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Michael Emmett Brady: 5.0 out of 5 stars
4.5 stars-Yes.Wall Street controls both the Republican and Democrat Parties,
October 12, 2009
(VINE VOICE) (TOP 1000 REVIEWER) (REAL NAME)
The author does an excellent job of demonstrating the extent to which both political parties are essentially guided by the policy recommendations of major Wall Street firms and the largest commercial banks.She shows that the bailout's main goal was, and is, solely to bail out the surviving financial institutions no matter what the costs are ,be it unemployment, foreclosure, or future inflation , that are imposed on the backs of the American taxpayer and Main Street.
An underlying current in the book ,that is not always correctly emphasized , is that it should now be obvious to everyone that Obama follows the policy advice advocated to him from Goldman Sachs, Citibank, Bank of America and J P Morgan. Geithner and Bernanke carry out this policy advise in the Obama administration in the same manner that Paulson , Greenspan, and Bernanke carried out Wall Street's policy recommendations in the George Bush administration, that Rubin, Greenspan, and Summers carried out Wall Street's policy recommendations in the Bill Clinton administrations, and Alfred Kahn and Paul Volcker carried out the policy advice of Wall Street in the Carter Administration. The same Wall Street domination shows up when one studies the Reagan and George H W Bush administrations. Their supply side economic policies were primarily derived from Wall Street speculator-manipulators who sought to destroy the firewalls erected and maintained from 1936-1976 that had prevented the type of massive debt leveraged, banker financed housing and stock market speculation that had destroyed the American economy in the late 1920's and early to mid 1930's .The destruction of the firewalls was called " privatization " and "deregulation" .It is easy to spot the Wall Street connections and underpinnings of the supply-side " economics " of A.Laffer, J.Wanniski, G. Gilder, etc.
One minor criticism of the book is that the author does not spend a chapter showing that Adam Smith, in his The Wealth of Nations (1776), and J M Keynes, in his The General Theory of Employment ,Interest and Money (1936),had come to the exact same conclusions as to the source of the problem - major banker financed and directed debt leveraged speculation, in the real estate and financial-stock markets, that leads inevitably to a bubble, mania, panic ,crash, and economic downturn.
It is clear that a political solution to America's, and the world's, banker induced and financed bubbles will require a Third Party candidate like Ross Perot who is not financed by Wall Street.
During the entire decade of the 1980's, the policies of the Reagan Bush and Bush administrations encouraged one of the greatest paroxysms of speculation and usury that the world has ever seen. Starting especially in the summer of 1982, a malignant and cancerous mass of speculative paper spread through all the vital organs of the banking, credit, and financial system. Capital had long since ceased to be used for the creation of new productive plant and equipment, and new productive manufacturing jobs; investment in transportation, power systems, education, health services and other infrastructure declined well below thje break even level. Wall Street investors came more and more to resemble vampires who ranged over a ghouilish landscape in search of living prey whose blood they could suck to perpetuate their own lively form of death.
Industrial employment was out, the service sector was in. The post-industrial society meant that the production of tangible, physical wealth, of hard commodities, within US borders was being terminated. The future would belong to parasitical legions of lawyers, financial services experts, accountants, and clerical support personnel, but the growth in the balance of payments deficit signalled that the game could not go on forever.
On the surface, wild speculation was the order of the day: there was the stock market boom, which underwent a crash in 1987, but then, thanks to James Brady's drugged futures and index options markets, kept rising until the Dow had passed 3,000, although by that time no one could remember why it was still called the industrial average. The stock market provided the right atmosphere for a much broader speculative boom, the one in commercial and residential real estate, which kept going until almost the end of the decade, but which then began to crash with a vengeance. When real estate began to implode, as in Texas at the middle of the 1980's or the northeast after 1988, savings banks and commercial banks by the scores became insolvent. Thus, by the third year of the Bush administration, a bankrupt savings and loan was being seized by federal regulators on almost every business day, and Congressman Dingell of Michigan had to announce that Citibank, still the largest bank in the USA, was indeed "technically" bankrupt. Depositors in Hong Kong started a run on the Citibank branch there; their US counterparts were slower to react, perhaps because deluded by the pathetic faith that the Federal Deposit Insurance Corporation could still cover their deposits.
Even more fundamental than speculation was the absolute primacy of debt. During the Reagan and Bush years, unprecedented federal deficits pushed the public debt of the United States into the ionosphere, with the total almost quadrupling over a little more than ten years to approach the fantastic total of $3.25 thousand billion. In 1989, it was estimated that total debt claims in the US economy had attained almost $25 thousand billion, and their total has increased exponentially ever since. The debt of state and local governments, corporate debt, consumer debt –all expanded into the wild blue yonder. In the meantime, the Great Lakes industrial region became the rust bowl, the Sun belt oil and computer booms collapsed, the great cities of the east were rotten to the core with slums, and farmers went bankrupt more rapidly than at any other time in the memory of man.
Living standards had been in a gradual but constant decline since the days of Nixon, and it began to dawn on more and more families who considered themselves members of the middle class that they could no longer afford their own home, nor hope to send their children to college, all because of the prohibitive costs. The Bureau of the Census made sure in 1990 not to count the number of those who had become homeless during the 1980's, since the real figure would be an acute political embarrassment to George Bush: were there 5 million, or 6, as many as the total population of Sweden, or of Belgium?
New jobs were created, but most of them were dead-ends for losers at or below the mimimum wage that presupposed illiteracy on the part of the applicant: hamburger sales and pizza home delivery were the growth areas, although a smart kid might still aspire to become a croupier. Behind it all lurked the pervasive narcotics trade, with hundreds of billions of dollars a year in heroin, crack, marijuana.
For the vast majority of the US population (to say nothing of the brutal immiseration in the developing countries) it was an epoch of austerity, sacrifice, and decline, of the entropy of a society in which most people have no purpose and feel themselves becoming redundant, both on the job market and ontologically.
But for a paper thin stratum of plutocrats and parasites, the 1980's were a time of unlimited opportunity. These were the practioners of the monstrous financial swindles that marked the decade, the protagonists of the hostile takeovers, mergers and acquisitions, leveraged buy-outs, greenmail and stock plays that occupied the admiration of Wall Street. These were corporate raiders like J. Hugh Liedkte, Blaine Kerr, T. Boone Pickens, and Frank Lorenzo, Wall Street financiers like Henry Kravis and Nicholas Brady.
August 23, 2010 | FT.com
The conservative economic counter-revolution associated with the names of Ronald Reagan and Margaret Thatcher began some three decades ago. The Great Recession almost certainly marks its end. What follows will be something different, though how different it will is still unclear. This is a good opportunity to assess the broad economic consequences of that revolution.
For the sake of simplicity, I focus on gross domestic product per head in the six biggest high-income economies: the US; Japan; Germany; the UK; France; and Italy. (I also use the Conference Board database. These data are in purchasing power parity (Elteto-Koves-Szulc (EKS) method).)
There is much more to performance than GDP per head. These data ignore the distribution of income, which is of crucial importance, especially for the US, where a very large proportion of additional income seems to have accrued to the wealthiest. The data also ignore the underlying causes of changes in GDP per head: changes in output per hour, in hours per worker and in employment. Even so, they are revealing.
The single most important point from the chart on relative GDP per head is that the US remains where it has been for over a century: the most productive large economy in the world. At its peak, in 1991, Japan's GDP per head reached 89 per cent of US levels. It then fell substantially in the 1990s. United Germany, France and Italy also experienced substantial relative declines in GDP per head over this period. The UK was the only one of these five countries to have achieved rising GDP per head, relative to the US, since 1990. This surely suggests that reforms led by American and British policymakers did bear some fruit.
The chart on growth of GDP per head elaborates this picture somewhat. The UK and US had the highest trend growth of GDP per head between 1980 and 2009. (All-German data are unavailable for the entire period.) But there are other interesting events: first, there is a progressive deceleration in trend growth: only Japan achieved faster trend growth in GDP per head between 2000-07 (that is, before the recent deep recession) than it did in the 1990s; second, the US growth deceleration in the most recent periods is marked, with growth in GDP per head only at the same rate as Japan between 2000 and 2007 – so much for the magic of the Bush-era tax cuts - and also between 2000 and 2009; third, GDP per head grew at less than 1 per cent a year in Germany, France and Italy in the most recent decade.
At first glance, then, the conservative revolution seems to have achieved some improvements in the previously lagging US and UK economies. But the magic potion started to lose effectiveness in the 2000s, particularly in the US.
The more interesting question, however, is how far this improved performance of the US and UK will turn out to have been a blip. There are two reasons for believing this.
- First, the expansion of the financial sector and associated leveraging of the household sector played a big part in the growth of the economies of the US and UK. The question is how far growth driven by these two linked developments will turn out to have been a mirage. It is not difficult to see why that might be the case. The financial sector creates money and credit not only used to pay fees to itself and to a host of brokers and agents, but also to finance construction booms. Furthermore, the next decade is likely to see deleveraging in the US and UK, in both household and financial sectors, while the willingness to leverage up the government sector seems set to hit political or economic limits. This combination of factors might make these countries' performance look a little like that of Japan in the 1990s, with chronically weak aggregate demand.
- Second, the US and UK have run substantial current account deficits in recent decades. Andrew Smithers of London-based Smithers & Co argues that this has allowed the relative shrinkage of manufacturing, a capital-intensive sector. That, in turn, has permitted the two economies to grow quite fast, despite relatively low rates of investment in physical capital. In the coming decade, this process is likely to be reversed. Savings and investment would then have to rise substantially to sustain given rates of overall economic growth. Should this not happen, growth would slow further.
Bubbles induce severe over-estimates of underlying economic performance. Will the same prove true of the US and UK? I would guess so. Might the next decade belong to Germany or Japan, instead? That would not surprise me either. Expect the unexpected. It is a good rule.
- Kevin Alexander | August 23 9:07pm
The "Great Recession"? It may yet to turn out as the neo-Dark Ages, where stupidity reigns.
- Gavyn Davies | August 23 10:19pm
Martin - I think we need to ask four separate questions.
- First, did the Reagan/Thatcher reforms help the relative performance of the US and UK, compared to other economies, in sectors other than the financial sector? My answer to this would be a resounding "yes".
- Second, did the US and the UK also gain because they had comparative advantages in the financial sector, which was the area of the global economy which expanded most rapidly from 1982-2007. My answer would be "yes" again.
- Third, did the conservative revolution itself contribute to the forces which triggered the growth in the global financial sector? Clearly, yes again.
- And, fourthly, can the pre-2007 growth in financial services be maintained in the long run? That seems very doubtful, to say the least.
If this is all true, then the conservative revolution may have improved the performance of the non-financial sectors in the UK/US, while also shifting resources excessively towards finance in those economies.
We may not be able to judge the final outcome until finance has settled down its sustainable share of global GDP, which is probably less than it was in 2007.
But we can ask ourselves this: is it possible to design the next revolution so that non financial sectors improve their performance, without also shifting resources (perhaps wastefully) into finance? It may require us to encourage market forces in some sectors, while regulating them in others. Not an easy message for politicians to get across.
- Richard W | August 23 10:38pm
I think in the context of future growth for Germany and Japan you would also need to calculate what impact a declining population will have on growth. Both countries have a declining population and an ageing population through declining births. Although the declining population will likely see GDP per capita growing. I would think nominal GDP will disappoint. Moreover, the demographics of an ageing population must have effects on the rate of new startup firms. Much will depend on whether the young can increase their per-capita output to support the inverted population pyramid. Although the US and UK face problems with deleveraging they do not have the declining population problem.
- Munzoenix | August 23 10:42pm
I agree with Martin on his last point -- that the relatively high growth in the US and UK could be due to higher leverage, and less investment in capital-intensive sectors like manufacturing.
But, I think Martin also did not mention two points I think are very valuable:
- that growth rates in various countries are reported in domestic currencies. The US and UK have shown to have high growth rates, but when you standardize/normalize all the growth rates using one currency for comparison, the US and UK economy shrunk markedly in the past decade if all these economies were compared in euros or yens. The pound had lost almost 20% of its value in the last year, which in euro terms is a 20% decline in the UK's per capita income measured in euros. So, all the growth the UK experienced in relation to Germany, France and Italy is a mirage already.
- per capita incomes are usually measured in purchasing power parity (and looking at how low Japan's figures were in Martin's graph, I'm assuming PPP was used). But this can be somewhat misleading. There is value in reading PPP, because it allows economists to measure what people can actually buy because it adjusts for varying price levels across countries. But, looking at nominal exchange rate also has value.
US PPP per capita income is high because prices levels are low -- NOT FOR GOOD reasons like higher productivity from greater capital-intensive utilization. US price levels are low because 1/3rd of the labor force lost their job in the manufacturing sector due to an overvalued dollar (thanks to Reagan excessive government debt). All this manufacturing labor flooded into the "booming" service sector, putting downward wage and price presses on service goods from restaurant meals to haircuts. Thus, haircuts and other services that comprise a country's price level are lower in America than a country like Sweden -- Thus using PPP makes Sweden look poorer, when in reality, the economy is more balanced for having more labor employed in a highly competitive goods-producing, capital-intensive manufacturing sector, that there is less labor in services that overall price levels are higher.
Therefore, using nominal market exchange rate to measure per capita income in the above countries maybe useful (alongside PPP).
In that case, Japan and Germany are far better off (and balanced) than the US and UK. In addition, growth is far more equal across those societies than in the US where all growth is top heavy, as Martin mentioned.
Overall, good article, nonetheless.
- Francobollo | August 24 1:08am
The idea that finance and leverage have made up part of the relative gains of US/UK seems eminently plausible. Nevertheless it doesn't seem, despite the Great Recession, that neo-con policies are dead. An example is Cameron's 'Big Society' concept which seems to be pure Gordon Tullock in seeking to transfer government activities to the voluntary sector.
- Padmanabha Rao Hari Prasad | August 24 2:07am
The relatively poor and declining quality of physical and human capital in the US will surely limit its growth over the next decade or more.
Raghuram Rajan has quite an extensive discussion in "Fault Lines" of how the US educational system and society are failing to provide an increasing portion of the population with the skills (and the socializing for the attitudes and work habits) needed for the more technologically sophisticated jobs of today.
The policy consensus to address these constraints seems all the more difficult to achieve in a highly polarized political environment.
- Akira Chimura | August 24 4:14am
I am surprised by Martin's analysis, based on PPP. I can choose nothing but to seriouly doubt the economic theory or further all logical theories as well as logical and abstract thinking itself. Only one ironical conclusion is "I think, therefore I am", just as Descarters said.
Concretely, Japan must unchangeably seek for a new catch-up model, successful in Ex-Japan Asia, signifying that more and more savings and capital-intensive investments in physical assets should be made. Does this signify a stronger inertia of continuing the conventionalities of the past, and so a more helpless vicious cycle of the debt-deflation dynamics, basically different from recently rising Germany? Greater havoc or collapse for Japan? Because no matter how based on PPP, the revenue by corporat tax peaked at a level of 13.4 trillion yen in 1991 and then sharply declined to a level of 5 trillion yen in FY 2009, and also other tax revenues similarly declined, except the revenue by consumption tax. Therefore, the country cannot stand up. Even though the tax system is the basics of the country, if Japan's tax system could be changed into the European-style tax system, centering around added value tax, would Japan get out from the vicious cycle of the debt-deflation dynamics and be really revived? What matters most importantly is that this task is the genuine difficulty for Japan, because it crucially and vitally needs a really strong leadership, differently different from "Leadersless Japan" ( The economist criticised ).
- Bryan Lewis | August 24 4:23am
I am in Japan. I just bought a new computer that is half the price of one I bought 5 years ago. It is much faster and has better features. If this pricing and growth in efficiency was carried across the board the GDP would fall by half.
So what kind of a measure of the economy is the GDP used in your graphs?
- Liberty | August 24 4:52am
Everyone can quote others' data and say "expect the unexpected." Wolf should find another job. Thatcher and Reagan did not achieve turning the tide of socialism in the west. They just stopped its progress for a while. That's why the West is not doing well. The real counter-revolutions were in China, India and eastern Europe, which are significantly less socialist now than before.
- Mycroft | August 24 6:38am
Reagan/Thatcher slowed the growth of the State, but hardly did they roll it back by any objective measure... just look at the budget numbers, number of govt. employees, etc..
Reagan in particular disillusioned his Goldwaterite supporters on every front.. from failing to abolish the Dept. of Education, to burying the Gold Comission, to incurring in huge deficits... Since then the US Empire and it's Welfare state have done nothing but grow.
If you want to see the triumph of market reforms, look to China, where a little more freedom has gone a long way...
- Roy | August 24 7:55am
honestly.. this is a bit of a joke.. in these decadent days we call anything a revolution... even if it's just tinkering around the edges.
If you want a measuring rod which will show you just how lame Reagan reforms were... contrast to Thomas Jefferson's spending cuts (almost 50% of the Federal budget in 4 years)..
- kedarsat | August 24 8:04am
Does conservatism allow for ZIRP?
In my book, low interest rates and a pernicious form of crony-capitalism brought the UK and US down. These need to be abandoned, rather than the conservatism that never was.
The decline in US public finances will lead to a partial dismantling of US public education, which could be the beginning of the re-skilling of the US.
- sceptic | August 24 8:16am
I love the way Krugman, Wolf and co. are trying to drive the keynesian dual narrative of "deregulation caused the bust" and "austerity killed the recovery".
Anything to focus the debate away from establishment sacred cows. I'll leave it to the reader to figure out what those are.
- Econoclast | August 24 8:29am
I am amazed by some of the comments here, which seem to imply quasi-socialism is a major constraint on the US and the UK.
As Martin Wolf points out, we've had 30 years of deregulation, which simply encouraged massive over-investment in housing to the detriment of other physical capital.
Thatcher-Reagan deregulation has failed. I regard the comparisons with China, India and eastern Europe has completely misplaced.
Look at the mess in many eastern European economies who shared in the financial/housing mania. And China and India are reaping the benefits of putting hundreds of millions of people to work. The true test for their political and economic systems will come over the next 20 years.
- central economic plannning | August 24 8:31am
10 Planks of the Communist manifesto:
5. Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.
- Gaute | August 24 9:58am
@ econoclast, "The true test for their political and economic systems will come over the next 20 years"
20 years is a very short perspective. Remember what Chou En Lai allegdly answered when asked about his opinion on the outcome of the French revolution. It was too early to tell.
- Brian Reading | August 24 10:15am
US industrial ICOR fell substantially from the early 1980s (measured over 7 years to smooth the cycle). Less investment was needed. Meanwhile LSR calculates that TFE was close to zero in the 1970s, rose to over 0.5% pa over the next two decades and in the noughties fell back to zero. I wonder how far the take-up of new technology has substantially increased TFP.
From 1985 US NIPA does allow for quality changes using hedonic pricing covering 20% of expenditure categories. Non-residential investment has been on a declining trend as a share of nominal GDP while on a rising trend on chain linked.
A good many years ago I devised a method of looking at relative performance using the errors in successive OECD GDP growth and inflation forecasts. The idea was that models are slow to capture changes in regression relationships. The result of a structural improvement should show up as a bias towards under estimating growth and over estimating inflation. There was such a bias for the US and UK but not for Germany, France and Japan. I have not repeated this exercise for many years. How long ago this was can be guess by the fact that Anthony Harris reported in in the FT.
- StuBails | August 24 10:23am
@ Martin Wolf
You said that the conservative revolution seems to have achieved some improvements in the previously lagging US/ UK economies.
Is there an alternative explanation here? Could it be that in the early 90s outsourcing started in earnest? The US & UK farmed out commodity production to the East and concentrated on comparative advantages in Financial Services/ property/ professional services. Was it this that accelerated growth rather than the deregulation of the US/ UK economies?
Either way, both countries are facing monster issues in the coming thirty years. The UK does have to concentrate more on exports, but my guess is that this will not result in manufacturing comprising a bigger % of GDP than it currently does.
- Luis H Arroyo | August 24 10:40am
I do not think the conservative revolution was the direct cause of the crisis. Therefore, I do not think the solution is the return of Keynesianism. Keynesianism has had its day, and lost the battle miserably. Moreover, much of today's problems come from the debts accumulated by the European countries that have chosen to follow Keynes.
There are many factors that have strayed from their beds Conservative revolution. for example, the commercialism of China, which has devastated the productive sectors of the world. In the West we have praised China as a simpleton when it has never been a credible rival.
Then the history of the euro has played a key role in the crisis, as determined interest rates very low in the countries which embarked on the bubble. Now, the Euro is a huge barrier for these countries to adjust their failure competitiveness.
These and other conditions can not be charged to the account of the Conservative Revolution, that brought capitalism to depressed areas that are now very close to us.
- Itzman | August 24 10:50am
The history of civilization is the history of economics, but it is not the history of economic theory or of political interference with it.
They merely lag the true economic history of it.
Wolf, Krugman et al would do well to step back from theories that express the conditions of limited populations with access to more resource bases than they can exploit, (the politics and economics of expansion) and look to develop an economics that reflects the situation today, of the only unlimited thing being our ability to generate people we have no hope of ever finding useful employment for. And print empty promises on banknotes.
Everything else is in short supply.
In short, stop behaving as though by believing in it, the world will become what we think it ought to be, and start treating with it, as it is, and must inevitably be. With or without political an economic fiddling.
The economic wealth of a nation is nothing more or less than the the resource bases it has access to, and its efficiency in exploiting them into desirable product, divided by its population (squared) . As higher density populations need proportionality higher use of resource per capita to regulate and organise. One man on an island needs no government or defence force or police force or waste disposal....60M need rather more..
Which leads to a simple conclusion. The only way forward to greater prosperity lies in managing populations down. The longer this distasteful alternative so at odds with expansionist economic and political theory is shied away from, the bigger will be the crash when some externality does what politicians and economists are so afraid to face.
The rest may be safely left to those engaged in economic activity: The best that government can do is not stand in the way. Economists, may not be worth the paper they write upon, sadly.
- Per Andersson | August 24 11:47am
Mr Wolf overestimates the influence of individual politicians (Reagan/Thatcher). What he calls 'the conservative counter-revolution' consists of two developments:
- The growth of the welfare state was halted.
- Technology enabled product markets to be deregulated (or, perhaps more appropriate, de-monopolized) to a much larger extent than before.
Both these developments took place in other industrialized nations, even in those that did not have political forces as strongly identified as 'conservative' as Reagan or Thatcher.
The welfare state itself was not significantly cut back, either by Reagan or Thatcher. This is because the welfare state was and is overwhelmingly popular. A large-scale reduction in the size of government through a dismantling of the welfare state simply is not politically feasible, despite the protestations of 'Tea-Partiers'.
- maximus | August 24 11:50am
Yes, Interesting article although I suspect that there is a bit of a sub text here- i.e all this deregulation - did it really deliver? Some really don't want to buy that argument! I think that RichardW below is on the right lines, although it is obviously variable by country/region. The developed world post WW II baby boom has coincided with much of these changes... looking at the UK.. greatly expanded higher education, student power, new families, house acquisition, overseas travel and rising real incomes, financial service needs, now retirement for many. It has run its course. You can measure some of these by tracking the "Branson Empire" as it has morphed along with that generation. I think it has very little to do with conventional economic theory and much to do with the available choices to most of those baby boomers. This has now run its course- ergo the pile of problems from pensions et al.
- Barry Thornton | August 24 1:05pm
A curious article.
you start by mentioning the deficiencies of using GDP as a metric, but then proceed to use it anyway and finally question the conclusions that can be drawn from the limited data.
It is not very surprising that since the 80s the GDP of the US and UK have surged ahead, what with the expansion of the financial sector and the flow of credit. However, the big gripe with conservative policies has been that this has only benefited a tiny minority (as you mention).
A far more instructive comparison would include median wages, inflation (including property inflation), average number of hours worked, employment (not unemployment), health care and crime.
I appreciate that the conservative reforms were mostly economic and financial in nature, but the success or otherwise of these reforms should be judged with a broad range of metrics, not just economic ones.
I suspect in such an analysis, the conservative revolution would not look as good.
- antitrust | August 24 1:27pm
Anybody who talks about regulation.. or deregulation.. and fails to mention that the monetary and banking system is set up as a government orchestrated cartel, that the whole financial sphere of economic life is, if not outright nationalized, pretty much directed by governments and a few govt-licensed players... is being short-sighted at best.
- Driftersescape | August 24 1:35pm
I would have thought that when one talks of 'Reganomics' in the very next breath Milton Friedman would be mentioned and then inevitably monetarism. John Maynard Keynes, one of the most brilliant minds of his generation has become persona non grata.
Rather oddly the article above mentions none of these. Those of a certain age will recall not awaiting the next unemployment number but that of the latest M4 and then M0.
Those have of course been assigned to the trashcan of history (about 1987) I think i.e. the same place as the conservative revolution you refer to.
The list of failures is too long to mention but in the charge sheet is rapid deregulation though to the shameless 'jacking up' of the UK economy to win the 1987 general election. Result, an overheating economy and galloping inflation brought under control, for many business and individuals by sky high interest rates leading to a very painful recession that lasted from 1989 to 1993/4.
You are right in one thing, it surely did begin thirty years ago and tragically that flawed theme (deregulation morphing into light touch regulation) was brought to a shuddering halt in the blood bath of that late 2008 early 2009 credit crunch.
The final analysis of the conservative revolution? An unmitigated disaster.
- Alasdair Rankin | August 24 1:42pm
The problem is essentially one of goals. Wasn't the conservative counter-revolution simply a piece of ideological special pleading by the owners of capital? Look at the proportion of the increase in GDP in the US which went to the owners of capital. They also seem to believe that the state should only spend money on things they like. All the rest is best left to the "private sector". But what's "private" about driving the global economy into a deep recession, which would have been a depression without international government intervention?
The goal of capital is ever more capital. Conservative theorists will tell you at great length about the merits of individual responsibility but what do they have to say about economic responsibility or the responsibilities of capital? Rather less. Their economic theory, including "trickle-down"and Laffer curves, is no more than intellectual window-dressing.
Health care provision in the US is a classic case. The UK's health service has long consumed less GDP per head than the US health sector. That is, it is more efficient. But overall efficiency and human welfare have come second in the US to vested interests and maximizing private profit. We shouldn't be surprised - the economic system is set up that way.
For balanced, sustainable economic development find, and maintain, the balance between democratic goals and wealth creation. If there is an economic holy grail, maybe that's it.
- eian | August 24 2:17pm
I wonder if the US data on GDP per capita include the 10-12 million undocumented workers -- the vast majority active in the workforce -- who contributed to that GDP growth?
If not, we should estimate and subtract their contribution to US GDP to make a fair comparison. Of course, other countries also have undocumented workers. But of the ones compared here, I would think that the scale of US reliance on such workers far exceeds the others.
- The Slog | August 24 2:39pm
The Conservative Agenda made one entirely erroneous assumption: that the ethics of those in banks and business were up to less regulation.
We've all been paying for the mistake ever since.
For instance - the recent EU bank stress tests - Why has Barclays' exposure to Italian sovereign debt risen tenfold since the stress-tests? Stupidity - or economical reporting?
July 14, 2010 | counterpunch
"You all are the house, you're the bookie. [Your clients] are booking their bets with you. I don't know why we need to dress it up. It's a bet."
- Senator Claire McCaskill, Senate Subcommittee investigating Goldman Sachs (Washington Post, April 27, 2010)
Ever since December 2008, the Federal Reserve has held short-term interest rates near zero. This was not only to try to stimulate the housing and credit markets but also to allow the federal government to increase its debt levels without increasing the interest tab picked up by the taxpayers. The total public U.S. debt increased by nearly 50% from 2006 to the end of 2009 (from about $8.5 trillion to $12.3 trillion), but the interest bill on the debt actually dropped (from $406 billion to $383 billion), because of this reduction in interest rates.
One of the dire unintended consequences of that maneuver, however, was that municipal governments across the country have been saddled with very costly bad derivatives bets. They were persuaded by their Wall Street advisers to buy credit default swaps to protect their loans against interest rates shooting up. Instead, rates proceeded to drop through the floor, a wholly unforeseeable and unnatural market condition caused by rate manipulations by the Fed. Instead of the banks bearing the losses in return for premiums paid by municipal governments, the governments have had to pay massive sums to the banks – to the point of bankrupting at least one city (Montgomery, Alabama).
Another unintended consequence of the plunge in interest rates has been that "savers" have been forced to become "speculators" or gamblers. When interest rates on safe corporate bonds were around 8%, a couple could aim for saving half a million dollars in their working careers and count on reaping $40,000 yearly in investment income, a sum that, along with social security, could make for a comfortable retirement. But very low interest rates on bonds have forced these once-prudent savers into the riskier and less predictable stock market, and the collapse of the stock market has forced them into even more speculative ventures in the form of derivatives, a glorified form of gambling. Pension funds, which have binding pension contracts entered into when interest was at much higher levels, need an 8% investment return to meet their commitments. In today's market, they cannot make that sort of return without taking on higher risk, which means taking major losses when the risks materialize.
Derivatives are basically just bets. Like at a racetrack, you don't need to own the thing you're betting on in order to play. Derivative casinos have opened up on virtually anything that can go up or down or have a variable future outcome. You can bet on the price of tea in China, the success or failure of a movie, whether a country will default on its debt, or whether a particular piece of legislation will pass. The global market in derivative trades is now well over a quadrillion dollars – that's a thousand trillion – and it is eating up resources that were at one time invested in productive enterprises. Why risk lending money to a corporation or buying its stock, when you can reap a better return betting on whether the stock will rise or fall?
The shift from investing to gambling means that not only are investors making very little of their money available to companies to produce goods and services, but the parties on one side of every speculative trade now have an interest in seeing the object of the bet fail, whether a company, a movie, a politician, or a country. Worse, high-speed program traders can actually manipulate the market so that the thing bet on is more likely to fail. Not only has the market become a casino, but the casino is rigged.
The Financialization of CapitalismJohn Bellamy Foster
Review of the Month more on Economics
This article was prepared for a panel organized by the Union for Radical Political Economics at the Left Forum in New York, March 11, 2007.
Changes in capitalism over the last three decades have been commonly characterized using a trio of terms: neoliberalism, globalization, and financialization. Although a lot has been written on the first two of these, much less attention has been given to the third.1 Yet, financialization is now increasingly seen as the dominant force in this triad. The financialization of capitalism-the shift in gravity of economic activity from production (and even from much of the growing service sector) to finance-is thus one of the key issues of our time. More than any other phenomenon it raises the question: has capitalism entered a new stage?
I will argue that although the system has changed as a result of financialization, this falls short of a whole new stage of capitalism, since the basic problem of accumulation within production remains the same. Instead, financialization has resulted in a new hybrid phase of the monopoly stage of capitalism that might be termed "monopoly-finance capital."2 Rather than advancing in a fundamental way, capital is trapped in a seemingly endless cycle of stagnation and financial explosion. These new economic relations of monopoly-finance capital have their epicenter in the United States, still the dominant capitalist economy, but have increasingly penetrated the global system.
The origins of the term "financialization" are obscure, although it began to appear with increasing frequency in the early 1990s.3 The fundamental issue of a gravitational shift toward finance in capitalism as a whole, however, has been around since the late 1960s. The earliest figures on the left (or perhaps anywhere) to explore this question systematically were Harry Magdoff and Paul Sweezy, writing for Monthly Review.4
As Robert Pollin, a major analyst of financialization who teaches economics at the University of Massachusetts at Amherst, has noted:
"beginning in the late 1960s and continuing through the 1970s and 1980s" Magdoff and Sweezy documented "the emerging form of capitalism that has now become ascendant-the increasing role of finance in the operations of capitalism. This has been termed 'financialization,' and I think it's fair to say that Paul and Harry were the first people on the left to notice this and call attention [to it].
They did so with their typical cogency, command of the basics, and capacity to see the broader implications for a Marxist understanding of reality." As Pollin remarked on a later occasion: "Harry [Magdoff] and Paul Sweezy were true pioneers in recognizing this trend….
[A] major aspect of their work was the fact that these essays [in Monthly Review over three decades] tracked in simple but compelling empirical detail the emergence of financialization as a phenomenon….It is not clear when people on the left would have noticed and made sense of these trends without Harry, along with Paul, having done so first."5
From Stagnation to Financialization
In analyzing the financialization of capitalism, Magdoff and Sweezy were not mere chroniclers of a statistical trend. They viewed this through the lens of a historical analysis of capitalist development. Perhaps the most succinct expression of this was given by Sweezy in 1997, in an article entitled "More (or Less) on Globalization." There he referred to what he called "the three most important underlying trends in the recent history of capitalism, the period beginning with the recession of 1974–75:
- the slowing down of the overall rate of growth,
- the worldwide proliferation of monopolistic (or oligipolistic) multinational corporations, and
- what may be called the financialization of the capital accumulation process."
For Sweezy these three trends were "intricately interrelated." Monopolization tends to swell profits for the major corporations while also reducing "the demand for additional investment in increasingly controlled markets." The logic is one of
"more and more profits, fewer and fewer profitable investment opportunities, a recipe for slowing down capital accumulation and therefore economic growth which is powered by capital accumulation."
The resulting "double process of faltering real investment and burgeoning financialization" as capital sought to find a way to utilize its economic surplus, first appeared with the waning of the "'golden age' of the post-Second World War decades and has persisted," Sweezy observed, "with increasing intensity to the present."6
This argument was rooted in the theoretical framework provided by Paul Baran and Paul Sweezy's Monopoly Capital (1966), which was inspired by the work of economists Michal Kalecki and Josef Steindl-and going further back by Karl Marx and Rosa Luxemburg.7
The monopoly capitalist economy, Baran and Sweezy suggested, is a vastly productive system that generates huge surpluses for the tiny minority of monopolists/oligopolists who are the primary owners and chief beneficiaries of the system. As capitalists they naturally seek to invest this surplus in a drive to ever greater accumulation. But the same conditions that give rise to these surpluses also introduce barriers that limit their profitable investment.
Corporations can just barely sell the current level of goods to consumers at prices calibrated to yield the going rate of oligopolistic profit. The weakness in the growth of consumption results in cutbacks in the utilization of productive capacity as corporations attempt to avoid overproduction and price reductions that threaten their profit margins. The consequent build-up of excess productive capacity is a warning sign for business, indicating that there is little room for investment in new capacity.
For the owners of capital the dilemma is what to do with the immense surpluses at their disposal in the face of a dearth of investment opportunities. Their main solution from the 1970s on was to expand their demand for financial products as a means of maintaining and expanding their money capital. On the supply side of this process, financial institutions stepped forward with a vast array of new financial instruments: futures, options, derivatives, hedge funds, etc. The result was skyrocketing financial speculation that has persisted now for decades.
Among orthodox economists there were a few who were concerned early on by this disproportionate growth of finance. In 1984 James Tobin, a former member of Kennedy's Council of Economic Advisers and winner of the Nobel Prize in economics in 1981, delivered a talk "On the Efficiency of the Financial System" in which he concluded by referring to "the casino aspect of our financial markets." As Tobin told his audience:
I confess to an uneasy Physiocratic suspicion…that we are throwing more and more of our resources…into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to their social productivity. I suspect that the immense power of the computer is being harnessed to this 'paper economy,' not to do the same transactions more economically but to balloon the quantity and variety of financial exchanges. For this reason perhaps, high technology has so far yielded disappointing results in economy-wide productivity. I fear that, as Keynes saw even in his day, the advantages of the liquidity and negotiability of financial instruments come at the cost of facilitating nth-degree speculation which is short-sighted and inefficient….I suspect that Keynes was right to suggest that we should provide greater deterrents to transient holdings of financial instruments and larger rewards for long-term investors.8
Tobin's point was that capitalism was becoming inefficient by devoting its surplus capital increasingly to speculative, casino-like pursuits, rather than long-term investment in the real economy.9 In the 1970s he had proposed what subsequently came to be known as the "Tobin tax" on international foreign exchange transactions. This was designed to strengthen investment by shifting the weight of the global economy back from speculative finance to production.
In sharp contrast to those like Tobin who suggested that the rapid growth of finance was having detrimental effects on the real economy, Magdoff and Sweezy, in a 1985 article entitled "The Financial Explosion," claimed that financialization was functional for capitalism in the context of a tendency to stagnation:
Does the casino society in fact channel far too much talent and energy into financial shell games. Yes, of course. No sensible person could deny it. Does it do so at the expense of producing real goods and services? Absolutely not. There is no reason whatever to assume that if you could deflate the financial structure, the talent and energy now employed there would move into productive pursuits. They would simply become unemployed and add to the country's already huge reservoir of idle human and material resources. Is the casino society a significant drag on economic growth? Again, absolutely not. What growth the economy has experienced in recent years, apart from that attributable to an unprecedented peacetime military build-up, has been almost entirely due to the financial explosion.10
In this view capitalism was undergoing a transformation, represented by the complex, developing relation that had formed between stagnation and financialization. Nearly a decade later in "The Triumph of Financial Capital" Sweezy declared:
I said that this financial superstructure has been the creation of the last two decades. This means that its emergence was roughly contemporaneous with the return of stagnation in the 1970s. But doesn't this fly in the face of all previous experience? Traditionally financial expansion has gone hand-in-hand with prosperity in the real economy. Is it really possible that this is no longer true, that now in the late twentieth century the opposite is more nearly the case: in other words, that now financial expansion feeds not on a healthy real economy but on a stagnant one?
The answer to this question, I think, is yes it is possible, and it has been happening. And I will add that I am quite convinced that the inverted relation between the financial and the real is the key to understanding the new trends in the world [economy].
In retrospect, it is clear that this "inverted relation" was a built-in possibility for capitalism from the start. But it was one that could materialize only in a definite stage of the development of the system. The abstract possibility lay in the fact, emphasized by both Marx and Keynes, that the capital accumulation process was twofold: involving the ownership of real assets and also the holding of paper claims to those real assets. Under these circumstances the possibility of a contradiction between real accumulation and financial speculation was intrinsic to the system from the start.
Although orthodox economists have long assumed that productive investment and financial investment are tied together-working on the simplistic assumption that the saver purchases a financial claim to real assets from the entrepreneur who then uses the money thus acquired to expand production-this has long been known to be false. There is no necessary direct connection between productive investment and the amassing of financial assets. It is thus possible for the two to be "decoupled" to a considerable degree.11 However, without a mature financial system this contradiction went no further than the speculative bubbles that dot the history of capitalism, normally signaling the end of a boom. Despite presenting serious disruptions, such events had little or no effect on the structure and function of the system as a whole.
It took the rise of monopoly capitalism in the late nineteenth and early twentieth centuries and the development of a market for industrial securities before finance could take center-stage, and before the contradiction between production and finance could mature. In the opening decades of the new regime of monopoly capital, investment banking, which had developed in relation to the railroads, emerged as a financial power center, facilitating massive corporate mergers and the growth of an economy dominated by giant, monopolistic corporations. This was the age of J. P. Morgan. Thorstein Veblen in the United States and Rudolf Hilferding in Austria both independently developed theories of monopoly capital in this period, emphasizing the role of finance capital in particular.
Nevertheless, when the decade of the Great Depression hit, the financial superstructure of the monopoly capitalist economy collapsed, marked by the 1929 stock market crash. Finance capital was greatly diminished in the Depression and played no essential role in the recovery of the real economy. What brought the U.S. economy out of the Depression was the huge state-directed expansion of military spending during the Second World War.12
When Paul Baran and Paul Sweezy wrote Monopoly Capital in the early 1960s they emphasized the way in which the state (civilian and military spending), the sales effort, a second great wave of automobilization, and other factors had buoyed the capitalist economy in the golden age of the 1960s, absorbing surplus and lifting the system out of stagnation. They also pointed to the vast amount of surplus that went into FIRE (finance, investment, and real estate), but placed relatively little emphasis on this at the time.
However, with the reemergence of economic stagnation in the 1970s Sweezy, now writing with Magdoff, focused increasingly on the growth of finance. In 1975 in "Banks: Skating on Thin Ice," they argued that "the overextension of debt and the overreach of the banks was exactly what was needed to protect the capitalist system and its profits; to overcome, at least temporarily, its contradictions; and to support the imperialist expansion and wars of the United States."13
If in the 1970s "the old structure of the economy, consisting of a production system served by a modest financial adjunct" still remained-Sweezy observed in 1995-by the end of the 1980s this "had given way to a new structure in which a greatly expanded financial sector had achieved a high degree of independence and sat on top of the underlying production system."14 Stagnation and enormous financial speculation emerged as symbiotic aspects of the same deep-seated, irreversible economic impasse.
This symbiosis had three crucial aspects: (1) The stagnation of the underlying economy meant that capitalists were increasingly dependent on the growth of finance to preserve and enlarge their money capital. (2) The financial superstructure of the capitalist economy could not expand entirely independently of its base in the underlying productive economy-hence the bursting of speculative bubbles was a recurrent and growing problem.15 (3) Financialization, no matter how far it extended, could never overcome stagnation within production.
The role of the capitalist state was transformed to meet the new imperatives of financialization. The state's role as lender of last resort, responsible for providing liquidity at short notice, was fully incorporated into the system. Following the 1987 stock market crash the Federal Reserve adopted an explicit "too big to fail" policy toward the entire equity market, which did not, however, prevent a precipitous decline in the stock market in 2000.16
These conditions marked the rise of what I am calling "monopoly-finance capital" in which financialization has become a permanent structural necessity of the stagnation-prone economy.
Class and Imperial Implications
If the roots of financialization are clear from the foregoing, it is also necessary to address the concrete class and imperial implications. Given space limitations I will confine myself to eight brief observations.
(1) Financialization can be regarded as an ongoing process transcending particular financial bubbles. If we look at recent financial meltdowns beginning with the stock market crash of 1987, what is remarkable is how little effect they had in arresting or even slowing down the financialization trend. Half the losses in stock market valuation from the Wall Street blowout between March 2000 and October 2002 (measured in terms of the Standard and Poor's 500) had been regained only two years later. While in 1985 U.S. debt was about twice GDP, two decades later U.S. debt had risen to nearly three-and-a-half times the nation's GDP, approaching the $44 trillion GDP of the entire world. The average daily volume of foreign exchange transactions rose from $570 billion in 1989 to $2.7 trillion dollars in 2006. Since 2001 the global credit derivatives market (the global market in credit risk transfer instruments) has grown at a rate of over 100 percent per year. Of relatively little significance at the beginning of the new millennium, the notional value of credit derivatives traded globally ballooned to $26 trillion by the first half of 2006.17
(2) Monopoly-finance capital is a qualitatively different phenomenon from what Hilferding and others described as the early twentieth-century age of "finance capital," rooted especially in the dominance of investment-banking. Although studies have shown that the profits of financial corporations have grown relative to nonfinancial corporations in the United States in recent decades, there is no easy divide between the two since nonfinancial corporations are also heavily involved in capital and money markets.18 The great agglomerations of wealth seem to be increasingly related to finance rather than production, and finance more and more sets the pace and the rules for the management of the cash flow of nonfinancial firms. Yet, the coalescence of nonfinancial and financial corporations makes it difficult to see this as constituting a division within capital itself.
(3) Ownership of very substantial financial assets is clearly the main determinant of membership in the capitalist class. The gap between the top and the bottom of society in financial wealth and income has now reached astronomical proportions. In the United States in 2001 the top 1 percent of holders of financial wealth (which excludes equity in owner-occupied houses) owned more than four times as much as the bottom 80 percent of the population. The nation's richest 1 percent of the population holds $1.9 trillion in stocks about equal to that of the other 99 percent.19 The income gap in the United States has widened so much in recent decades that Federal Reserve Board Chairman Ben S. Bernanke delivered a speech on February 6, 2007, on "The Level and Distribution of Economic Well Being," highlighting "a long-term trend toward greater inequality seen in real wages." As Bernanke stated, "the share of after-tax income garnered by the households in the top 1 percent of the income distribution increased from 8 percent in 1979 to 14 percent in 2004." In September 2006 the richest 60 Americans owned an estimated $630 billion worth of wealth, up almost 10 percent from the year before (New York Times, March 1, 2007).
Recent history suggests that rapid increases in inequality have become built-in necessities of the monopoly-finance capital phase of the system. The financial superstructure's demand for new cash infusions to keep speculative bubbles expanding lest they burst is seemingly endless. This requires heightened exploitation and a more unequal distribution of income and wealth, intensifying the overall stagnation problem.
(4) A central aspect of the stagnation-financialization dynamic has been speculation in housing. This has allowed homeowners to maintain their lifestyles to a considerable extent despite stagnant real wages by borrowing against growing home equity. As Pollin observed, Magdoff and Sweezy "recognized before almost anybody the increase in the reliance on debt by U.S. households [drawing on the expanding equity of their homes] as a means of maintaining their living standard as their wages started to stagnate or fall."20 But low interest rates since the last recession have encouraged true speculation in housing fueling a housing bubble. Today the pricking of the housing bubble has become a major source of instability in the U.S. economy. Consumer debt service ratios have been rising, while the soaring house values on which consumers have depended to service their debts have disappeared at present. The prices of single-family homes fell in more than half of the country's 149 largest metropolitan areas in the last quarter of 2006 (New York Times, February 16, 2007).
So crucial has the housing bubble been as a counter to stagnation and a basis for financialization, and so closely related is it to the basic well-being of U.S. households, that the current weakness in the housing market could precipitate both a sharp economic downturn and widespread financial disarray. Further rises in interest rates have the potential to generate a vicious circle of stagnant or even falling home values and burgeoning consumer debt service ratios leading to a flood of defaults. The fact that U.S. consumption is the core source of demand for the world economy raises the possibility that this could contribute to a more globalized crisis.
(5) A thesis currently popular on the left is that financial globalization has so transformed the world economy that states are no longer important. Rather, as Ignacio Ramonet put it in "Disarming the Market" (Le Monde Diplomatique, December 1997):
Financial globalization is a law unto itself and it has established a separate supranational state with its own administrative apparatus, its own spheres of influence, its own means of action. That is to say, the International Monetary Fund (IMF), the World Bank, the Organization of Economic Cooperation and Development (OECD) and the World Trade Organization (WTO)….This artificial world state is a power with no base in society. It is answerable instead to the financial markets and the mammoth business undertakings that are its masters. The result is that the real states in the real world are becoming societies with no power base. And it is getting worse all the time.
Such views, however, have little real basis. While the financialization of the world economy is undeniable, to see this as the creation of a new international of capital is to make a huge leap in logic. Global monopoly-finance capitalism remains an unstable and divided system. The IMF, the World Bank, and the WTO (the heir to GATT) do not (even if the OECD were also added in) constitute "a separate supranational state," but are international organizations that came into being in the Bretton Woods System imposed principally by the United States to manage the global system in the interests of international capital following the Second World War. They remain under the control of the leading imperial states and their economic interests. The rules of these institutions are applied asymmetrically-least of all where such rules interfere with U.S. capital, most of all where they further the exploitation of the poorest peoples in the world.
(6) What we have come to call "neoliberalism" can be seen as the ideological counterpart of monopoly-finance capital, as Keynsianism was of the earlier phase of classical monopoly capital. Today's international capital markets place serious limits on state authorities to regulate their economies in such areas as interest-rate levels and capital flows. Hence, the growth of neoliberalism as the hegemonic economic ideology beginning in the Thatcher and Reagan periods reflected to some extent the new imperatives of capital brought on by financial globalization.
(7) The growing financialization of the world economy has resulted in greater imperial penetration into underdeveloped economies and increased financial dependence, marked by policies of neoliberal globalization. One concrete example is Brazil where the first priority of the economy during the last couple of decades under the domination of global monopoly-finance capital has been to attract foreign (primarily portfolio) investment and to pay off external debts to international capital, including the IMF. The result has been better "economic fundamentals" by financial criteria, but accompanied by high interest rates, deindustrialization, slow growth of the economy, and increased vulnerability to the often rapid movements of global finance.21
(8) The financialization of capitalism has resulted in a more uncontrollable system. Today the fears of those charged with the responsibility for establishing some modicum of stability in global financial relations are palpable. In the early 2000s in response to the 1997–98 Asian financial crisis, the bursting of the "New Economy" bubble in 2000, and Argentina's default on its foreign debts in 2001, the IMF began publishing a quarterly Global Financial Stability Report. One scarcely has to read far in its various issues to get a clear sense of the growing volatility and instability of the system. It is characteristic of speculative bubbles that once they stop expanding they burst. Continual increase of risk and more and more cash infusions into the financial system therefore become stronger imperatives the more fragile the financial structure becomes. Each issue of the Global Financial Stability Report is filled with references to the specter of "risk aversion," which is seen as threatening financial markets.
In the September 2006 Global Financial Stability Report the IMF executive board directors expressed worries that the rapid growth of hedge funds and credit derivatives could have a systemic impact on financial stability, and that a slowdown of the U.S. economy and a cooling of its housing market could lead to greater "financial turbulence," which could be "amplified in the event of unexpected shocks."22 The whole context is that of a financialization so out of control that unexpected and severe shocks to the system and resulting financial contagions are looked upon as inevitable. As historian Gabriel Kolko has written, "People who know the most about the world financial system are increasingly worried, and for very good reasons. Dire warnings are coming from the most 'respectable' sources. Reality has gotten out of hand. The demons of greed are loose."23
- Gerald A. Epstein, "Introduction," in Epstein, ed., Financialization and the World Economy (Northampton, MA: Edward Elgar, 2005), 1.
- John Bellamy Foster, "Monopoly-Finance Capital," Monthly Review 58, no. 7 (December 2007), 1–14.
- The current usage of the term "financialization" owes much to the work of Kevin Phillips, who employed it in his Boiling Point (New York: Random House, 1993) and a year later devoted a key chapter of his Arrogant Capital to the "Financialization of America," defining financialization as "a prolonged split between the divergent real and financial economies" (New York: Little, Brown, and Co., 1994), 82. In the same year Giovanni Arrighi used the concept in an analysis of international hegemonic transition in The Long Twentieth Century (New York: Verso, 1994).
- Harry Magdoff first raised the issue of a growing reliance on debt in the U.S. economy in an article originally published in the Socialist Register in 1965. See Harry Magdoff and Paul M. Sweezy, The Dynamics of U.S. Capitalism (New York: Monthly Review Press, 1972), 13–16.
- Robert Pollin, "Remembering Paul Sweezy: 'He was an Amazingly Great Man'" Counterpunch, http://www.counterpunch.org, March 6–7, 2004; "The Man Who Explained Empire: Remembering Harry Magdoff," Counterpunch, http://www.counterpunch.org, January 6, 2006.
- Paul M. Sweezy, "More (or Less) on Globalization," Monthly Review 49, no. 4 (September 1997), 3–4.
- Paul A. Baran and Paul M. Sweezy, Monopoly Capital (New York: Monthly Review Press, 1966).
- James Tobin, "On the Efficiency of the Financial System," Lloyd's Bank Review, no. 153 (1984), 14–15.
- In the following analysis I follow a long-standing economic convention in using the term "real economy" to refer to the realm of production (i.e. economic output as measured by GDP), as opposed to the financial economy. Yet both the "real economy" and the financial economy are obviously real in the usual sense of the word.
- Harry Magdoff and Paul M. Sweezy, Stagnation and the Financial Explosion (New York: Monthly Review Press, 1987), 149. Magdoff and Sweezy were replying to an editorial in Business Week concluding its special September 16, 1985, issue on "The Casino Society."
- Paul M. Sweezy, "Economic Reminiscences," Monthly Review 47, no. 1 (May 1995), 8; Lukas Menkhoff and Norbert Tolksdorf, Financial Market Drift (New York: Springer-Verlag, 2001).
- The failure of investment banking to regain its position of power at the very apex of the system (as the so-called "money trust") that it had attained in the formative period of monopoly capitalism can be attributed to the fact that the conditions on which its power had rested in that period were transitory. See Paul M. Sweezy, "Investment Banking Revisited," Monthly Review 33, no. 10 (March 1982).
- Harry Magdoff and Paul M. Sweezy, The End of Prosperity (New York: Monthly Review Press, 1977), 35.
- Sweezy, "Economic Reminscences," 8–9.
- This is in line with the financial instability hypothesis of Keynes and Hyman Minsky. See Minsky, Can "It" Happen Again? (Armonk, New York: M. E. Sharpe, 1982).
- Robert W. Parenteau, "The Late 1990s' US Bubble," in Epstein, ed., Financialization and the World Economy, 136–38.
- Doug Henwood, After the New Economy (New York: The New Press, 2005), 231; Fred Magdoff, "Explosion of Debt and Speculation," Monthly Review 58, no. 6 (November 2006), 7, 19; Epstein, "Introduction," 4; Garry J. Schinasi, Safeguarding Financial Stability (Washington, D.C.: International Monetary Fund, 2006), 228–32.
- Greta R. Krippner, "The Financialization of the American Economy," Socio-economic Review 3, no. 2 (2005), 173–208; James Crotty, "The Neoliberal Paradox," in Epstein, ed., Financialization and the World Economy, 77–110.
- Edward N. Wolff, "Changes in Household Wealth in the 1980s and 1990s in the U.S." The Levy Economics Institute of Bard College, Working Paper No. 407 (May 2004), table 2, http://www.levy.org.
- Pollin, "The Man Who Explained Empire."
- See Daniela Magalhães Pates and Leda Maria Paulani, "The Financial Globarlization of Brazil Under Lula" and Fabríco Augusto de Loiveira and Paulo Nakatini, "The Brazilian Economy Under Lula," in Monthly Review 58, no. 9 (February 2007), 32–49.
- International Monetary Fund, The Global Financial Stability Report (March 2003), 1–3 and (September 2006), 74–75.
- Gabriel Kolko, "Why a Global Economic Deluge Looms," Counterpunch, http://www.counterpunch.org, June 15, 2006.
Jul 02,2010 | huffingtonpost.com
A New Labor Contract
Think of the work experience of a Wall Street analyst. (Here the ethnography work of Karen Ho, particularly her book Liquidated, is useful.) It's a form of labor with a strictly quantitatively graded measurement system, "rank-and-yank" style of rapid promotions, and massive turnover and layoffs. This rampant job insecurity is made coherent through strict market identification, with a special emphasis on working for power, prestige and most of all, cash.
It's a job where being "smart" and "working hard" are the primary values that override any other concerns. It is fiercely hierarchical, centered around a pernicious form of meritocratic elitism. The "superstar" contract generates inequality, uncertainty and anxiety but also ruthless internal competition and an adversarial relationship with clients and co-workers.
A New Elite
There's a lot of talk about brain drain as a result of finance. Our smartest minds are dedicating their lives to finding ways to trade ahead of our pensions and 401(k)s 15 milliseconds in order to make a windfall, instead of leading the globe on any number of much more worthwhile endeavors. This is a major problem. Simon Johnson is a professor of entrepreneurship at the Sloan School of Management at MIT and must see this unfortunate trend firsthand. I would love to hear more from him on this matter.
But I'd like to go further and note that increasingly our elites, be it government, corporate, etc., will come from the financial sector. Notice Ezra Klein's interview with a Harvard student who works on Wall Street. For him, it's something to do for a few years before moving on to elite positions in other parts of the economy.
But what kind of future elites will the next decades feature when their primary experience of work and the economy will be fashioned through work in the financial market? Obviously, the superstar economy and "rip their face off" client relationship undermines any potential for solidarity. But it also undermines entrepreneurship, even though it is surrounded by business. When a business is something to manage from the aerial view of a spreadsheet, when it is something to breakup or build up solely for the purpose of manipulating a stock price in the short term, it isn't part of the organic process of finding a way of advancing the economy through meeting the needs of consumers and a work force.
A disadvantage to this crisis, as opposed to the 1970s Keynesian crash, was that it occurred so fast that it became another policy issue instead of a call to rethink the way our real economy is put together. With the clock already running on next major financial collapse, I hope there will be time to take a step back and realize that the problems here aren't some rich people ripping off other rich people, but that this new financial power is shaping the world and the experiences of millions of people who aren't directly on Wall Street.
Jun 30, 2010 | huffingtonpost.com
Tyler Cowen agrees with our argument in 13 Bankers that there is a confluence of interests between the financial sector and the government that results in policies that are generally favorable to the banks. Cowen argues, however, that it is Washington, not Wall Street, that is calling the shots. The federal government needs a large and concentrated financial sector and liquid markets in order to finance its large and increasing debts, and for that reason has allowed the megabanks to flourish. In Cowen's words:It's our government deciding to assemble a cooperative ruling coalition -- which includes banks -- at the heart of its fiscal core. It's our government deciding who belongs to this coalition and who does not, mostly for reasons of political expediency and also a perception - correct or not -- of what is best for the welfare of American voters. If we don't in this year 'get tough' with banking regulation, it's because our government itself doesn't want to, not because of some stubborn recalcitrant Republicans.
One piece of evidence Cowen provides is the government's past willingness to bail out entities other than major banks, such as Mexico and (via the International Monetary Fund) emerging markets such as Indonesia. I find this not entirely convincing, since the indirect beneficiaries of those bailouts often included U.S. banks who had lent money indiscriminately to the latest developing-world "economic miracle." But it is certainly true that the federal government has motives other than simply looking out for Citibank.
More generally, I would argue that our interpretation and Cowen's are not necessarily contradictory. There is certainly a symbiosis between the banking sector and the federal government, although our book is predominantly about one side of that relationship. When push came to shove in late 2008, the banks' ultimate power was not that they were secretly controlling the levers of power, but that their place at the center of the financial system enabled them to hold the real economy hostage. It was politicians in Washington who made the decisions. In early 2009, President Obama tried to make it clear that he was taking orders from no bankers. But he, too, decided that the government needed the banks it had -- instead, for example, of taking over the weakest megabanks and making them wards of the state.
Cowen is no doubt right when he says that the government finds it convenient to manage its debts through a handful of broker-dealers. In fact, the government debt is handled by a continuum of entities, from the Treasury Department (part of the administration) to the Federal Reserve Board of Governors (an independent government agency) to the Federal Reserve Bank of New York (a private institution with a government mandate) to the Wall Street broker-dealers.
Still, though, I find it unsatisfying to say that the weakness of financial reform is that "our government itself doesn't want to [get tough]" -- unsatisfying because the government is the product, and the creature, of private interests. And if "the government" has a certain view of the world -- one in which large, sophisticated financial institutions play a central role -- in this case that view was largely promulgated by the financial sector and in service of its own interests.
The counterargument to my counterargument (I don't go to law school for nothing) is that governments, like banks, are made up of people, and those people have their own interests apart from those of either the voters who vote for them or the corporations who fund them. So "the government" can constitute a distinct interest group.
If this is the case, I still think the striking fact of the past few decades is that the "government employees" interest group and the "bankers" interest group came to see their interests as being largely identical, at least on issues affecting the financial sector. And the problem is that the interests of those two groups are not the same as the interests of the economy or society at large. The solution still lies in politics: convincing the government employees that they should represent the interests of society at large, not those of the banking sector. But insofar as the government independently needs the financial system we have, that only makes the job that much tougher.
Jun 29, 2010 | huffingtonpost.com
The chairman and CEO of Bertelsmann Foundation Dr. Gunter Thielen, speaking at the Bertelsmann/Financial Times conference on the worldwide financial crisis in Washington recently remarked ,
"If we continue with casino capitalism, then sooner or later the legitimacy of our entire economic system will come into question on a global level. "
And, we all heard Senator Claire McCaskill at the hearings with Goldman Sachs senior executives exclaim, "You are all the house, you're the bookie. [Clients] are booking their bets with you. I don't know why we need to dress it up. It's a bet."
The casino comparison from diverse onlookers on the financial crisis is an apt and correct one. While the government regulators were asleep or looking the other way they were not regulating Wall Street. Simon Johnson feels that the "regulators are now completely captured by the big banks."
It is beyond me that there is not more outrage around the country. After watching the smug and arrogant Goldman executives, one felt like demanding that they be contrite and ashamed of what they had done to our financial system. Yet there they sat, looking bored, not being back in the Big Apple making their bets so they can rake in their bonuses. Can anyone seriously explain how you bet against investments that you are making to your clients? Is there not fraud or at least misrepresentation involved in these transactions?
And, let us not forget that Congress was also asleep at the wheel and did not foresee or try to prevent the financial crisis. While the traders from Goldman played their role as arrogant and aloof from the financial storm, the senators all performed their roles as outraged citizens who yelled before the cameras so the voters could see their populist anger. Where was their outrage while the economy was tanking and people who could not afford homes were given loans as if they were candy?
While Congress and the administrations' answer was to spend boatloads of our money on the stimulus package, the head of Pew Research Center Andrew Kohut, speaking at the Bertelsmann/FT conference said, "The public feels that the stimulus and TARP did not work".
While Americans continue to be bombarded by the reckless casino attitude and practices that exist on Wall Street and in our largest banks we see the rest of the world is not immune from similar economic and financial problems--most of them man -made.
Greece is trying to keep its head above water and not default on its large debt. Portugal and other European Union nations are also reeling from a large debt and too much public spending.
Having worked at the European Commission for fifteen years and given many talks on the euro in its early years I would point out that the introduction of the single currency was more of a political event than an economic one.
If this was purely an economic problem across Europe we would see a different outcome. However, the EU countries have too much invested in the success of the euro to see it collapse. They have too much political capital involved to let the single currency fail.
Europe and the U.S. are so intertwined with trade and investments that a collapse of the Greek economy (some are calling Greece the Lehman Brothers of Europe) would affect not only the rest of its EU partners, but America as well.
Are countries like banks too big to fail? Are traders at Goldman Sachs really allowed to go long and short on the same trade? Are government regulators who didn't regulate beyond being fired?
As Simon Johnson stated at his talk at Johns Hopkins, "There is no social value for having large banks. And, big banks should be able to fail."
As anyone who has taken Economics 101 knows the laws of capitalism provide winners and losers. If you provide enough campaign money and lobby effectively I guess that negates you from losing in today's America. This has to change. If traders take unacceptable risks and do it from our banks they need to suffer the consequences when their deals go south.
We should break up our largest banks, as being bigger does not provide any guarantee of anything these days except, it appears, immunity from any wrongdoing. We should control the outrageous behavior of casino gamblers posing as bankers and seriously curtail their activities in trading that cause more harm than good.
Big is not better and wrong is wrong. Get some serious financial reform with real teeth that can send people who break the law to jail. Move our casinos from the banks and insurance firms in New York back to Las Vegas where they belong. As Simon Johnson said, "Bets in Vegas don't upset the U.S. financial system".
We may not be able to change the smugness and arrogance of the Goldman traders who testified before Congress but we certainly can pass tougher legislation that could put them in prison if they break the law. Casino capitalism has to end before it is allowed to bring on another financial crisis.
June 28, 2010 PrudentBear
To explain our current plight, I use the terminology of The Fourth Turning (1997) by Strauss and Howe. This twenty-year Crisis phase began during 2005 – 2008 with the collapse of the housing bubble and subsequent repercussions on the worldwide financial system. The progression from High to Awakening through the Unraveling took from 1946 until 2006. The intensity of a Crisis is very much dependent upon how a country and its citizens prepare for the Crisis during the final years of the Unraveling. The last Unraveling period in U.S. history from 1984 through 2005 was symbolized by Boomer greed, materialism, debt and selfishness.
The Unraveling began during the second Reagan term with the "Morning in America" landslide re-election. The Dow Jones Industrial Average on January 1, 1984 was 1,259. The national debt was $1.6 trillion. This generation of 76 million over-indulged spoiled social activists is the proverbial pig in a python. Whatever path this generation chooses to take transforms the country for better or worse. The term Yuppie was coined in the early 1980s as the egocentric Boomers poured onto Wall Street. The country was exhausted from the 1960s turmoil and the depressing 1970s. Failed presidencies, oil shortages, raging inflation, and American hostages had left an America that was looking for a renaissance. Reagan's first term required extreme measures by Federal Reserve Chairman Paul Volcker to break the back of inflation. By raising interest rates to 18%, Volcker set the stage for a 20-year bull market in stocks and bonds. Reagan survived an assassination attempt, the U.S. military conducted a successful operation in Grenada, Reagan fired 11,000 air traffic controllers, and an unprecedented peacetime military buildup was initiated. This created an atmosphere for economic revival, led by the Boomers.
The new laissez faire era was based on Reagan's belief that government was the problem, not the solution. His goal was to cut the size of government while slashing taxes and unleashing the animal spirits of the free market. Reagan was a rhetorical genius. It is a shame his soaring rhetoric did not match what actually ensued. Corporate tax rates were decreased from 50% to 38% by the end of Reagan's term. Corporate America was delighted. The tax savings permitted profits to soar. This additional capital could have been used to invest in the business. The Harvard-trained CEOs decided it was more beneficial to pay them outrageously high compensation and to buy back their own stock in order to inflate earnings per share.
The tone for the next twenty years was set. Reagan's policies did reignite the animal spirits of America. Reagan's defense buildup increased annual spending from $303 billion in 1980 to $426 billion in 1988, a 40% surge. This most certainly contributed to the collapse of the Soviet Union. They were a hollowed out oak tree and Reagan's defense buildup was the gust of wind that blew the rotting tree over. His achievements were great, but his failure to reduce government spending will haunt the country for decades and planted the seeds of economic disaster. The federal government spent $590 billion in 1980. In 1988, federal spending had grown to $1.064 trillion. Rhetoric did not translate into action. Politicians have always been good at following through on promises that buy them votes. The tough stuff can be pushed off to the next guy.
The 1980s proved to be a confidence-building decade after two decades of tumult. With the most egocentric self-centered generation in history entering the prime of their careers, a double shot of renewed confidence and debt accumulation began a cycle of unprecedented greed and hubris.
The self-absorbed yuppies' pursuit of wealth, power, and material possessions was captured accurately in the 1987 movie Wall Street and Tom Wolfe's fantastic 1987 novel Bonfire of the Vanities.
More Wall Street "inventions" like program trading, portfolio insurance, and arbitrage combined with hype and hubris to cause a 508-point crash on October 19, 1987. This 22.6% one-day drop was the largest percentage decline in history. This scared the average investor out of the market for years. It also unleashed a 20-year reign of banking terror, as the Greenspan Put was born. Alan Greenspan became Federal Reserve Chairman in August 1987. His first major act was to pour billions of liquidity into the market after the Crash. This was the first of his many risk-enhancing acts over the next two decades.
As the Boomers grew rich and cynical on the street of dreams, moralistic charlatans like Jesse Jackson and Al Sharpton exacted profits for themselves and their constituents. The working middle class sank deeper into despair as their wages continued a two decade long stagnation. Real hourly earnings were the same in 2005 as they were in 1984, and 10% below the level of 1972.
The appearance of progress on some issues overshadowed the underlying deterioration of societal institutions and practices. Social Security was "saved" by Alan Greenspan and his commission. Essentially he manipulated the CPI calculation downward, screwing future generations of seniors out of their rightful payouts. Politically difficult decisions regarding Medicare and Medicaid were deferred to sometime in the distant future. With oil prices averaging $20 per barrel through the 1980s and 1990s, a coherent long-term energy strategy seemed unnecessary to the next-election-cycle politicians. The deregulation of the savings & loan industry gave them many of the capabilities of banks, without the same regulations as banks. Imprudent real estate lending, fraud and insider transactions by S&L executives, protected by Washington politicians, led to the first financial crisis. The failure of 747 thrifts and losses of $160 billion to the taxpayer can be attributed to lax oversight and fraud.
The Berlin Wall fell as communism collapsed under the weight of central planning, corruption, and fraud. By 1991, the U.S. was again at war. The first Gulf War was considered a moral war as the United States came to the rescue of Kuwait and Saudi Arabia. Using traditional military maneuvers, General Schwarzkopf obliterated Sadaam Hussein's Republican Guard, but there was no consensus to follow through and eliminate Hussein.
The United States has experienced a three-decade-long "expenditure cascade." The cascade begins among top earners, which encourages the middle class to spend more which, in turn, encourages the lower class to spend more. Ultimately, these expenditures reduce the amount each family saves. This is a dangerous reaction for those at the bottom who have little disposable income originally and even less after they attempt to keep up with others' spending habits. The personal savings rate was 12% in the early 1980s and declined to negative 1% by 2005. The expenditure cascade couldn't have occurred without easy access to debt. The question that must be asked is, who benefits from debt and who pays?
Without the corporate consumerism marketing machine, an unlimited amount of credit provided by bankers, and ultra-low interest rates supplied by the Federal Reserve, the delusions of grandeur could not have been realized. Credit cards didn't even exist until 1968. Until the 1990s mortgage lenders followed the 28/36 rule. Your mortgage payment, including taxes and insurance, couldn't exceed 28% of your monthly gross income. All of your debt payments couldn't exceed 36% of your monthly gross income. Homebuyers rarely put down less than 10% of the home's value. Home equity loans were virtually non-existent. The subprime loan market for homes and automobiles was miniscule. In the early 1980s auto loans averaged 45 months and buyers put 12% down on the purchase. By the mid 2000s auto loans averaged 64 months with only 5% down on the purchase. By 1999, 40% of all cars on the highway were leased. The proliferation of easy credit allowed average people to live a life of excessive opulence, occupying 7,000-sq-ft McMansions, driving BMWs, and wearing Rolex watches. Americans bought so much stuff on credit they couldn't fit it all in their oversized abodes, so they rented outside storage. In 1984 there were 6,601 facilities with 290 million square feet of rentable self storage in the U.S. In 2009, there were 46,000 self-storage facilities with 2.21 billion square feet, a 762% increase.
Delusional middle and lower class Boomers believed they were equal to the top 1% of ultra-wealthy because they were living like them. As Orwell noted, "All animals are equal, but some animals are more equal than others." Those that were "more equal" worked on Wall Street. The repeal of the Glass-Steagall Act in 1999 with overwhelming majorities in both Houses of Congress and cheered on by Wall Street-groomed Secretary of the Treasury Robert Rubin, opened Pandora's Box. Bank holding companies started dealing in mortgage-backed securities, credit default swaps, and structured investment vehicles. A blizzard of products solely designed to generate fees while ignoring the banks' fiduciary duty to their clients was unleashed. Subprime mortgages surged from 5% of all mortgages to 30% by 2008, as issuing the mortgage became detached from the risk of the mortgage. The issuer of the loan had no risk, since the mortgages were immediately bundled and sold off to investors (suckers).
Charles Mackay in his book Extraordinary Popular Delusions and the Madness of Crowds , written in 1841, captures the essence of what has happened:
"Money, again, has often been a cause of the delusion of the multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper."
The nation had an opportunity to come to its senses with the election of George Bush in 2000. The gravity of the coming Saecular Winter could have been moderated through prudent actions taken on the fiscal, political, and defense fronts. The autumnal Unraveling is a time of foreboding and a brooding pessimism. As a howling wind begins to blow, leaves turn brown and wither, determined squirrels scurry around collecting acorns in preparation for the bitter snowy Winter ahead. The opportunity to judiciously prepare was wasted after the September 11, 2001 terrorist attack on America. The result was that the Crisis that arrived in 2005-2008 will be more painful and possibly fatal for the United States. The multiple wars of choice, immense housing bubble, stunning government deficits and unaddressed unfunded liabilities have created a nation weakened and unprepared for the harsh reality ahead. The Empire of Debt has reached epic proportions.
It took two more decades, but the Wall Street money culture is in the process of being discredited. Americans are slowly coming to the realization that unbridled greed is not the same as capitalism. Excessively low interest rates punish savers and senior citizens, while benefitting borrowers, risk takers and Wall Street. Savings leads to investment, while borrowing leads to impoverishment. The actions taken thus far by politicians, government bureaucrats, and the Federal Reserve are the exact opposite of what was required. The next leg down in this Greater Depression will thoroughly discredit those who have promoted a money culture over those virtues that will benefit society in the long run. The current Crisis will require personal sacrifice, renewed community spirit, public consensus, and truth. Failure could prove fatal for our nation. The best of human nature must win out over greed, ignorance, and love of power. Our future hangs in the balance.
"It has always seemed strange to me… the things we admire in men, kindness and generosity, openness, honesty, understanding and feeling, are the concomitants of failure in our system. And those traits we detest, sharpness, greed, acquisitiveness, meanness, egotism and self-interest, are the traits of success. And while men admire the quality of the first they love the produce of the second." – John Steinbeck
Jim Quinn is a senior director of strategic planning for a major university.
The third form is finance capitalism, in which money is made from the business of buying, selling and trading various financial instruments, for example, home mortgages, and most recently, their "securitized" form. That is the form which more and more is taking over American capitalism. In the first decade of this century, the financial sector made 41% of the total profits accumulated in the United States ("The Quiet Coup," Simon Johnson, The Atlantic, May, 2009). Some that profit was made the old-fashioned way, by collecting interest on loans made.
But increasingly, in the financial sector, profits were made by trading pieces of paper, some of which were of such a complicated structure that very few people actually understood how they were pieced together, to say nothing of being to explain their structures to anyone else. The key to making profits with these instruments was to be able to convince a potential buyer that they would become evermore valuable. This was the case even though their intrinsic worth was based on other pieces of paper that had been sliced and diced into such small bits of supposed base value that no one could ever trace them to their source. We all know what happened when the belief-in-the-ever-increasing-value-of-financial-instruments-that-few-people-understood collapsed
This post appeared as an op-ed in Mint, India's second largest business newspaper.
The financial market upheaval that started in May is a stark reminder that the conditions that produced the global financial crisis of 2007-08 have not been resolved. The sucking sound of deflation emanating from Europe and the creaking of bank balance sheets are calling into question the cheery assumption that patching up the financial system with baling wire and duct tape was a viable long-term plan.
With a large private sector debt overhang in most advanced economies, deflationary pressures are hard to forestall. It has become unacceptable politically to bail out banks, although monetary authorities such as the European Central Bank are creating SIV equivalents to do just that. Defaults look inevitable on a number of fronts, from homeowners in the US who are increasingly willing to abandon their mortgages, to the riskiness of not just Hungary, but other Eastern European borrowers as well (German investors have long expected serious trouble in Austria, whose banks were gateway lenders to Eastern Europe).
But why was the opportunity to restructure debts and revamp the financial system missed? In early 2009, the banking industry was on the ropes. Both the stock and the credit default swaps markets indicated that many of the big players were at serious risk of failure. But rather than bring vested banking interests to heel, the Obama administration and its counterparts in the UK and the European Union instead chose to reconstitute, as much as possible, the same industry whose reckless pursuit of profit had thrown the world economy off the cliff.
Why did we witness such a failure of imagination and will? Policymakers seem unable to recognize that they are in the middle of a breakdown of an economic paradigm.
In 1776, Adam Smith published The Wealth of Nations. In it, he argued that self-interested action sometimes produced, as if by "an invisible hand", results that were beneficial to broader society. Smith also pointed out that self-interest could just as readily do harm. He fiercely criticized both how employers colluded to keep wages low, as well as the "savage injustice" that European mercantilist interests had "commit(ted) with impunity" in colonies in Asia and the Americas.
Smith's ideas were cherry-picked and turned into a simplistic ideology that dominates university economics departments and policymaking. This theory proclaims that the "invisible hand" ensures that economic self-interest will always lead to the best outcomes imaginable. It follows that any restrictions on the profit-seeking activities of individuals and corporations are inefficient and nonsensical.
Uncritical allegiance to these precepts over the last 30 years has produced a world in which corporations, especially in finance, are far less restricted in their pursuit of profit. In my book Econned, I describe how this lawless environment allowed the financial services industry to pursue its own unenlightened self-interest. The industry has become systematically predatory. Its employees did not confine their predation to outsiders; their efforts to loot their own firms nearly destroyed the industry and the entire global economy. Similar destructive behaviour by other players, often viewed through a distorted lens that saw all unconstrained commercial behaviour as virtuous, added more fuel to the conflagration.
India, in rejecting much of this ideology, and maintaining firm control over its financial sector, escaped the worst of the crisis. But despite the abject failure of this line of thinking, its hold remains firm in the West. The parallels to the 1920s and the Great Depression are striking. The key elements of the current system then and now-lightly regulated financial firms and markets, comparatively unrestricted and destabilizing international capital flows, economic growth dependent on rising levels of consumer debt-are no longer viable. However, no one in authority seems able to see that the ancien regime is well past its sell-by date. They cling to it because the old system comported itself well for a protracted period, just as the now-repudiated crisis and deflation-generating gold standard once did. Thus, the authorities reflexively put duct tape on the machinery rather than hazard a teardown.
But is this paralysis just a failure of imagination on the part of policymakers? They are not just cognitively captured by the financial service industry's "free markets" ideology. They are also beholden to banksters for campaign contributions and for their careers, both inside and outside Washington, DC. It is not a stretch to say that most central bankers, treasury officials, and Congressman are now sock puppets for global finanzkapital.
In the wake of the Great Depression, it took more than a decade of experimentation to construct a new architecture. Among its tenets was the recognition that successful markets depended on tough policing, and the importance of the prosperity of the middle class, which in turn meant workers should reap their fair share of productivity gains. But the amorphous and often contradictory "free markets" ideology has conditioned policymakers and the public to view unregulated commerce as virtuous, when unconstrained markets are, in fact, a brawl. In the Anglo-Saxon world where this model has been taken the furthest, we've seen shallow expansions, stagnant average worker wages and rising income disparity, with very big gains at the very top. That's a particularly difficult model to dislodge. As former International Monetary Fund chief economist Simon Johnson has pointed out, reform programmes usually fail unless some members of the oligarchy break ranks. Unfortunately, it may take an unmanageable crisis to convince them.
"But is this paralysis just a failure of imagination on the part of policymakers? They are not just cognitively captured by the financial service industry's "free markets" ideology. They are also beholden to banksters for campaign contributions and for their careers, both inside and outside Washington, DC. It is not a stretch to say that most central bankers, treasury officials, and Congressman are now sock puppets for global finanzkapital." Yves
Please tell me well what part of a government backed fractional reserve banking cartel in a government enforced money supply sounds like the "free market"?
We can attempt to "out-regulate" the rest of the world or we can take a truly principled approach to money creation according to principles of liberty and the rule of law.
Please read ECONNED. Over the course of about 1/3 of the book, I dissect both neoclassical economics (the dominant school as far as policymaking is concerned) and financial economics, and show how the efforts to mathematicize the discipline have led economics badly astray. I discuss specifically how some of the key proofs lead to internal contradictions and for several crucial ones, have later had their creators distance themselves from them. I further discuss how the "free markets" ideology is incoherent and riddled with internal contradictions, yet has served as the basis for a radical program of deregulation of the financial services industry, which was a particularly bad idea, given the inherent propensity of financial markets to boom-bust cycles.
The balance of ECONNED discusses the results: predatory behavior (and not at the retail end, which has been amply covered in the media, but in the institutional side of the business), looting, and played a direct role in the global financial crisis.
The book specifically discusses why even the less incoherent "free markets" formulation is an abstraction that can never be attained, and why efforts to move closer to that ideal will not necessarily lead to better outcomes which is a core hidden assumption of "free markets" advocates.
@ F. Beard … Liberty and the "rule of law" sound great until we recognize that market players have consistently invoked Adam Smith's system of "natural liberty" to pursue their own selfish ends. Unfortunately, while they channel the spirit of Adam Smith to justify their efforts in the market, their activities regularly undermine the spirit of the law in ways that lead to market imbalances and societal disconnect. These activities violate Adam Smith's "laws of justice" and his "order of nature and reason" on such a regular basis that I'm baffled as to why predatory behavior and outright looting on the part of large firms surprises anyone today.
Still, people like Milton Friedman – who was a smart man – run with these simplistic caricatures of how (they think) our market world should be. This leads them to develop unrealistic "umpire" models of government which place market players on a pedestal. The result is a make believe world where some kind of virtuous Homo Economicus Man exists. Unfortunately their virtuous Homo Economicus Man resembles nothing anyone of us has seen on a regular basis, beyond a local market setting. Milton Friedman got alot of things wrong
( http://markmartinezshow.blogspot.com/2010/05/what-milton-friedman-got-wrong-exam.html ), and his umpire model was one of them.
Read Econned (Full disclosure, I'm using it this fall in one of my classes). It really helps move us away from the unicorn theories of markets that continue to dominate our thinking on markets today.
March 11, 2010 | Senator for Delaware Newsroom - Floor Statement
Introduction: Where the Burden of Proof Lies
Financial regulatory reform is perhaps the most important legislation that the Congress will address for many years to come. Because if we don't get it right, the consequences of another financial meltdown could truly be devastating.
In the Senate, as we continue to move closer to consideration of a landmark bill, however, we are still far short of addressing some of the fundamental problems – particularly that of "too big to fail" – that caused the last crisis and already have planted the seeds for the next one. And this is happening after months of careful deliberation and negotiations, and just a year and a half after the virtual meltdown of our entire financial system.
Following the Great Depression, the Congress built a legal and regulatory edifice that endured for decades. One of the cornerstones of that edifice was the Glass-Steagall Act, which established a firewall between commercial and investment banking activities. Another was a federally guaranteed insurance fund to back up bank deposits. Other rules were imposed on investors to tamp down rampant speculation, like margin requirements and the uptick rule on short selling.
That edifice worked well to ensure financial stability for decades. But in the past thirty years, the financial industry, like so many others, went through a process of deregulation. Bit by bit, many of the protections and standards put in place by the New Deal were methodically removed. And while the seminal moment came in 1999 with the repeal of Glass-Steagall, that formal rollback was primarily the confirmation of a lengthy process already underway.
Indeed, after 1999, the process only accelerated. Financial conglomerates that combined commercial and investment banking consolidated, becoming more leveraged and interconnected through ever more complex transactions and structures, all of which made our financial system more vulnerable to collapse. A shadow banking industry grew to larger proportions than even the banking industry itself, virtually unshackled by any regulation. By lifting basic restraints on financial markets and institutions, and more importantly, failing to put in place new rules as complex innovations arose and became widespread, this deregulatory philosophy unleashed the forces that would cause our financial crisis.
I start by asking a simple question: Given that deregulation caused the crisis, why don't we go back to the statutory and regulatory frameworks of the past that were proven successes in ensuring financial stability?
And what response do I hear when I raise this rather obvious question? That we have moved beyond the old frameworks, that the eggs are too scrambled, that the financial industry has become too sophisticated and modernized and that it was not this or that piece of deregulation that caused the crisis in the first place.
Mind you, this is a financial crisis that necessitated a $2.5 trillion bailout. And that amount includes neither the many trillions of dollars more that were committed as guarantees for toxic debt nor the de facto bailout that banks received through the Federal Reserve's easing of monetary policy. The crisis triggered a Great Recession that has thrown millions out of work, caused millions to lose their homes, and caused everyone to suffer in an American economy that has been knocked off its stride for more than two years.
Given the high costs of our policy and regulatory failures, as well as the reckless behavior on Wall Street, why should those of us who propose going back to the proven statutory and regulatory ideas of the past bear the burden of proof? The burden of proof should be upon those who would only tinker at the edges of our current system of financial regulation. After a crisis of this magnitude, it amazes me that some of our reform proposals effectively maintain the status quo in so many critical areas, whether it is allowing multi-trillion-dollar financial conglomerates that house traditional banking and speculative activities to continue to exist and pose threats to our financial system, permitting banks to continue to determine their own capital standards, or allowing a significant portion of the derivatives market to remain opaque and lightly regulated.
To address these problems, Congress needs to draw hard lines that provide fundamental systemic reforms, the very kind of protections we had under Glass-Steagall. We need to rebuild the wall between the government-guaranteed part of the financial system and those financial entities that remain free to take on greater risk. We need limits on the size of systemically significant non-bank players. And we need to regulate effectively the derivatives market that caused so much widespread financial ruin. It is my sincere hope that we don't enact compromise measures that give only the illusion of change and a false sense of accomplishment. If we do, then we will only have set in place the prelude to the next financial crisis.
The Steady Removal of Glass-Steagall Protections
First, however, let us examine the origins – both obscure and well-known – of the Great Recession of 2008. As I have already noted, the regulators began tearing down the walls between commercial banking and investment banking long before the repeal of Glass-Steagall. Through a series of decisions in the 1980s and 1990s, the Federal Reserve liberalized prudential limitations placed upon commercial banks, allowing them to engage in securities underwriting and trading activities, which had traditionally been the particular province of investment banks. One fateful decision in 1987 to relax Glass-Steagall restrictions passed over the objections of then Federal Reserve Chairman Paul Volcker, the man who is today leading the charge to restrict government-backed banks from engaging in proprietary trading and other speculative activities.
With the steady erosion of these protections by the Federal Reserve, the repeal of Glass-Steagall had become a fait accompli even before the passage of the Gramm Leach Bliley Act (GLBA) in 1999. In effect, by passing GLBA, Congress was acknowledging the reality in the marketplace that commercial banks were already engaging in investment banking. As the business of finance moved from bank loans to bonds and other forms of capital provided by investors, commercial banks pushed the Federal Reserve to relax Glass-Steagall standards to allow them to underwrite bonds and make markets in new products like derivatives. Even before GLBA was passed, J.P. Morgan, Citigroup, Bank of America and their predecessor organizations had all become leaders in those businesses.
After Glass-Steagall's Repeal: The Opening of the Floodgates
If the changes in the financial marketplace that led to the repeal of Glass-Steagall took place over many years, the market's transformation after 1999 was swift and profound.
The Emergence of Mega Banks
First, there was frenzied merger activity in the banking sector, as financial supermarkets that had bank and nonbank franchises under the umbrella of a single holding company bought out smaller rivals to gain an ever-increasing national and international footprint. While the Riegle-Neal Banking of Act of 1994, which established a 10% cap nationally on any particular bank's share of federally-insured deposits, should have been a barrier for at least some of these mergers, regulatory forbearance permitted them to go through anyway. In fact, then Citicorp's proposed merger with Travelers Insurance was actually a major rationale behind the Glass-Steagall Act. Most of the largest banks are products of serial mergers. For example, J.P. Morgan Chase is a product of J.P. Morgan, Chase Bank, Chemical Bank, Manufacturers Hanover, Banc One, Bear Stearns, and Washington Mutual. Meanwhile, Bank of America is an amalgam of that predecessor bank, Nation's Bank, Barnett Banks, Continental Illinois, MBNA, Fleet Bank, and finally Merrill Lynch.
Financial Disintermediation and the Rise of Shadow Banking
Second, the business of finance was changing. Disintermediation, the process by which investors directly fund businesses and individuals through securities markets, was already in full bloom by the time of the repeal of Glass-Steagall. This was demonstrated by the dramatic growth in money market fund and mutual fund assets and by the fact that corporate bonds actually exceeded non-mortgage bank loans by the middle of the 1990s.
The subsequent boom in structured finance took this process to ever greater heights. Securitization, whereby pools of illiquid loans and other assets are structured, converted and marketed into asset-backed securities (ABS), is in principle a valuable process that facilitates the flow of credit and the dispersion of risk beyond the banking system. Regulatory neglect, however, permitted a good model to mutate and grow into a sad farce.
On one end of the securitization supply chain, regulators allowed underwriting standards to erode precipitously without strengthening mortgage origination regulations or sounding the alarm bells on harmful nonbank actors (not even those within bank holding companies over which the regulators had jurisdiction). On the other, securities backed by risky loans were transformed into securities deemed "hi-grade" by credit rating agencies, only after a dizzying array of steps where securities were packaged and repackaged into many layers of senior tranches, which had high claims to interest and principal payments, and subordinate tranches.
The non-banking actors – investment banks, hedge funds, money market funds, off-balance-sheet investment funds – that powered structured finance came to be known as the shadow banking market. Of course, the shadow banking market could only have grown to surpass by trillions of dollars the actual banking market with the consent of regulators.
In fact, one of the primary purposes behind the securitization market was to arbitrage bank capital standards. Banks that could show regulators that they could offload risks through asset securitizations or through guarantees on their assets in the form of derivatives called credit default swaps (CDS) received more favorable regulatory capital treatment, allowing them to build their balance sheets to more and more stratospheric levels.
With the completion of the Basel II Capital Accord, determinations on capital adequacy became dependent on the judgments of rating agencies and, increasingly, the banks' own internal models. While this was a recipe for disaster, it reflected in part the extent to which the size and complexity of this new era of quantitative finance exceeded the regulators' own comprehension.
When Basel II was effectively applied to investment banks like Lehman Brothers and Goldman Sachs, which had far more precarious and potentially explosive business models that utilized overnight funding to finance illiquid inventories of assets, the results were even worse. The SEC, which had no track record to speak of with respect to ensuring the safety and soundness of financial institutions, allowed these investment banks to leverage a small base of capital over 40 times into asset holdings that, in some cases, exceeded $1 trillion.
Third, little more than a year after repealing Glass-Steagall, Congress passed legislation – the Commodity Futures Modernization Act of 2000 (CFMA) – to allow over-the-counter (OTC) derivatives to essentially remain unregulated. Following the collapse of the hedge fund Long Term Capital Management (LTCM) in 1998, then Commodities Futures Trading Commission (CFTC) Chairwoman Brooksley Born began to warn of problems in this market. Unfortunately, her calls for stronger regulation of the derivatives market clashed with the uncompromising free-market philosophies of Federal Reserve Chairman Alan Greenspan, then Treasury Secretary Robert Rubin and later Treasury Secretary Larry Summers. To head off any attempt by the CFTC or another agency from regulating this market, they successfully convinced Congress to pass the CFMA.
The explosive growth of the OTC derivatives market following the passage of the CFMA was stunning – the size of the OTC derivatives market grew from just over $95 trillion at the end of 2000 to over $600 trillion in 2009. This growth had profound implications for the overall risk profile of the financial system. While derivatives can be used as a valuable tool to mitigate or hedge risk, they can also be used as an inexpensive way to take on leverage and risk. As I noted before, certain OTC derivatives called credit default swaps were crucial in allowing banks to evade their regulatory capital requirements. In other contexts, CDS contracts have been used to speculate on the credit worthiness of a particular company or asset.
But they pose other problems as well. Since derivatives represent contingent liabilities or assets, the risks associated with them are imperfectly accounted for on company balance sheets. And they have concentrated risk in the banking sector, since even before the repeal of Glass-Steagall, large commercial banks like J.P. Morgan were major derivatives dealers. Finally, the proliferation of derivatives has significantly increased the interdependence of financial actors while also overwhelming their back-office infrastructure. Hence, while the growth of derivatives greatly increased counterparty credit risks between financial institutions - the risk, that is, that the other party will default at some point during the life of the derivative contract - those entities had little ability to quantify those risks, let alone manage them.
Therefore, on the eve of what was arguably the biggest economic crisis since the Great Depression, which was caused in large part by the confluence of all the forces and trends that I have just described, the financial industry was larger, more concentrated, more complex, more leveraged and more interconnected than ever before. Once the sub-prime crisis hit, it spread like a contagion, causing a collapse in confidence throughout virtually the entire financial industry. And without clear walls between those institutions the government insures and those that are free to take on excessive leverage and risk, the American taxpayer was called upon to step forward into the breach.
The Crisis and the Response: Expanding the Safety Net
Unfortunately, the government's response to the financial meltdown has only made the industry bigger, more concentrated and more complex. As the entire financial system was imploding following the bankruptcy filing by Lehman Brothers, the Treasury and the Federal Reserve hastily arranged mergers between commercial banks (which had a stable source of funding in insured deposits) and investment banks (whose business model depended on market confidence to roll over short-term debt).
Before the Lehman bankruptcy, Bear Stearns had been merged into J.P. Morgan. After the Lehman collapse, one of the biggest mergers to occur was between Bank of America and Merrill Lynch. And Ken Lewis, the CEO of Bank of America at the time, alleges that it was consummated only following pressure he received from Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke.
As merger plans for the remaining two investment banks, Goldman Sachs and Morgan Stanley, faltered, another plan was hatched. Both Goldman Sachs and Morgan Stanley – neither of which had anything even close to traditional banking franchises – were both given special dispensations from the Federal Reserve to become bank holding companies. This provided them with permanent borrowing privileges at the Federal Reserve's discount window – without having to dispose of risky assets. In a sense, it was an official confirmation that they were covered by the government safety net because they were literally "too big to fail."
Following the crisis, the U.S. mega banks left standing have even more dominant positions. Take the multi-trillion-dollar market for OTC derivatives. The five largest banks control 95 percent of that market. With such strong pricing power, these firms could afford to expand dramatically their margins. The Federal Reserve estimated that those five banks made $35 billion from trading in the first half of 2009 alone. Of course, they used these outsized profits from trading activities in derivatives and other securities not only to replenish their capital, but also to pay billions of dollars in bonuses.
The New Financial Order
Large and complex institutions like Citigroup dominate our financial industry and our economy. MIT professor Simon Johnson and James Kwak, a researcher at Yale Law School, estimate that the six largest U.S. banks now have total assets in excess of 63 percent of our overall GDP. Only 15 years ago, the six largest U.S. banks had assets equal to 17 percent of GDP. We haven't seen such concentration of financial power since the days of Morgan, Rockefeller and Carnegie.
As I stated at the outset, I am extremely concerned that our reform efforts to date do little, if anything, to address this most serious of problems. By expanding the safety net - as we did in response to the last crisis - to cover ever larger and more complex institutions heavily engaged in speculative activities, I fear that we may be sowing the seeds for an even bigger crisis in only a few years or a decade.
Unfortunately, the current reform proposals focus more on reorganizing and consolidating our regulatory infrastructure, which does nothing to address the most basic issue in the banking industry: that we still have gigantic banks capable of causing the very financial shocks that they themselves cannot withstand.
The Need for Fundamental Reform
Rather than pass the buck to a reshuffled regulatory deck, which will still be forced to oversee banks that former FDIC Chairman Bill Isaac describes as "too big to manage, and too big to regulate," we must draw hard statutory lines between banks and investment houses.
We must eliminate the problem of "too big to fail" by reinstituting the spirit of Glass-Steagall, a modern version that separates commercial from investment banking activities and imposes strict size and leverage limits on financial institutions.
We must also establish clear and enforceable rules of the road for our securities markets in the interest of making them less fragmented, opaque and prone to collapse. The over-the-counter derivatives market must be tightly regulated, as originally proposed by Brooksley Born – and rejected by Congress – in the late 1990s.
Finally, I believe the myriad conflicts of interest on Wall Street must be addressed through greater protection and empowerment of individual investors. Our anti-fraud provisions, as represented for example by Rule 10(b)5, under the 1934 Securities Act, need to be strengthened.
Eliminating "Too Big to Fail"
The Insufficiency of Resolution Authority
One key reform that has been proposed to address the "too big to fail" problem is resolution authority. The existing mechanism whereby the FDIC resolves failing depository institutions has, by and large, worked well. After the experiences of Bear Stearns and Lehman Brothers in 2008, it is clear that a similar process should be applied to entire bank holding companies and large nonbank institutions.
While no doubt necessary, this is no panacea. No matter how well Congress crafts a resolution mechanism, there can never be an orderly wind-down, particularly during periods of serious stress, of a $2-trillion institution like Citigroup that had hundreds of billions of off-balance-sheet assets, relies heavily on wholesale funding, and has more than a toehold in over 100 countries.
There is no cross-border resolution authority now, nor will there be for the foreseeable future. In the days and weeks following the collapse of Lehman Brothers, there was an intense and disruptive dispute between regulators in the U.S. and U.K. regarding how to handle customer claims and liabilities more generally. Yet experts in the private sector and governments agree – national interests make any viable international agreement on how financial failures are resolved difficult to achieve. A resolution authority based on U.S. law will do precisely nothing to address this issue.
While some believe market discipline would be reimposed by refining the bankruptcy process, Lehman Brothers demonstrates that the very concept of market discipline is illusory with institutions like investment banks, which used funds that they borrowed in the repo market to finance their own inventories of securities, as well as their own book of repurchase agreements, which they provided to hedge funds through their prime brokerage business.
Investment banks, the fulcrum of these institutional arrangements, found themselves in a classic squeeze. On one side, their hedge fund clients and counterparties withdrew funds and securities in their prime brokerage accounts, drew down credit lines and closed out derivative positions, all of which caused a massive cash drain on the bank. On the other side, the repo lenders, concerned about the value of their collateral as well as the effect of the cash drain on the banks' credit worthiness, refused to roll over their loans without the posting of substantial additional collateral. These circumstances quickly prompted a vicious cycle of deleveraging that brought our financial system to the brink. With such large, complex and combustible institutions like these, there can be no orderly process of winding them down. The rush to the exits happens much too quickly.
That is why we need to directly address the size, the structure and the concentration of our financial system.
The Volcker Rule: A Good Beginning
The Volcker Rule, which would prohibit commercial banks from owning or sponsoring "hedge funds, private equity funds, and purely proprietary trading in securities, derivatives or commodity markets," is a great start, and I applaud Chairman Volcker for proposing that purely speculative activities should be moved out of banks. That is why I joined yesterday with Senators Jeff Merkeley (D-OR) and Carl Levin (D-MI) to introduce a strong version of the Volcker Rule. But I think we must go further still. Massive institutions that combine traditional commercial banking and investment banking are rife with conflicts and are too large and complex to be effectively managed.
Glass-Steagall for the 21st Century
We can address these problems by reimposing the kind of protections we had under Glass-Steagall. To those who say "repealing Glass-Steagall did not cause the crisis, that it began at Bear Stearns, Lehman Brothers and AIG," I say that the large commercial banks were engaged in exactly the same behavior as Bear Stearns, Lehman and AIG – and would have collapsed had the federal government not stepped in and taken extraordinary measures. Moreover, in response to the last crisis, we increased the safety net that covers these behemoth institutions. The result: they will continue to grow unchecked, using insured deposits for speculative activities without running any real risk of failure on account of their size.
We need to reinstate Glass-Steagall – in an updated form – to prevent or at least severely moderate the next crisis.
By statutorily splitting apart massive financial institutions that house both banking and securities operations, we will both cut these firms down to more reasonable and manageable sizes and rightfully limit the safety net only to traditional banks. President of the Federal Reserve Bank of Dallas Richard Fisher recently stated: "I think the disagreeable but sound thing to do regarding institutions that are ['too big to fail'] is to dismantle them over time into institutions that can be prudently managed and regulated across borders. And this should be done before the next financial crisis, because it surely cannot be done in the middle of a crisis."
A growing number of people are calling for this change. They include former FDIC Chairman Bill Isaac, former Citigroup Chairman John Reed, famed investor George Soros, Nobel-Prize-winning-economist Joseph Stiglitz, President of the Federal Reserve Bank of Kansas City Thomas Hoenig, and Bank of England Governor Mervyn King, among others. A chastened Alan Greenspan also adds to that chorus, noting: "If they're too big to fail, they're too big. In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that's what we need to do."
Size and Leverage Constraints: Cutting the Mega Banks and Shadow Banking System Down to Size
But even this extraordinary step of splitting these institutions apart is not sufficient. Cleaving investment banking from traditional commercial banking will still leave us with massive investment banks, some with balance sheets that exceed $1 trillion in assets.
For that reason, Glass-Steagall would need to be supplemented with strict size and leverage constraints. The size limit should focus on constraining the amount of non-deposit liabilities at large investment banks, which rely heavily on short-term financing like repos and commercial paper.
The growth of those funding markets in the run-up to the crisis was staggering. One report by researchers at the Bank of International Settlements estimated that the size of the overall repo market in the U.S., Euro region and the U.K. totaled approximately $11 trillion at the end of 2007. Incredibly, the size was more than $5 trillion more than the total value of domestic bank deposits at that time, which was less than $7 trillion.
The overreliance on such wholesale financing made the entire financial system vulnerable to a classic bank run, the type that we had before we instituted a system of deposit insurance and strong bank supervision. Remarkably, while there is a prudential cap on the amount of deposits a bank can have (even though deposits are already federally insured), there is no limit of any kind on liabilities like repos that need to be rolled over every day. With a sensible limit on these liabilities at each financial institution (for example, as a percentage of GDP), we can ensure that never again will the so-called shadow banking system eclipse the real banking system.
In addition, institutions that rely upon market confidence every day to finance their balance sheet and market prices to determine the worth of their assets should not be leveraged to stratospheric levels. To ensure that regulatory forbearance does not permit another Lehman Brothers, we should institute a simple statutory leverage requirement, that is, a limit on how much firms can borrow relative to how much their shareholders have on the line. As I have said in a previous speech, a statutory leverage requirement that is based upon banks' core capital - i.e. their common stock plus retained earnings - could supplement regulators' more highly-calibrated risk-based assessments, providing a sorely-needed gut check that ensures that regulators don't miss the forest for the trees when assessing the capital adequacy of a financial institution.
This would push firms back towards the levels of effective capital they had in the "pre-bailout" days – like in the post World War II period when our financial system generally functioned well. To be sure, this would move our core banks from being predominantly debt financed to being substantially capitalized by equity. But other parts of our financial system already operate well on this basis – with venture capital being the most notable example. The return on equity relative to debt would need to rise to accommodate this change, but – as long as we preserve a credible monetary policy – this is consistent with low interest rates in real terms.
I would also stress that a leverage limit without breaking up the biggest banks will have little effect. Because of their implicit guarantee, "too big to fail" banks enjoy a major funding advantage – and leverage caps by themselves do not address that. Our biggest banks and financial institutions have to become significantly smaller if we are to make any progress at all.
Reforming Our Financial Markets
Turning now to derivatives reform, I have already noted how large dealer banks completely dominate the OTC marketplace for derivatives, an opaque market where these banks exert enormous pricing power. For over two decades, this market has existed with virtually no regulation whatsoever.
Amazingly, it is a market where the dealers themselves actually set the rules for the amount of collateral and margin that needs to be posted by different counterparties on trades. Dealers never post collateral, while the rules they set for their counterparties are both lax and pro-cyclical, meaning that margin requirements tend to increase during periods of market turmoil when liquidity is at a premium. The complete lack of oversight of these markets has almost brought our financial system to its knees twice in ten years, first with the failure of LTCM in 1998, and then with the failure of Lehman Brothers in 2008. We have known about these problems for over a decade – yet we have so far done nothing to make this market better regulated.
That is why I applaud CFTC Chairman Gary Gensler's efforts in pushing for centralized clearing and regulated electronic execution of standardized OTC derivatives contracts as well as more robust collateral and margin requirements. Clearinghouses have strong policies and procedures in place for managing both counterparty credit and operational risks. Chairman Gensler underscores that this would get directly at the problem of "too big to fail" by stating: "Central clearing would greatly reduce both the size of dealers as well as the interconnectedness between Wall Street banks, their customers and the economy." Moreover, increased clearing and regulated electronic trading will make the market more transparent, which will ultimately give investors better pricing.
A strong clearing requirement, however, should not be swallowed by large exemptions that circumvent the rules. While I am sympathetic to concerns about increased costs raised by non-financial corporations that use interest rate and currency swaps for hedging purposes, any exemption of this sort should be narrowly crafted. For example, it might be limited to transactions where non-financial corporations use OTC derivatives in a way that qualifies for GAAP hedge accounting treatment. In any case, we should recognize more explicitly that when such derivatives contracts are provided by too big to fail banks, the end users are in effect splitting the hidden taxpayer subsidy with the big banks. And remember that this subsidy is not only hidden – it is also dangerous, because it is central to the incentives to become bigger and to take more risk once any financial firm is large.
Given that one of the key objectives behind increased clearing is to reduce counterparty credit risk, it also seems reasonable that derivatives legislation place meaningful constraints on the ownership of clearinghouses by large dealer banks.
Addressing Conflicts of Interest
Finally, we need to address the fundamental conflicts of interest on Wall Street. While separating commercial banking from investment banking is a critical step, there are still inherent conflicts within the modern investment banking model.
Better Addressing Securities Fraud
Let's take the example of auction rate securities. Brokers at UBS and other firms marketed these products, which were issued by municipalities and not-for-profit entities, as "safe, liquid cash alternatives" to retail investors even though they were really long-term debt instruments whose interest rates would reset periodically based upon the results of Dutch auctions. In other words, these unsuspecting investors would be unable to sell their securities if new buyers didn't enter the market, which is exactly what happened. As credit concerns by insurers who guaranteed these securities drained liquidity from the market, bankers continued to sell these securities to retail clients as safe, liquid investments. There was a blatant conflict of interest where the banks served as broker to their retail customers while also underwriting the securities and conducting the auctions.
There is an open issue of why such transactions did not constitute securities fraud, for example under Rule 10(b)5 – which prohibits the nondisclosure of material information. Civil actions are still in progress and perhaps we will learn more from the outcomes of particular cases. But no matter how these specific cases are resolved, we should move to strengthen the legal framework that enables both private parties and the SEC (both civil and criminal sides) to bring successful enforcement actions.
Individuals at Enron, Merrill Lynch, and Arthur Anderson were called to account for their participation in fraudulent activities – and at least one executive from Merrill went to prison for signing off on a deal that would help manipulate Enron's earnings. But it is quite possible that no one will be held to account, either in terms of criminal or civil penalties, due to the deception and misrepresentation manifest in our most recent credit cycle. We must work hard to remove all the loopholes that helped create this unfair and unreasonable set of outcomes.
Strengthening Investor Protection
We can begin by strengthening investor protection. Currently, brokers are not subject to a fiduciary standard as financial advisors are, but only subject to a "suitability" requirement when selling securities products to investors. Hence, brokers don't have to be guided by their customers' best interest when recommending investment product offerings – they might instead be focused on increasing their compensation by pushing proprietary financial products. By harmonizing the standards that brokers and financial advisors face and by better disclosing broker compensation, retail investors will be able to make better, more informed investment decisions. Even Lloyd Blankfein, the CEO of Goldman Sachs, has stated that he "support[s] the extension of a fiduciary standard to broker/dealer registered representatives who provide advice to retail investors. The fiduciary standard puts the interests of the client first. The advice-giving functions of brokers who work with investors have become similar to that of investment advisers."
It has also become known that some firms underwrite securities – promoting them to investors – and then short these same securities within a week and without disclosing this fact, which any reasonable investor would regard as adverse material information. In the structured finance arena, investment banks sold pieces of collateralized debt obligations - which were packages of different asset-backed securities divided into different risk classes - to their clients and then took proceeded to take short positions in those securities by purchasing credit default swaps. Some banks went further by shorting mortgage indexes tied to securities they were selling to clients and by shorting their counterparties in the CDS market. This is how a firm like Goldman Sachs could claim that they were effectively hedged to an AIG collapse.
Unfortunately, the use of products like CDS in this way allows the banks to become empty creditors who stand to make more money if people and companies default on their debts than if they actually paid them. These and other problematic practices that place financial firms' interests against those of their clients need to be restricted. They also completely violate the spirit of our seminal legislation from the 1930s, which insisted – for the first time – that the sellers and underwriters of securities disclose all material information. This is nothing less than a return to the unregulated days of the 1920s; to be sure, those days were heady and exciting, but only for a while – such practices always end in a major crash, with the losses disproportionately incurred by small and unsuspecting investors.
Investors should also have greater recourse through our judicial system. For example, auditors, accountants, bankers and other professionals that are complicit in corporate fraud should be held accountable. That is why I worked on a bill with Senators Specter and Reed to allow for private civil actions against individuals who knowingly or recklessly aid or abet a violation of securities laws.
Conclusion: Hard Lines, Not Regulator Discretion
Admittedly, this is not an exhaustive list of financial reforms. I also believe we need to reconstitute our system of consumer financial protection, which was a major failure before our last crisis. We must have an independent Consumer Financial Protection Agency (CFPA) that has strong and autonomous rulemaking authority and the ability to enforce those rules at nonbanking entities like payday lenders and mortgage finance companies. Most importantly, the head of this agency must not be subject to the authority of any regulator responsible for the "safety and soundness" of the financial institutions. The CFPA must look out for the interests of consumers and for consumers alone.
Unfortunately, like the public option in healthcare, the CFPA issue has become something of a "shiny object" – though certainly an important one – that has distracted the focus of debate away from the core issues of "too big to fail."
Beginning with the solutions for "too big to fail," each of these challenges represents a crucial step along the way towards fixing a regulatory system that has permitted both large and small failures. Each is an important piece to the puzzle.
I know there are those who will disagree with some, and perhaps all of these proposals. They sincerely advocate a path of incrementalism, of achieving small reforms over time. They say that problems as complex as these need to be solved by the regulators, not by Congress. After all, they are the ones with the expertise.
I respectfully disagree.
Giving more authority to the regulators is not a complete solution. While I support having a systemic risk council and a consolidated bank regulator, these are necessary but not sufficient reforms – the President's Working Group on Financial Markets has actually played a role in the past similar to that of the proposed council, but to no discernible effect. I do not see how these proposals alone will address the key issue of "too big to fail."
In the brief history I outlined earlier, the regulators sat idly by as our financial institutions bulked up on short-term debt to finance large inventories of collateralized debt obligations backed by subprime loans and leveraged loans that financed speculative buyouts in the corporate sector.
They could have sounded the alarm bells and restricted this behavior, but they did not. They could have raised capital requirements, but instead farmed out this function to credit rating agencies and the banks themselves. They could have imposed consumer-related protections sooner and to a greater degree, but they did not. The sad reality is that regulators had substantial powers, but chose to abdicate their responsibilities.
What is more, regulators are almost completely dependent on the information, analysis and evidence as presented to them by those with whom they are charged with regulating. Last year, former Federal Reserve Chairman Alan Greenspan, once the paragon of laissez faire capitalism, stated that "it is clear that the levels of complexity to which market practitioners, at the height of their euphoria, carried risk management techniques and risk-product design were too much for even the most sophisticated market players to handle properly and prudently." I submit that if these institutions that employ such techniques are too complex to manage, then they are surely too complex to regulate.
That is why I believe that reorganizing the regulators and giving them additional powers and responsibilities isn't the answer. We cannot simply hope that chastened regulators or newly appointed ones will do a better job in the future, even if they try their hardest. Putting our hopes in a resolution authority is an illusion. It is like the harbor master in Southampton adding more lifeboats to the Titanic, rather than urging the ship to steer clear of the icebergs. We need to break up these institutions before they fail, not stand by with a plan waiting to catch them when they do fail.
Without drawing hard lines that reduce size and complexity, large financial institutions will continue to speculate confidently, knowing that they will eventually be funded by the taxpayer if necessary. As long as we have "too big to fail" institutions, we will continue to go through what Professor Johnson and Peter Boone of the London School of Economics have termed "doomsday" cycles of booms, busts and bailouts, a so-called "doom loop" as Andrew Haldane, who is responsible for financial stability at the Bank of England, describes it.
The notion that the most recent crisis was a "once in a century" event is a fiction. Former Treasury Secretary Paulson, National Economic Council Chairman Larry Summers, and J.P. Morgan CEO Jamie Dimon all concede that financial crises occur every five years or so.
Without clear and enforceable rules that address the unintended consequences of unchecked financial innovation and which adequately protect investors, our markets will remain subverted.
These solutions are among the cornerstones of fundamental and structural financial reform. With them we can build a regulatory system that will endure for generations instead of one that will be laid bare by an even bigger crisis in perhaps just a few years or a decade's time. We built a lasting regulatory edifice in the midst of the Great Depression, and it lasted for nearly half a century. I only hope we have both the fortitude and the foresight to do so again.
Jun 16, 2010 | huffingtonpost.comSimon Johnson and James Kwak, the authors of 13 Bankers, appeared on "Bill Moyers Journal" Friday evening to discuss the financial crisis and the push for Wall Street reform.
The pair, who both blog at BaselineScenario.com, painted a disturbing and dysfunctional picture of the relationship between Wall Street and the politicians who craft the rules that govern them.
Kwak and Johnson explained that Wall Street created the crisis, relied on public money to generate private profits, and is spending billions to defeat reforms that would protect Americans from another financial crisis.
Johnson said that people in Washington are wrong when they talk of "populist anger." "Most of what I encounter," Johnson said "is legitimate, sensible anger. People actually understand what happened. They understand what went wrong and they want to stop it. And the banks don't get this."
To illustrate how out of touch banks are with reality and the bailouts that facilitated their profits, Johnson pointed to comments by JP Morgan Chase CEO Jamie Dimon. In May 2009, Dimon told shareholders that Chase had its "finest year ever." Roughly six months prior to his speech, JP Morgan Chase benefited from $25 billion in U.S. Treasury funds.
Johnson trashed Dimon's view. "They didn't have their best year ever," Johnson said. "They went through crisis. They were saved like the rest of the financial system by the government, by the taxpayers. But that's not how they see it. That's not what they believe. That's really important. That belief must be shaken if we're to make any progress at all."
Pointing to the power of Wall Street's lobbying money, Moyers said that the American people don't stand a chance against the Washington-Wall Street oligarchy in the fight for financial reform. Johnson wasn't ready to concede and pointed to the political events of 1902, as proof that reform was achievable.
In 1902, President Theodore Roosevelt took on J.P. Morgan and filed an antitrust suit to dissolve the banker's railroad monopoly. Johnson argued that there was no precedent for Roosevelt's campaign for reform, and yet the president won.
Johnson acknowledged that modern financial reform movement lacks an advocate like Roosevelt, but he told Moyers that they're out there. "We must find them," Johnson said, "and we must fund them financially, sufficiently, to fight against this nonsense from the corporate sector."
Jan 8, 2010 | Bloomberg
Sitting in his London office, Adair Turner is a study in gray eminence. A charcoal wool suit complements his silver fringe of hair, and he's framed by a window that looks out to a leaden winter sky punctured by steely skyscrapers. The towers are home to Barclays Plc, HSBC Holdings Plc and other lenders Turner watches over as chairman of the U.K. Financial Services Authority, Britain's financial regulator. The setting belies Turner's growing reputation in the City, London's financial district, as a troublemaker.
Turner, a former director general of the Confederation of British Industry, or CBI, the main U.K. business lobby, might have reasonably been expected to act as a bureaucratic booster for banks and investment firms reeling from the global recession.
Instead, since taking the job in September 2008, he's used his time as regulator to scold the financial services industry for growing too large on the back of risky products that he says offer little value to society, Bloomberg Markets magazine reported in its February issue. To reduce the appetite for speculative risk, Turner is promoting a levy on financial transactions to divert money to the poor and support efforts to address climate change. The so-called Tobin tax is named after the late U.S. economist James Tobin, a Nobel laureate who proposed a surcharge on currency trading to deter speculation.
"I believe in markets; I believe in enterprise," says Turner, who numbers Franklin D. Roosevelt and British economist John Maynard Keynes among his personal heroes. "But I have always believed that market economies will not of themselves combine that with environmental sustainability or with a reasonably just and good society. I believe that capitalism needs to be saved from itself."
Turner -- a member of the British House of Lords and head of the country's Committee on Climate Change -- seems to enjoy his role as a pinstriped provocateur, casually remarking that he also supports the decriminalization of drugs.
"I very strongly believe that society is best served by not having shibboleths, areas where we can't go," he says.
Turner's public campaign has helped nudge British lawmakers into getting tough on banks. U.K. Prime Minister Gordon Brown told a Group of 20 nations meeting in November that he supported a global transaction tax. Then, on Dec. 9, Brown's government imposed a temporary 50 percent levy on bank bonuses, which applies to awards over 25,000 pounds ($39,800) issued from that day to April 5. The charge will be paid by banks instead of employees.
Turner is using his post and influence to ask that bankers consider what purpose they serve in society.
"To say that in Britain, in London, as head of the FSA, is really something one would not expect," says Tommaso Padoa- Schioppa, European chairman of Promontory Financial Group, a regulatory advisory firm. "He addressed a core issue: that the size of finance may have grown beyond what is serving a useful purpose for the economy," says Padoa-Schioppa, who was Italy's finance minister from 2006 to 2008.
Turner is lambasting an industry still smarting from the credit crisis. Financial services accounted for 10.1 percent of the U.K.'s gross domestic product and 27.5 percent of corporate taxes in 2007, according to statistics from the U.K. government and PricewaterhouseCoopers LLP. More than 1 million Britons were employed in financial services that year, according to the U.K. Office for National Statistics. The London-based Centre for Economics and Business Research estimates that City firms have cut as many as 50,000 jobs since the beginning of 2008.
In the wake of the global recession, Turner's FSA is proposing that U.K. banks at least double the amount of capital they set aside to cover the risks of proprietary trading and bolster the level of shareholder equity available to absorb potential losses from activities such as lending. The FSA also wants to require big banks to draw up so-called living wills to guide regulators on how to wind up their operations the next time a disaster strikes.
Turner triggered controversy in August when he first floated the transaction tax idea and criticized the size of the U.K. financial sector in an interview in Prospect, a British journal. At a black-tie gathering of financial executives in London on Sept. 22, Turner said banks should move away from products, such as complex derivatives, that don't benefit society.
"Some financial activities which proliferated over the last 10 years were socially useless, and some parts of the system were swollen beyond their optimal size," he told the gathering.
'Appalled, Disgusted, Ashamed'
Turner's remarks have been condemned by executives who say it's ridiculous to introduce a moral dimension to regulation.
"Quite honestly, I am appalled, disgusted, ashamed and hugely embarrassed," wrote Howard Wheeldon, a senior strategist at BGC Partners LP, in an August note. "How dare he?" Wheeldon now says. "Markets will decide if something is too big or too small. It's not for an individual, however powerful, to slam and damn nearly 1 million people."
Michael Spencer, chief executive officer of London-based broker ICAP Plc, joined the chorus of critics in late November.
"I was genuinely offended," Spencer said at an industry awards dinner in London. "Using his logic, I presume he would describe Porsche as socially useless for making cars that go twice the speed limit or Jimmy Choo for making shoes in dozens of different colors."
Turner is mostly unrepentant. While his words may have been imperfect, he now says, he stands by the sentiments behind them.
"I wish I had said 'economically useless' rather than 'socially useless,' as it would have been more precise," he says.
Now, Turner has a potentially more powerful forum for his ideas: the G-20. As a member of the global Financial Stability Board, he's been asked by the G-20's central bankers and finance ministers to propose ways in which governments should regulate international firms such as Deutsche Bank AG and Goldman Sachs Group Inc. His brief is to explore whether banks' trading arms should be split from their deposit-taking units.
Turner has said he's against such a divide and instead favors surcharges on riskier trades to make them less attractive. He has also proposed requiring lenders to set up separate regional subsidiaries so that bank failures can be contained, helping to prevent the market seizures that followed the 2008 collapse of Lehman Brothers Holdings Inc.
The son of a town planner, Jonathan Adair Turner has displayed a political suppleness throughout his public career. At the University of Cambridge, where he studied history and economics, he was chairman of the student Conservative Association, only to shift his allegiance to the now-defunct center-left Social Democratic Party in 1981. Though Turner was given a peerage in 2005 by the Labour government, he joined the House of Lords as a cross-bench, or unaffiliated, member.
"There are very few people out there who have his charisma," Wheeldon says. "Power seems to ooze from his fingertips."
After graduating with top honors from Cambridge in 1978, Turner worked as an economics tutor and joined McKinsey & Co. four years later, eventually opening the management consulting firm's banking practice in Eastern Europe and Russia. It was at McKinsey that he met his Irish-born wife, Orna Ni-Chionna, with whom he has two daughters. In 1995, he became director general of the CBI at the age of 39.
At the CBI, Turner built a relationship with Labour Party leader Tony Blair and was dubbed "Red Adair" by the British press, a play on the name of the late American oil-well firefighter. At the time, Labour officials regularly met with City executives to assure them that the party was friendly to business. Blair became prime minister following Labour's landslide win in May 1997, ending four terms of Conservative rule that began with Margaret Thatcher's election in 1979.
"The CBI in the old days was the bulwark of the Thatcher regime," says Simon Gleeson, a regulatory lawyer at Clifford Chance LLP in London. "Adair was seen to be extending the CBI hand of friendship to the Blairites. For the mainstream CBI, this was just the most radical thing."
As one of his first acts as chancellor of the Exchequer in Blair's government, Brown created the FSA in 1997 and divided oversight for the financial system among it, the Bank of England and the Treasury. In 2002, Blair appointed Turner to head a government commission on the U.K.'s pension system.
Turner's 2005 report recommended requiring all workers to enroll in a pension program and called for boosting the retirement age to 68 from 65. The proposals were initially rejected by Brown for being too costly. Today, both major parties endorse Turner's plan to keep people working longer, following bank rescue deals that have cost U.K. taxpayers about 850 billion pounds.
Turner, named FSA chairman by now-Prime Minister Brown's government in 2008, may lose his job after the next general election, which must be held by June. The opposition Conservatives have pledged to abolish the FSA and hand regulation back to the Bank of England.
Thanks in part to his public profile, Turner currently appears as a character in a David Hare play about the financial crisis called "The Power of Yes." The drama, based on interviews with bankers and investors, reaches a climax with Turner's character noting that following the recession, talented people may turn their backs on financial careers to battle climate change or drive medical research.
In real life, Turner is just as skeptical about the size of the industry he regulates.
"There is a confusion that blew up over the years that the FSA ought to be the cheerleader for London's financial services industry," he says. "It's not the role of the regulator to make the industry as large as possible. I think some people get confused about that."
After Turner's yearlong campaign to challenge presumptions in the City, there's little doubt that the days of uncritical oversight are over.
-- Editors: David Ellis, Gail Roche
To contact the reporters on this story: Caroline Binham in London at [email protected];
Taibblog - True-Slant
It has become conventional wisdom, perhaps even cliche, to pin the origins of the credit crisis on the big banks or, AIG or even the practice of financial modeling. Certainly, these actors have received the most play in the media, and have now endured the focus of populist ire for more than a year. We now think that the analysis leading commentators to focus blame on these entities is fatally flawed.
via Origins of an American Kleptocracy | zero hedge.
Over the Christmas holiday a nasty thing happened: Tim Geithner's Treasury Department decided to lift the cap on aid to the Government-Sponsored Entities, Fannie Mae and Freddie Mac, apparently in response to Obama administration fears that the two agencies would become insolvent. The cap was raised from $200 billion on each and government backstopping of the mortgage market will apparently now extend into infinity for at least three years, through 2012.
The move has already inspired a mini-firestorm, with several outlets delving deeply into the recent history of the GSEs and uncovering some disturbing new facts. Chief among those were an analysis of the GSEs by a former chief credit officer of Fannie named Edward Pinto, who found that Fannie and Freddie routinely mismarked subprime or Alt-A (a sort of purgatory class of nonprime risky mortgage, resting between subprime and prime) mortgages as prime. The Wall Street Journal explains:
In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.
This is a damning fact and if true certainly supports the Journal claim that the GSE actions were a "principal cause of the financial crisis." But having established this, the Journal then goes in this direction:
Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007. Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other government agencies, and 1.4 million were on the books of the four largest U.S. banks.
Sometimes I'm amazed at the speed with which highly provocative information like this GSE business can be converted into distracting propaganda in this country. In the right hands Pinto's analysis of the GSEs - just like the revelations in the past few years about practices at AIG, Moody's, Countrywide, Goldman Sachs, the Fed, and, hell, let's add the offices of Senator Chris Dodd - would have been a starting point for a deeper investigation into a financial system that is clearly a complex and intimate symbiosis of state and private corruption.
For what we've learned in the last few years as one scandal after another spilled onto the front pages is that the bubble economies of the last two decades were not merely monstrous Ponzi schemes that destroyed trillions in wealth while making a small handful of people rich. They were also a profound expression of the fundamentally criminal nature of our political system, in which state power/largess and the private pursuit of (mostly short-term) profit were brilliantly fused in a kind of ongoing theft scheme that sought to instant-cannibalize all the wealth America had stored up during its postwar glory, in the process keeping politicians in office and bankers in beach homes while continually moving the increasingly inevitable disaster to the future.
That is a terrible story and it is also sort of a taboo story, since we don't really have a system of media now that is willing or even able to digest that dark and complicated truth. Instead, our media - which has always been at best an inadvertent accomplice to these messes - is basically set up to take every revelation about the underlying truth and split it down the middle, feeding half to one side of the political spectrum and one half to the other, where the actual point is then burned up in the useless smoke of a blame game.
The essentially complicit nature of the two ruling political parties was in this way covered up for decades, as the crimes of the Democrats were greedily consumed as entertainment by the Limbaugh crowd while the crimes of the Bushies became hot-selling t-shirts and bumper stickers for the Air America listenership. The abiding mutual hatred the red/blue groups shared consistently prevented any kind of collective realization about the structure of the overall scheme.
What worries me is that we're now reverting to the same old pattern with the financial crisis story. We're starting to see fault lines develop, where one side blames the government while another side blames Wall Street for the messes of the last two decades. The side blaming the government tends to belong to the free-marketeer class and divines in safety-net purveyors like the GSEs and in the Fed's money-printing fundamental corruptions of the capitalist ideal, while the side blaming the bankers tends to belong to the left-liberal tradition that focuses on greed and seeming absence of community conscience among the CEO class as primary corruptors of the social contract.
In the former view the government is to blame for punting on its oversight responsibilities and for corrupting the financial bloodstream with market-altering guarantees, while in the latter view the bankers are at fault for lobbying the politicians to make exactly the same moves. The antigovernment folks like to focus on the irresponsible (and typically low-income or minority) home-borrower and their political allies in Washington as chief villains, while the anti-banker crowd looks at the massive personal profits and outsized influence of the executive class and waves the Cui bono? stick in that direction.
Both sides are right and both sides are wrong. I know that sounds like pox-on-both-their-houses pundit sophistry. But the point is that if you focus on one side and not the other, you miss the entire point. That's why I get freaked out when I see an important story like this GSE thing come out, and have it be immediately accompanied by arguments that "market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system," as though the irresponsibility of the government agency precluded similar (and, I might add, intimately related) abuses on the private side.
I mean, really - market observers were unaware of the number of subprime mortgages infecting the system? Are we to understand that nobody caught on when outstanding mortgage debt grew by $3.7 trillion between 2003 and 2005, nearly equaling the entire value of all American real estate in the year 1990? They didn't notice when subprime mortgages went from 3% of all mortgage lending in 1997 to 20% of the market in 2003? They didn't notice when the volume of Alt-A loans and home equity loans surged through the early part of last decade?
Now I know that that's not what Peter Wallison of the Journal is saying here; he's saying that even if the market saw that increase in subprime loans, even those numbers were understated thanks to Fannie and Freddie's deceptions. But the inference that the market was hoodwinked by the GSEs is absurd. It was plain to most everyone in the financial services industry that there was a bubble going on last decade, that something deeply fucked up was going on with the mortgage markets - just as it was plain to everyone in the late nineties that something was wrong with the stock markets, when companies like Theglobe.com with annual sales under $5 million could have a $5 billion stock valuation.
Everyone was involved in the mortgage scam. At the lender level the deceptions were myriad; liar's loans, fraudulent income documentation, negative amortization loans, HELOCs, etc. The rush to get as many loans written as possible and then get those hot potatoes moved to the next sucker in the line was furious and extended from coast to coast, sinking one lender after another in Ponzoid debt and indictments.
Then there were the countless deceptions that emerged from the securitization process, the bad math that allowed banks like Goldman to do $474 million mortgage deals where the average equity in the home was just 0.71 percent, and sell 93% of that deal as investment grade paper.
Are we really to believe that the people who did those deals didn't know what total crap they were selling? That the people who used CDO-squareds to magically turn BBB investments into AAA investments didn't know how nuts that was?
There were the ratings agencies, who accepted all that bad math and slapped AAA ratings on crap mortgage-backed securities in exchange for the continued largess of the banks upon whom they were financially dependent - the same ratings agencies that later sputtered and coughed up bullshit my-dog-ate-my-homework excuses for mismarking mortgages, with the Moody's revelation that a computer error caused them to misapply AAA ratings to billions' worth of MBS being the comic low point.
Then further along in the chain you had crooks like the folks at AIG, who took advantage of the basic nonexistence of derivatives regulation to issue billions in guarantees for these mortgage investments that they had never had any intention of paying off, to say nothing of actually having the ability to do so. And of course underwriting the entire enterprise was the implicit guarantee of Alan Greenspan's Fed, which made it known time and time again that its modus operandi was to refuse to recognize the existence of bubbles until after they blew up, at which point it would rush in and clean up the mess, bailing out all the chief actors out with easy money.
Everyone had a hand in the bubble, from the congressmen who killed regulatory initiatives to the regulators who snoozed at the wheel to the GSEs to the Fed to the banks to the ratings agencies to the lenders. I don't think it's really controversial to say that, but it does seem like there's an argument brewing about what that across-the-board complicity means.
My own personal feeling is that our recent bubbles weren't much different than pyramid scams and lotteries; they're the handiwork of an essentially regressive and deeply cynical political organization that systematically hoovers up taxes and investment money mainly from middle-class suckers, where it eventually gets eaten in short-term cashouts and mostly blown on sports cars and tropical vacations and eye jobs for the trophy wives of Wall Street executives. Crackonomics: take literally all the spare money from four square city blocks and turn it into one tricked-out Escalade.
For me the basic dynamic of the mortgage bubble is some Ivy League dickwad hawking a billion dollars of securitized subprime mortgages to a pension fund, and then Hobie-sailing off into the sunset with a bonus after they all blow up. Of course my seeing it that way might have a lot to do with my own personal psychological prejudices, and I get that some other person with different hangups might choose to focus on Barney Frank deciding to "roll the dice on home ownership" with the GSEs.
But what I don't see is how anybody can say that all of this happened because Fannie and Freddie rigged the game to get Mexicans in homes, and then the banks and the ratings agencies just reacted organically to the corrupted market and helped the bubble along through no fault of their own. That's just another (albeit more convincing) version of the early attempt to pin the disaster on the Community Reinvestment Act, which in turn is just another way of playing the red-blue blame game, which in turn is missing the point.
This GSE story is a big one, but if it gets used as a path back to a "The Market Reacted Rationally" version of history, we're screwed. It has to be looked at as an important part of a diabolical whole, a symbiotic scheme in which the banks and the state were irreversibly intertwined in an enterprise that on both sides was never about market economics, but crime. Because otherwise… the diversionary notion that one side or the other is wholly to blame is part of what makes the whole scam possible.
p.s. Just to get this out of the way, I love Zero Hedge, and Marla Singer has been really nice to me personally. I just don't completely agree with this particular thing. I don't see any reason why focusing blame on the banks and the ratings agencies and AIG was "fundamentally flawed," because, well, shit, they were to blame. The fact that Fannie and Freddie now get to jump in the pigpen with them doesn't change that for me.
I think in the end what we're going to find is that all the relevant actors had their own motivations for getting involved in the bubble. Two and now three presidential administrations let the Fed overheat the economy for political reasons that should be obvious. Alan Greenspan, hell, he did it because he loves seeing himself on magazine covers and wanted to keep getting invited to the right Manhattan parties. There were congressmen that converted the expansion of cheap credit into low-income votes. The bankers and lenders went along because the system of compensation on Wall Street is fucked and rewards short-term thinking while ignoring long-term consequences.
To me all of these people were equally guilty of making bad decisions to benefit themselves in the here and now at the expense of the whole in the future. When it comes to bubbles, It Takes a Village, and blaming the whole mess on the "socialist" aims of a pair of government agencies seems off base - particularly since the Randian protocapitalists running the banks benefited every bit as much from this socialism as actual homeowners, and perhaps even more, when one considers that homeowners get foreclosed upon, while bonuses are forever.
This gets to the heart of it:
"We're starting to see fault lines develop, where one side blames the government while another side blames Wall Street for the messes of the last two decades"
I have to admit my first thought when reading your first paragraphs was a sort of "Oh shit, more ammunition for the right wingers claiming that all of the housing bubble was caused by "the government forcing poor people to buy homes they couldn't afford" as they tend to put it.
"Don't even go there" I was thinking, just because it's so abused and misconstrued, as you acknowledge.
I do think the whole thing can certainly still be seen as a problem of regulation, but more in the sense of implementation than in the sense of passing the laws or regulations, it was a lack of enforcement and oversight more than anything else.
One fairly clear refutation of the "the bubble was all because of Fanny/Freddy loaning money to unworthy people" meme is that housing bubbles happened all over the world, and Fanny Mae and Freddie Mac don't operate all over the world. There are similar programs in other countries, but no one is trying to blame the worldwide housing bubbles on them.
Or, in fact I maybe some people are. (I live in France, I should check here. Most likely the same accusations are being made, I would bet). But that just demonstrates even more clearly that it can't possibly be the fault of "government agencies" all over the world, in some wild coincidence of making the same errors and engaging in the same malpractice at the same moment.
Anyway this I entirely agree with:
"This GSE story is a big one, but if it gets used as a path back to a "The Market Reacted Rationally" version of history, we're screwed."
"Blame the Banks" ultimately also means, "Blame the Government" as well – only the blame is for insufficient regulation. You can't blame the banks for doing lawful business.
The only thing that the bank-hating side of the argument can really blame them for is the achievement of "regulatory capture", that is, controlling their own regulators through lobbying.
The government-hating side, of course, is really complaining about too MUCH regulation, the banks being "forced" to make bad loans to poor people.
I don't think one needs to get into long economic proofs that this wasn't so; you just need to look at how enthusiastically they sold and pushed those bad loans. If they were being forced to make them by idealist, lefty regulators, they would have made them with a maximum of reluctance, gritted teeth, and foot-dragging. And there would be unsuccessful lobbying efforts they could point to where they tried to escape the poisonous requirements.
I don't disagree that blame is shared all around – you achieve regulatory capture with campaign donations and junkets, nobody held a gun to the government's head. My point is that the mechanisms of the corruption all run through a choke-point on the government side, the regulators and the Fed.
The solution is thus clear if difficult: regulatory capture must be undone and the Fed made responsive to the long-term needs of the larger public, not the short-term needs of Wall Street.
I'd start with a major staff turnover, something Congress could probably push for successfully if they had enough pressure put on them by their voters.
Sure. Except that a lot of this had nothing to do with regulatory capture at all. A lot of this was private lenders making bad loans, then private banks securitizing them and, using mismarkings of private ratings agencies, selling them to institutional suckers.
I would argue that while the mortgage bubble involved quite a lot of state participation/guarantees, it wasn't a whole lot different in its particulars from the equity bubble, which was basically private entities fleecing private investors. In both cases the regulators stood idly by and did nothing, but the operating dynamic was private capital turning fraudulent/bad investments into private profits. It seems to me that what made mortgages such a logical pick to reinflate the bubble was that with so much saved wealth destroyed in the previous scheme, the next bubble had to involve borrowed money, and government sponsorship of "home ownership" was an easy way to make that happen.
What I take issue with is the notion that the bubble was caused by some socialist/government scheme to give homes to poor people. In my mind the poor people were incidental to the larger scheme, the same way wrecked cars are incidental to insurance fraud.
Amen brother. The market reacted like a market: Huge, hungry, voracious even, and something that will consume whatever you let it until it's way past time to stop. It's like a animal in which all of the synapses or genes or nerve pathways that regulate when to stop eating have been surgically removed, so it will literally just eat and eat until it explodes, like Mr. Creosote.
Everything you wrote is dead-nuts on, thank you. However, you have pointed out half of the problem. The flourishing of bubbles, scams, and Ponzi schemes over the last two decades is not the result of personality flaws or intellectual shortcomings of individuals on Wall Street or among the economic regulatory bodies. These men and women are not fools or stupid, they understand that these devices are only short term sources of profits, ones that are ultimately corrosive to the long term health of the US economy. The fundamental problem is that there is no alternative outlet for investors.
Imagine you have 100 million dollars to invest and you want the greatest return that is save and legal, where do you put your money. Legitimate, legal investments in the US pay hardly anything at all. Nancy Miller has two excellent posts on how poorly traditional investments have done.
The WSJ reported that the first decade of the 21st century was the worst performing decade in two centuries of stock market history. Washington and Wall Street are only too aware that there is an investment crisis. This is main reason that they have been repealing regulatory safeguards and turning a blind eye to Wall Street shenanigans, this is the only way to create a profitable outlet for investors. I am sure that they are all thinking that these are just transitional allowances until some more substantive, longer term solution comes along. There is little doubt that the real estate bubble was a direct result of economic regulators trying to alternative investment opportunities following the "dot.com" bubble / bust.
How many communities in this country once had thriving industries but are now dependent on casinos and tourism? Wall Street has made the same transition, it was once a place where investors met manufacturers to build industry. Speculation and gambling were always a part of Wall Street but since the 1930's they were just a side-show, now they are the show.
With the lose of our industrial base, where else can investors get a competitive profit except through bubbles, scams, and Ponzi schemes.
Sure. Except they're not making profits. They're losing money, great masses of it in fact.
What you're talking about is compensation. There is no way to make high short-term profits when there are no easy investment opportunities. But when you can take some homeless person, give him a mansion, then sell his debt to a pension fund for real money, there's a profit for you! Not a real profit, mind you, but a real bonus comes out of it.
I get that there weren't many obvious high-returning investment opportunities suitable for all that money. But there were some that panned out, and there were probably a lot more that were never discovered because too much energy was expended simply trying to steal the crumbs still lying around. What if all of that money had gone into alternative energy companies? Into education? Border security? Aerospace research? Biomed? We might be sitting on a pile of cancer cures and solar generators instead of worthless IOUs. 9/11 might not have happened. We might not be at war. Who knows?
This story was always about the changed priorities of the investor class. Instead of taking chances on the industry and imagination of the American people, they decided to just steal the stuff those Americans already have. That's the difference between bubbles and forward-thinking economics. Hell, that's why we supposedly pay bankers so much - it's their jobs to take money and use it to create new businesses that haven't even been developed yet. To let them off the hook because there was nothing to invest in but savings accounts… to met that's more an reflection of their general incompetence to do their jobs correctly.
I'm confused by something.
As I understand things, Fannie and Freddie play only in the secondary market for mortgages. That is, neither GSE originates any mortgage loan, they only buy mortgages AFTER somebody else has made the loan. See Barry Ritholtz's "Bailout Nation" for further details.
From that perspective, the WSJ's claim that the GSEs were primarily responsible for the financial crisis has no merit even if you accept Fannie's 15-month old admission, which I'll grant you. However Fannie/Freddie mischaracterized the mortgages they bought, they did not make the bad loans that helped spark the crisis and cannot be held responsible for doing so (NOTE: subprime was too small to cause the crisis; it was the securitization of subprime that inflated the size of the problem to a point where things could explode). The folks at ZH are smart enough to know this (and I'm sure they do), so they're talking their book if they argue otherwise (and they tell all of us to assume that they are talking their book).
Nevertheless, something is still rotten in Denmark. Why did Fannie mischaracterize the loans it had purchased? Was it, perhaps, to nominally stay within guidelines it was supposed to follow when purchasing loans on the secondary market? Was Fannie already trying to bailout the banks through the back door?
That's the real issue in the Xmas Eve Massacre: a backdoor bailout of Wall Street not subject to Congressional oversight. When you really look into it, I think you'll agree.
In the meantime, I'd suggest spending more time at the Baseline Scenario, Calculated Risk, Barry's the Big Picture, Yves' Naked Capitalism, Jesse's Cafe Americain, and Mish's site (just to get a full spectrum of politics in there). ZH has a lot of provocative stuff, but it just isn't a reliable starting point. You're probably just smarter than I am, but I need the perspectives that these other bloggers bring to bear to understand whether ZH is spot-on or full of it.
Amen brother. The puppeteers had a field day with the rest of us fools. They lined their pockets and feathered their nests and got us to look the other way by creating the ultimate blame game that split us right down the middle.
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Last modified: March, 03, 2020