Economic Free Fall? By William Greider

July 30, 2008/August 18, 2008 edition of The Nation Magazine

Washington can act with breathtaking urgency when the right people want
something done. In this case, the people are Wall Street’s titans, who
are scared witless at the prospect of their historic implosion. Congress
quickly agreed to enact a gargantuan bailout, with more to come, to calm
the anxieties and halt the deflation of Wall Street giants. Put aside
partisan bickering, no time for hearings, no need to think through the
deeper implications. We haven’t seen “bipartisan cooperation” like this
since Washington decided to invade Iraq.

In their haste to do anything the financial guys seem to want, Congress
and the lame-duck President are, I fear, sowing far more profound
troubles for the country. First, while throwing our money at Wall
Street, government is neglecting the grave risk of a deeper catastrophe
for the real economy of producers and consumers. Second, Washington’s
selective generosity for influential financial losers is deforming
democracy and opening the path to an awesomely powerful corporate state.
Third, the rescue has not succeeded, not yet. Banking faces huge losses
ahead, and informed insiders assume a far larger federal bailout will be
needed–after the election. No one wants to upset voters by talking
about it now. The next President, once in office, can break the bad
news. It’s not only about the money–with debate silenced, a dangerous
line has been crossed. Hundreds of billions in open-ended relief has
been delivered to the largest and most powerful mega-banks and
investment firms, while government offers only weak gestures of sympathy
for struggling producers, workers and consumers.

The bailouts are rewarding the very people and institutions whose
reckless behavior caused this financial mess. Yet government demands
nothing from them in return–like new rules for prudent behavior and
explicit obligations to serve the national interest. Washington ought to
compel the financial players to rein in their appetite for profit in
order to help save the country from a far worse fate: a depressed
economy that cannot regain its normal energies. Instead, the Federal
Reserve, the Treasury, the Democratic Congress and of course the
Republicans meekly defer to the wise men of high finance, who no longer
seem so all-knowing.

Let’s review the bidding to date. After panic swept through the global
financial community this spring, the Federal Reserve and Treasury rushed
in to arrange a sweetheart rescue for Bear Stearns, expending $29
billion to take over the brokerage’s ruined assets so JPMorgan Chase,
the prestigious banking conglomerate, would agree to buy what was left.
At the same time, the Fed and Treasury provided a series of emergency
loans and liquidity for endangered investment firms and major banks.
Investors were not persuaded. Their panic was not “mental,” as former
McCain adviser Phil Gramm recently complained. The collapse of the
housing bubble had revealed the deep rot and duplicity within the
financial system. When investors tried to sell off huge portfolios of
spoiled financial assets like mortgage bonds, nobody would buy them. In
fact, no one can yet say how much these once esteemed “safe” investments
are really worth.

The big banks and investment houses are also stuck with lots of bad
paper, and some have dumped it on their unwitting customers. The largest
banks and brokerages have already lost enormously, but lending
portfolios must shrink a lot more–at least $1 trillion, some estimate.
So wary shareholders are naturally dumping financial-sector stocks.

Most recently, the investors’ fears were turned on Fannie Mae and
Freddie Mac, the huge quasi-private corporations that package and
circulate trillions in debt securities with implicit federal backing.
Treasury Secretary Henry Paulson (formerly of Goldman Sachs) boldly
proposed a $300 billion commitment to buy up Fannie Mae stock and save
the plunging share price–that is, save the shareholders from their
mistakes. So much for market discipline. For everyone else, Washington
recommends a cold shower.

Talk about warped priorities! The government puts up $29 billion as a
“sweetener” for JP Morgan but can only come up with $4 billion for
Cleveland, Detroit and other urban ruins. Even the mortgage-relief bill
is a tepid gesture. It basically asks, but does not compel, the bankers
to act kindlier toward millions of defaulting families.

A generation of conservative propaganda, arguing that markets make wiser
decisions than government, has been destroyed by these events. The
interventions amount to socialism, American style, in which the
government decides which private enterprises are “too big to fail.”
Trouble is, it was the government itself that created most of these
mastodons–including the all-purpose banking conglomerates. The
mega-banks arose in the 1990s, when a Democratic President and
Republican Congress repealed the New Deal-era Glass-Steagall Act, which
prevented commercial banks from blending their business with investment
banking. That combination was the source of incestuous self-dealing and
fraudulent stock valuations that led directly to the Crash of 1929 and
the Great Depression that followed.

Even before Congress and Bill Clinton repealed the law, the Federal
Reserve had aggressively cleared the way by unilaterally authorizing
Citigroup to cross the line. Wall Street proceeded, with accounting
tricks described as “modernization,” to re-create the same scandals from
the 1920s in more sophisticated fashion. The financial crisis began when
these gimmicky innovations blew up.

Democrats who imagine they can reap partisan advantage from this crisis
don’t know the history. The blame is bipartisan; so also is the
disgrace. In 1980, before Ronald Reagan even came to town, Democrats
deregulated the financial system by repealing federal interest-rate
ceilings and other regulatory restraints–a step that doomed the savings
and loan industry and eliminated a major competitor for the bankers.
Democrats have collaborated with Republicans on behalf of their
financial patrons every step of the way.

The same legislation also repealed the federal law prohibiting
usury–the predatory practices that ruin debtors of modest means by
lending on terms that ensure borrowers will fail. Usurious lending is
now commonplace in America, from credit cards and “payday loans” to the
notorious subprime mortgages. The prohibition on usury really involves
an ancient moral principle, one common to Judaism, Christianity and
Islam: people of great wealth must not be allowed to use it to ruin
others who lack the same advantages. A decent society cannot endure it.

The fast-acting politicians may hope to cover over their past mistakes
before the public figures out what’s happening (that is, who is screwing
whom). But the Federal Reserve has a similar reason to move
aggressively: the Fed was a central architect and agitator in creating
the circumstances that led to the collapse in Wall Street’s financial
worth. The central bank tipped its monetary policy hard in one
direction–favoring capital over labor, creditors over debtors, finance
over the real economy–and held it there for roughly twenty-five years.
On one side, it targeted wages and restrained economic growth to make
sure workers could not bargain for higher compensation in slack labor
markets. On the other side, it stripped away or refused to enforce
prudential regulations that restrained the excesses of banking and
finance. In The Nation a few years back, I referred to Alan Greenspan as
the “one-eyed chairman” [September 19, 2005] who could see inflation in
the real economy–even when it didn’t exist–but was blind to the
roaring inflation in the financial system.

The Fed’s lopsided focus on behalf of the monied interests, combined
with its refusal to apply regulatory laws with due diligence, eventually
destabilized the overall economy. Trying to correct for previous errors,
the Fed, with its overzealous free-market ideology, swung monetary
policy back and forth to extremes, first tightening credit without good
reason, then rapidly cutting interest rates to nearly zero. This erratic
behavior encouraged a series of financial bubbles in interest-sensitive
assets–first the stock market, during the late 1990s tech-stock boom,
then housing–but the Fed declined to do anything or even admit the
bubbles existed. The nation is now stuck with the consequences of its

The Federal Reserve’s dereliction of duty is central to the financial
failures. It betrayed the purpose for which the central bank was first
created, in 1913, abandoning the sense of balance the Fed had long
pursued and that Congress requires. Most politicians, not to mention the
press, are too intimidated to question the Fed’s daunting power, but
their ignorance is about to compound the problem. Instead of demanding
answers, the political system is about to expand the Fed’s governing
powers–despite its failure to protect us. Treasury Secretary Paulson
proposed and Democratic leaders have agreed to make the insulated Fed
the “supercop” that oversees not only commercial banks and banking
conglomerates but also the largest investment houses or anyone else big
enough to destabilize the system. This “reform” would definitely
reassure club members who are already too cozy with the central bankers.
Everyone else would be left deeper in the dark.

The political system, once again, is rewarding failure. The Fed is an
unreliable watchdog, ideologically biased and compromised by its
conflicting obligations. Is it supposed to discipline the big money
players or keep them afloat? Putting the secretive central bank in
charge, with its unlimited powers to prop up troubled firms, would
further eviscerate democracy, not to mention economic justice.

If Congress enacts this concept early next year, the privileged group of
protected financial interests is sure to grow larger, because other
nonfinancial firms could devise ways to reconfigure themselves so they
too would qualify for club membership. A very large manufacturing
conglomerate–General Electric, for instance–might absorb elements of
banking in order to be covered by the Fed’s umbrella (GE Capital is
already among the largest pools of investment capital). Private-equity
firms, with their buccaneer style of corporate management, are already
trying to buy into banking, with encouragement from the Fed (the Service
Employees International Union has mounted a campaign to stop them). A
new President could stop the whole deal, of course, but John McCain has
surrounded himself with influential advisers who were co-architects of
this financial disaster. For that matter, so has Barack Obama.

The nation, meanwhile, is flirting with historic catastrophe. Nobody yet
knows how bad it is, but the peril is vastly larger than previous
episodes, like the savings and loan bailout of the late 1980s. The
dangers are compounded by the fact that the United States is now utterly
dependent on foreign creditors–Japan and China lead the list–who have
been propping us up with their lending. Thanks to growing trade deficits
and debt, foreign portfolio holdings of US long-term debt securities
have more than doubled since 1994, from 7.9 percent to 18.8 percent as
of June 2007. If these countries get fed up with their losses and pull
the plug, the US economy will be a long, long time coming back. The
gravest danger is that the national economy will weaken further and
spiral downward into a negative cycle that feeds on itself: as
conditions darken, people hunker down and wait for the storm to
pass–consumers stop buying, banks stop lending, producing companies cut
their workforces. That feeds more defaulted loan losses back into the
banking system’s balance sheets. This vicious cycle is essentially what
led to the Great Depression after the stock market crash of 1929. I
offer not a prediction but a warning. The comparison may sound
farfetched now, but US policy-makers and politicians are putting us at
risk of historic deflationary forces that, once they take hold, are very
difficult to reverse.

A more aggressive response from Washington would address the real
economy’s troubles as seriously as it does Wall Street’s. Financial
firms have lost capital on a huge scale–more of them will fail or be
bought by foreign investors. But Wall Street cannot get well this time
if the economy remains stuck in the ditch. Washington needs to revive
the “animal spirits” of the nation at large. The $152 billion stimulus
package enacted so far is piddling and ought to be three or four times
larger. Instead of sending the money to Iraq, we should be spending it
here on getting people back to work, building and repairing our tattered
infrastructure, investing in worthwhile projects that can help stimulate
the economy in rough weather.

An agenda of deeper reforms can boost public confidence even as it
undoes a lot of the damage caused by the financiers and bankers. Some

§ Nationalize Fannie Mae and other government-supported enterprises
instead of coddling them. Restore them to their original status as
nonprofit federal agencies that provide a valuable service to housing
and other markets. Make the investors eat their losses. Buy the shares
at 2 cents on the dollar. Without a federal guarantee, these firms are
doomed anyway.

§ Resolve the democratic contradiction of “too big to fail” bailouts by
dismantling the firms that are too big to fail–especially the newly
created banking conglomerates that have done so much harm. Restore the
boundaries between commercial banking and investment banking. In any
case, market pressures are likely to shrink those behemoths as banks
sell off their parts to survive. For the remaining big boys, revive
antitrust enforcement. Set stern new conditions for emergency lending
from government–supervised receivership, stricter lending rules to
prevent recidivism and severe penalties for greed-crazed shareholders
and executives.

§ Assign the Federal Reserve’s regulatory role to a new public agency
that is visible and politically accountable. Make the Fed a subsidiary
agency of the Treasury Department and reform its decision-making on
money and credit to restore an equitable balance between competing goals
and interests–seeking full employment but also stable money and
moderate inflation.

§ Begin the hard task of re-creating a regulated financial system
Americans can trust, one that recognizes its obligations to the broad
national interest. This requires regulatory reforms to cover moneypots
like private-equity funds and to clear away the blatant conflicts of
interest and double-dealing on Wall Street, and also to give responsible
shareholders, workers and other interests a greater voice in corporate
management and greater protection against rip-offs of personal savings.

§ Re-enact the federal law against usury. The details are difficult and
can follow later, but this would be a meaningful first step toward
restoring moral obligations in the financial sector. People would
understand it, and so would a lot of the money guys. Maybe in the
deepening crisis, Washington will begin to grasp that money is also a
moral issue.

Copyright © 2008 The Nation

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