The Quiet Coup
Cult of finance protecting failed banks, economists tell Congress
The crash has laid bare many unpleasant truths about the United States. One is that the finance sector has captured our government -- a state of affairs typical of emerging markets. We trim, blend, and append two 2009 articles from (1) MarketWatch, Apr 21, on a Congressional hearing by Rex Nutting, their Washington bureau chief, and (2) the Atlantic of May by usimon Johnson, ex chief economist of the IMF now at MIT.
by Rex Nutting and by Simon JohnsonBanks have a stranglehold over the American economy and the American political system, leaving the country vulnerable to another financial crisis and more blackmail from Wall ustreet, two prominent economists warned.
Big banks must be broken up, and strict regulations must be reimposed, “Nobel” Prize-winning economist Joseph Stiglitz said, “leaving risk taking or management to others.”
MIT economist Simon Johnson, who saw dozens of emerging economies deal with these very same problems from his previous perch at the International Monetary Fund, said the real danger to our political economy is the "cult of finance" that has grown up in Washington and in the popular culture. A financial oligarchy has seized political and economic power and will not loosen its grip easily, Johnson said.
Stiglitz, Johnson, and Kansas City Fed President Thomas Hoenig testified at a hearing before the Joint Economic Committee. All three men said the current policy of protecting the big banks and their management must stop.
Hoenig said regulators should simply liquidate insolvent banks, and require those that need more capital to raise it in the private markets. If taxpayer money is needed temporarily until private investors shake off their fear, taxpayers should be put in the first position to be repaid, he said.
The current policy of giving some banks hundreds of billions of dollars, with few strings attached, only gives those banks an unfair competitive advantage and encourages all banks to try to get "too big to fail," Hoenig said.
"Anything that is 'too big to fail' is now 'too big to exist,'" said Johnson.
A "relatively small" investment of $5 billion in campaign contributions from those in the financial institutions "succeeded in transferring losses to the public estimated well in excess of a trillion dollars,” Stiglitz said. The banks have wrung favorable deals out of Washington by exploiting the fear of a systemic meltdown, he adds.
The financial sector itself is too big, commanding too much income for the value it contributes to society, Stiglitz said. "These big banks are not responsible for whatever dynamism there is in the American economy," he said. Their high returns “were the result of risk taken at the expense of American taxpayers."
He suggested competition is the answer to "too big to fail."
JJS: Johnson had more to say. It’s long but clear and damning of how high finance really works.
The Quiet Coup
Emerging-market governments and their private-sector allies commonly form a tight-knit -- and, most of the time, genteel -- oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that benefit the broader economy, but they also start making bigger and riskier bets. They reckon – correctly, in most cases -- that their political connections will allow them to push onto the government any substantial problems that arise.
In its depth and suddenness, the US financial crisis is reminiscent of emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is what drove Lehman Brothers into bankruptcy, causing all sources of funding to the US financial sector to dry up overnight.
Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.
JJS: Actually, the recession was already underway and had to happen because too many people had already spent too much money on land (“housing”). Every “housing” bubble has resulted in recession, which people who see money as more real than land always forget.
From 1973 to 1985, the financial sector never received more than 16% of domestic corporate profits. In 1986, that figure reached 19%. In the 1990s, it oscillated between 21% and 30%, higher than it had ever been in the postwar period. This decade, it reached 41%. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99% and 108% of the average for all domestic private industries. From 1983, it shot upward, reaching 181% in 2007.
The great wealth that the financial sector created and concentrated gave bankers enormous political weight -- a weight not seen in the US since the era of JP Morgan. The banking panic of 1907 could be stopped only by his coordination of private-sector bankers.
JJS: Did lenders “create” wealth or merely unstopper credit, enabling others to create wealth? And a financial tycoon was the “only” way? Why not spread around the “concentrated” wealth and power? Why underestimate the power of economic justice?
In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption -- envelopes stuffed with $100 bills -- is probably a sideshow today, Jack Abramoff notwithstanding.
Instead, the American financial industry gained political power by amassing a kind of cultural capital -- a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country.
These personal connections (between broker and politician) were multiplied many times over at the lower levels of the past three presidential administrations, strengthening the ties between Washington and Wall Street.
Professors increasingly took positions as consultants or partners at financial institutions. This migration gave the stamp of academic legitimacy (and the intimidating aura of intellectual rigor) to the burgeoning world of high finance.
In a society that celebrates the idea of making money, it was easy to infer that the interests of the financial sector were the same as the interests of the country -- and that the winners in the financial sector knew better what was good for America than did the career civil servants in Washington. Faith in free financial markets grew into conventional wisdom -- trumpeted on the editorial pages of The Wall Street Journal and on the floor of Congress.
JJS: But as he just painstakingly demonstrated, markets are not free but orchestrated. And most “civil servants” are not fiscal savants.
Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew.
The new administration’s bailout enables insider investors to go after depreciated assets at a price that makes sense for the investors and at a price that makes sense for the banks; but what makes sense for the third group involved: the taxpayers?
Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector at a time when that behavior must change. As a senior bank official said, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” But the economy can’t recover until the banks are healthy and willing to lend.
JJS: Oh? In the past the economy has recovered before banks. Again, the writer implies a pseudo-supremacy of money -- symbols -- over land -- stuff. The human brain’s need for symbol -- which finds so much pleasure in religion and literature and so forth -- can easily obscure reality.
In some ways, the government has already taken control of the banking system. It has essentially guaranteed the liabilities of the biggest banks. Meanwhile, the Federal Reserve has taken on a major role in providing credit to the economy.
JJS: To the “economy”? Not to me or anyone around here. It’s that scepter-centric worldview again.
Cleaning up the megabanks will be complex. And it will be expensive for the taxpayer.
JJS: “Complex” means don’t blame those responsible if it doesn’t work or takes too long. And it calls for self-styled “experts”. And sticking the citizen with the tab is not a foregone conclusion.
Forget bailouts. Just de-tax efforts, charge full-market value for government-granted privilege (from EM spectrum licenses to oil leases) and pay the citizenry a dividend, as would any healthy economic entity.
Break the oligarchy. While the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.
JJS: His solution, after breaking up the banking cartel, is a political one, “thou shalt not grow nor merge." It lacks a correction of the condition that allowed concentration in the first place, which is the privatization of publicly-generated value, mainly and classically the value of land, or location more precisely.
For a basic solution, use geonomics: have government, while de-taxing useful effort, recover natural value. That'd shrink the price of land. Then mortgages -- at half size and no longer inflating -- would never again be such hot commodities. Plus, you’d flatten the business cycle. Then, in widespread prosperity, the only problem is it’d take the limelight off economists and commentators. So? Let’s get a life!
Jeffery J. usmith runs the Forum on Geonomics.
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