Economic Free Fall?
By William Greider
02/08/08 "The
Nation" -- - 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 blindness.
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 suggestions:
§ 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.
About William Greider
National affairs correspondent William Greider has been a
political journalist for more than thirty-five years. A former
Rolling Stone and Washington Post editor, he is the author of
the national bestsellers One World, Ready or Not, Secrets of the
Temple, Who Will Tell The People, The Soul of Capitalism (Simon
& Schuster) and--due out in February from Rodale--Come Home,
America.
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