What is Washington to do as the financial system collapses? Clearly, stark
differences in approach as well as in public policy have already emerged.
Bail-out Bear Stearns and pump up the brokerage and investment business with
new lines of credit. Nationalize Fannie Mae and Freddie Mac on the backs of the
taxpayer - but let Lehman drown.
Tell the financial community to save itself, after which Bank of America
salutes and buys Merrill Lynch. Then, the Federal Reserve gets cold feet and
decides it can't let an institution the size of the insurance giant AIG go
under as well. Washington is left staring into the abyss. The old rules no
longer apply.
And that's the point. At moments of crisis since the mid-1980s, the
relationship between Washington and Wall Street has
changed fundamentally, at least when compared with anything that would have
been recognizable in the previous century. As a result, the road ahead is dark
and unknown.
During the 19th century, Washington was generally happy to do favors for Wall
Street financiers. Railroad tycoons, who often used those railroads as vehicles
of extravagant speculation, enjoyed subsidies, tax exemptions, loans, and a
whole smorgasbord of financial fringe benefits supplied by pliable congressmen
and senators (not to mention armadas of state and local officials).
Since the political establishment was committed to laissez-faire, legerdemain
by greedy bankers was immune from public scrutiny, which was also useful (for
them). But when panic struck, the mighty, as well as the meek, went down with
the ship. Washington felt no obligation to rush to the rescue of the reckless.
The bracing, if merciless, discipline of the free market did its work and there
was blood on the floor.
By early in the 20th century, however, the savage anarchy of the financial
marketplace had been at least partially domesticated under the reign of the
greatest financier of them all, J P Morgan. Ever since the panic of 1907, the
legend of Morgan's heroics in single-handedly stopping a meltdown that
threatened to become worldwide, the iron discipline he imposed on more timorous
bankers, has been told and re-told each time an analogous implosion looms.
Indeed, last week's news carried its fair share of 1907-Morgan stories,
trailing in their wake an implicit wistfulness. They all asked, in effect:
Where is the old boy when we need him?
Back then, with Morgan performing his role as the nation's unofficial private
central banker, president Teddy Roosevelt's administration continued to keep
its distance from Wall Street, still unready to offer salvation to desperate
financial oligarchs. Not normally chummy with Morgan and his crowd, Roosevelt
did cheer from the sidelines as the uber-banker performed his rescue operation.
As it turned out, though, the days of Washington agnosticism about Wall Street
were numbered. The economy had become too complex and delicate a mechanism and,
in 1907, had come far too close to meltdown - even Morgan's efforts couldn't
prevent several years of recession - to leave financial matters entirely in the
hands of the private sector.
First came the Federal Reserve. It was established in 1913 under president
Woodrow Wilson as a quasi-public authority meant to regulate the country's
credit markets - albeit one heavily influenced by the viewpoints and interests
of the country's principal bankers. That worked well enough until the Great
Crash of 1929 and the Great Depression that followed and lasted until World War
II. The depth of the country's trauma in those long years vastly expanded the
scope of Washington's involvement in the financial marketplace.
President Franklin D Roosevelt's New Deal did, as a start, engage in some
bail-out operations. The Reconstruction Finance Corporation, actually created
by president Herbert Hoover, continued to rescue major railroads and other key
businesses, while some of the New Deal's efforts to help homeowners also
rewarded real estate interests.
The main emphasis, however, now switched to regulation. The Glass-Steagall
Banking Act, the two laws of 1933 and 1934 regulating the stock exchange, the
creation of the Securities and Exchange Commission, and other similar measures
subjected the financial sector to fairly rigorous public supervision.
This lasted for at least two political generations. Wall Street, after all, had
been convicted in the court of public opinion of reckless, incompetent,
self-interested, even felonious behavior with consequences so devastating for
the rest of the country that government was licensed to make sure it didn't
happen again.
The undoing of that New Deal regulatory regime, and its replacement, largely
under Republican administrations (although Glass-Steagall was repealed on Bill
Clinton's watch), with what some have called the "socialization of risk" has
contributed in a major way to the mess we're in today.
Beginning most emphatically with the massive bail-out of the savings and loan
industry in the late 1980s, Washington committed itself, at least under
conditions of acute crisis, to off-loading the risks taken by major financial
institutions, no matter how irrationally speculative and wasteful, onto the
backs of the American taxpaying public.
Despite free market/anti-big-government rhetoric, real-life Washington has
tacitly acknowledged the degree to which our national economy has become
dependent on the financial sector (finance, insurance and real estate - or
FIRE). It will do whatever it takes to keep it afloat.
This applies not only to particular institutions like Bear Stearns, or even to
mortgage mega-firms like Fannie and Freddie, but to finance in general. When it
seemed necessary, public monies were indeed funneled in the general direction
of the banking/brokerage community to shore up the whole rickety structure.
This allowed one burst bubble - the dot-com debacle - to be replaced by
another, namely our late, lamented mortgage/collaterized-debt-obligation
bonanza, just now dramatically going down the tubes.
Backstopping the present bail-out is the ever-credulous, put-upon American
public with its presumably inexhaustible resources. Even while Washington was
instituting the periodic "socialization" of bad debts, it was systematically
abandoning the New Deal's commitment to regulation. That, of course, was in the
very period when financial markets became ever more arcane, ever less
comprehensible even to their Frankenstein-ian inventors, and ever more in need
of monitoring. So the "socialization of risk" was accompanied by the
"privatization of reward," which now is likely to prove a truly deadly
combination.
That the crisis has now reached a newly terrifying stage is suggested by
Washington's sudden willingness to depart from the new orthodoxy and let the
huge investment bank, Lehman Brothers, go under. Some may see in this a steely
return to a laissez-faire faith. More likely, it represents wholesale confusion
on the part of George W Bush administration and Federal Reserve policymakers
about what to do, even as all endangered businesses have come to take it for
granted that Washington will toss them a life-preserver when they need it.
The times call for a new departure. The next administration, which will surely
enter office under the greatest economic pressure in memory, must confront
reality. The financial system is out of control and has led the economy into a
wildly turbulent sea of heavily leveraged speculation.
It's time for a reversal of course. Stringent re-regulation of FIRE is not
enough any more. Washington's mission may, at this late date, be an even
greater one than Roosevelt's New Deal faced. The government must figure out how
to deploy its power to shift the flow of investment capital out of the
minefields of speculative paper transactions and back into productive channels
that will help meet the material needs of American society.
Real value must be created in place of chimeras. In the meantime, we all have
ringside seats - in fact, far too close to the action for comfort - as another
gilded age is ending. What comes after is, in part, up to us.
Steve Fraser is working on a book about the two gilded ages. A
TomDispatch regular and co-director of the American Empire Project series at
Metropolitan Books, he is the author of, among other works, the recently
published Wall Street: America's Dream Palace.
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