Jones Industrial Average from the high 700s to more than 1,200, an increase of more than 425 points and more than $400 million in stock market value. Still, that studies from the SEC chief economist’s office supporting Jarrell’s position on the takeover issue suddenly appeared prominently in the press did not, under the circumstances, seem a deep mystery.

  And then Jarrell was exposed. Not long after Shad’s June speech, Jarrell leaked to a reporter from Barron’s an advance copy of a confidential SEC study he had drafted demonstrating that greenmail, the antitakeover tactic of buying off corporate raiders by paying them premiums for the stock they owned, was actually good for shareholders. The reporter had promised Jarrell anonymity, but on a Friday night, as Barron’s went to press, she called him with what Jarrell later characterized as “a big sob story about how her editor made her identify me.” Jarrell had leaked the reporter a rough and aggressively worded draft of his study, which she used to prepare her story. Then he spent all weekend polishing a new version that toned down his conclusions and included lots of “wiggle words,” as Jarrell referred to moderate, qualified language.

  After he saw the Barron’s article, Shad tore into Jarrell at SEC headquarters on Monday morning. “We don’t do these sorts of things here,” the chairman said in an intimidating baritone.

  “It’s much easier to beg for forgiveness than ask for permission,” Jarrell answered.

  “That works once,” Shad said, and turned on his heel.

  But Jarrell, determined to play a role in preventing any possible SEC action that might restrict corporate takeovers, couldn’t help himself. The leaks continued, one after another, and often they were poorly disguised. “I had to deny, deny, deny that I had leaked my studies,” Jarrell admitted later, but even after Shad caught him again, he kept on. Shad treated his chief economist the way an indulgent, curmudgeonly uncle might treat a wayward but promising nephew; he was always willing to give him one more chance.

  Shad’s indulgence seemed in defiance of logic to Jarrell’s rivals among the senior SEC staff. They didn’t share the chairman’s concern that it would be difficult to hire a new chief economist if Jarrell were fired, and it seemed to them that Jarrell got away with things that no one else at the commission could hope to try—including, for example, his friendship with corporate raider Boone Pickens. Jarrell even attacked his colleagues publicly, a common-enough practice in Washington, but virtually unheard of at the SEC. Once Jarrell gave an on-the-record interview to the Wall Street Journal, attacking the decisions of Clarence Sampson, who headed the SEC’s office of the chief accountant, in a matter involving changes in oil-industry accounting. When the story was published, there was an outcry in Washington—Shad felt pressure from several quarters of the capital, including from the Secretary of the Interior.

  “Why did you have to leak it?” Shad asked Jarrell when he angrily called him to his office.

  “Well, at least I didn’t pose as an unofficial source and try to hide behind some shield of anonymity,” Jarrell answered, disregarding the fact that anonymity was his usual tactic when he leaked to reporters.

  “Yeah, well, that’s just stupid,” Shad said.

  That afternoon Jarrell drove off to Delaware, where he had grown up in the small capital city of Dover, and where his parents still lived. What he didn’t know was that the Journal reporter to whom he had given the original interview denouncing Sampson had decided to write two stories. The next day another story appeared, and Jarrell was again quoted prominently, still criticizing his colleagues at the SEC. He was in the front yard of his parents’ house when his sister appeared on the doorstep.

  “Gregg, you have a phone call—do you know a guy named Chad?”

  “I might have your office cleared out,” Shad said when Jarrell got on the phone. “What am I going to do to get you to understand?”

  “Sir, there is an explanation.”

  “Well, I am just giddy with anticipation.”

  When Jarrell told him that the reporter had made two stories out of one interview, Shad seem unimpressed. The chairman was fuming when he hung up—but he said nothing more about cleaning out Jarrell’s office.

  Jarrell had figured from the beginning, when he first accepted the position of chief economist at the SEC, that there was a good chance he would be fired for breaking the rules. That didn’t bother him. In some ways, getting fired was the easy way out.

  If Shad had decided to let him go, the SEC chairman would have confirmed for Jarrell the wisdom of Milton Friedman and George J. Stigler, the Nobel Prize recipients who were the intellectual and spiritual leaders of the University of Chicago’s graduate-school program in economics, where Jarrell studied during the 1970s and early 1980s. Jarrell’s career prospects at the SEC had been the topic of several discussions at the famous (among conservative intellectuals) Thursday lunch group, where Friedman and Stigler led a savage roundtable exchange with their graduate students about the political, social, and economic policy implications of Chicago School free market theory. There was a great deal of self-consciousness among the group, a sense that the Thursday lunches were a forum for developing the vanguard to the next great political revolution in the United States: the triumph of free market theory. Yet when the Chicago School’s political champion, Ronald Reagan, swept to power in 1980, the éminences grises of the Thursday lunch group reacted with ambivalence rather than elation. Heated discussions ensued about whether it was politically correct for a free market intellectual, who believed that government should play the smallest role possible in society and the economy, to actually join the government and attempt to promote change. Jarrell’s dilemma about whether to accept the SEC chief-economist job offered by Shad in 1984 became a model for the application of this theoretical dispute. Stigler—who had been approached indirectly, soon after Reagan’s 1980 victory, about taking an SEC post and had spurned the idea—cautioned Jarrell that Washington was an “efficient political market,” which in Chicago School jargon meant that the entrenched bureaucracy was too big and too powerful for one person to make any difference.

  Jarrell thought otherwise. “How can we possibly know the answers and marshal all this evidence and then concede that we can’t convince anyone who’s in power to make different decisions?” he asked.

  He possessed an undeniable, even insidious, charm. Slim and sandy-haired, with an unblemished, boyish visage, Jarrell gave the appearance of a clever, pleasant elf—he was the Chicago School’s Peter Pan. He was brilliant and incisive in conversation, but also mocking and funny and virtually unself-censored in word and thought, like a frolicking child. In college, during the 1960s, he had been a committed hippie, and even after his deep conversion to a free market outlook, there remained in him the impulses of a merry prankster, someone who distrusted the establishment and liked to tweak its nose at every opportunity.

  Jarrell respected Friedman and Stigler, his mentors at the University of Chicago, but he thought their cynical attitude toward government reflected their ages as much as anything else. They had seen it all, or so they believed, and
they thought nothing in Washington could be changed fundamentally. A younger economist such as Jarrell had the enthusiasm and arrogance and enough outrage about the status quo to believe he could make a difference. Jarrell convinced them finally that he would go only for a few years, that he would approach the SEC job like a guerrilla fighter infiltrating the enemy command, and that he would escape Washington at the first sign that he actually enjoyed the place.

  He listened politely to what Friedman and Stigler said, but all along, in the back of his mind, he thought, “I’m going to get in there and I’m going to do what I do. I’m going to rely heavily on the empirical work and stay away from the rhetoric and try to show them that the economist from Chicago doesn’t have to be a lunatic—and trick them. I’m going to try to be as big a backslapper as these people are—in Washington, you slap them on the back and then you go into chambers and call them thieving maniacs. There are rules and I’m going to learn them and compete very, very hard and see if we can’t get some kicks out of it.” At worst, Jarrell thought, if he went too far, he would be fired by Jack Shad over some matter of principle, and that didn’t seem so bad at all. He could return to Chicago like some celebrated prisoner of war released to his family.

  Though his views were to the far right of the political spectrum, Jarrell in many ways resembled a clandestine Marxist revolutionary when he arrived at the SEC in 1984. Like the Marxists, Jarrell subscribed to a sweeping, often dogmatic, doctrine of economics that he used to explain a panoply of social and political phenomena. Change was urgent. The growth of the federal bureaucracies during the 1960s and 1970s, the interference in the economy by agencies like the SEC and the Justice Department, and their attempts to prescribe standards of regulatory morality, provoked a visceral reaction in Jarrell. He felt enormous intellectual disdain—almost disgust—for what the regulators had done in fields like antitrust. Failing or marginal companies used antitrust cases brought by Washington bureaucrats to protect themselves from free market competition, Jarrell believed.

  He applied a similar analysis to the SEC. Investment bankers and lawyers on Wall Street lobbied for complex takeover regulations at the commission to increase demand for their interpretive and advisory services. Old-line traders on the floor of the New York Stock Exchange used SEC rules to stem the introduction of new and competitive technologies at the country’s financial exchanges. Lawyers and bureaucrats in the market regulation and enforcement divisions vied for power by pushing trivial rules that, far from ensuring the fairness of the financial markets, only distorted and inhibited their efficiency. The SEC bureaucracy didn’t protect the public, Jarrell believed, but was instead an instrument for interest groups—economic classes, in Marxist vocabulary—to improve a given group’s position at the expense of its rivals.

  That was the way Jarrell saw the unfolding debate in 1984 over computerized program trading of stocks and stock futures. There were those at the commission who wanted to slow Wall Street down, to put controls on the “quant jocks,” those academics-turned-Wall-Street-traders whose computers and mathematical models linking stock and stock-futures trading increased the speed and volatility of market activity. Jarrell was convinced that new trading regulations would merely benefit the old guard, the gray-haired Wall Street traders who were not keeping up.

  Shad, who ran his own life at high speed and found the pace exhilarating, generally agreed with Jarrell that it was best to let technology and the markets race ahead. In Shad’s view, computerized trading made the markets more efficient and increased trading volume, which meant stock prices reflected all available information more rapidly than before. Liquidity and efficiency, liquidity and efficiency—that’s what Shad wanted for the markets, and he thought the computers and stock index futures would help.

  The rise of computerized trading by big institutional investors and major Wall Street firms whipsawed prices back and forth in 1984, prompting the first major cries for regulatory reform since stock index futures had been created. But Shad believed that the gyrations and volatility, while highly visible, obscured many important but less obvious benefits, such as the ability of institutional investors to move large blocks of stock in a short time. The real question was whether the stock index futures and computerized trading techniques Shad endorsed would reduce risk in the markets through various risk-transfer techniques, or whether the theory of risk transfer would be used as a rationalization, a shield hoisted by powerful market players to disguise massive speculation.

  The debate inside the SEC over computerized trading paralleled the battle for Shad’s heart and mind on the issue of takeover regulation. On one side were the free market theorists, led by Jarrell, who told Shad that the changes were healthy, and that to oppose the introduction of new computer-trading strategies would be a form of regulatory Luddism—irrational fear of technology. On the other side were the senior staff of the market regulation division. Cognizant of Shad’s suspicions about market regulation of any sort, the staff proposed no drastic restrictions, and indeed backed some proposals that made certain forms of computerized trading easier. But they were not so sanguine about it as Jarrell.

  The truth was, the SEC staff didn’t really understand what was going on as the markets in New York and Chicago became linked on the computer screens of high-powered traders. When traders began profiting in 1984 by doing complex transactions linking the stock market in New York and the stock-futures market in Chicago, Jarrell was delighted. It helped to prove his conviction that regulators in Washington were always years behind the universities and quant jocks in their approach. The principal issue at the SEC, and during congressional debate when the Chicago stock futures had been created in 1981, was whether the new financial futures would generate excessive speculation. No one had even considered whether computers and mathematicians and Wall Street rocket scientists would find ways to link the markets. Jarrell urged Shad and the other SEC commissioners to move cautiously on the issue. There was plenty of emotion generated by the issue, he said, but no quantitative proof that computer-driven trading was bad.

  Jarrell had acquaintances and intellectual allies all through the administration—young, committed, heavily ideological economists and lawyers who had taken key posts at various federal agencies. Their youth, the generational experience they had shared during the 1960s, and their self-awareness as leaders of a potentially powerful political and intellectual force, distinguished them from the old-guard conservative Republicans who held the most important senior cabinet posts in the Reagan administration. And yet the Chicago School “cabal,” as Jarrell liked to call it, was well positioned to influence economic policy. Charles Cox was now an SEC commissioner. Douglas Ginsburg, later denied a seat on the Supreme Court after admitting he once smoked marijuana, was the antitrust chief at the Justice Department. Tom Campbell had begun to shake up antitrust enforcement at the Federal Trade Commission. Christopher DeMuth headed the economic policy section of the powerful Office of Management and Budget (OMB), which worked closely with the White House. Joseph Grundfest, an attorney who had become an advocate for some aspects of Chicago School economics, was in charge of takeover issues at the White House Council of Economic Advisers.

  They were called by some the “movement” conservatives, a self-conscious appellation derived from the antiwar movement of the 1960s. Jarrell and his brethren not only fought against the bureaucrats and the Democrats but also fought at times against the entrenched establishment of their own Republican administration—against men like Jack Shad and Treasury Secretary Donald Regan and Chief of Staff James Baker, who had strong emotional and material links to the Wall Street and Washington establishments.

  In fact, conservative seemed an inadequate word to describe both Shad and Jarrell. Shad often seemed a traditional conservative, in the sense that he wanted to conserve, or preserve, institutional agendas that he thought were good for the country—those of Harvard and Wall Street, for example. Jarrell, on the other hand, was the sort of “conservativ
e” who didn’t want to conserve much of anything. He wanted to foster radical change. Shad’s outlook had been shaped by experiences such as the patriotic fervor of World War II and the economic dislocations of the Great Depression. In contrast, Jarrell had grown up amid cynicism about Vietnam and the runaway inflation of the 1970s that devalued savings and encouraged consumers to accumulate debt. They seemed bound more by a shared spirit for adventure than by similarities of experience. Jarrell admired Shad because the SEC chairman was still full of life and curiosity late in his middle age. When Michael Jackson came to Washington, Shad bought a ticket from a scalper and went out to Robert F. Kennedy Memorial Stadium by himself to see what the fuss was about. Another time he hurt his ankle while parachuting with Senator Jake Garn, Republican chairman of the banking committee that oversaw the SEC.

  The idea that Shad jumped out of an airplane for thrills impressed Jarrell. But the issue that galled him more than any other at the SEC, and the one that most provoked his adolescent and rebellious tendencies, was the commission’s regulation of corporate takeovers. He couldn’t stop thinking about Shad’s speech warning of the dangers of takeovers. Jarrell, like nearly everyone else from the Chicago School, believed that takeovers were fundamentally good for the economy and the country because they brought free market discipline to the entrenched corporate managements of the target companies and also increased shareholder wealth. Among the University of Chicago ideologues generally, Justice Department antitrust policy was the issue that stirred the greatest emotion, but SEC takeover regulation was a close second, and it was one of Jarrell’s fields of specialization. As one of only two academics on Shad’s takeover advisory committee, Jarrell had struggled against the Wall Street bankers and lawyers to produce a manifesto for laissez-faire theory.