Sunday, February 19, 2012

Sunday in the Park With George, Oops, Jeff Madrick

Jeff Madrick’s *Age of Greed*

by on June 13, 2011 at 1:17 am in Books, Economics | Permalink
Here is my review, along with Diane Coyle’s review of Tim Harford, and here is an excerpt (from the most negative part of my review):
…I found numerous points to object to. The chapter is titled “Milton Friedman, Proselytizer,” and there is a good deal of (fascinating) information about Friedman’s early years as a “fanatically religious” Jew. One is left with a picture of Friedman as a rather clever but irresponsible simplifier and dogmatist. There is not a comparable discussion of Friedman’s role in insisting on good empirical work and the testing and falsifiability of economics propositions, his building of the University of Chicago department with first-rate scholars and future Nobel laureates, and the numerous times he changed his mind on economic issues, including on monetary theory and policy. Friedman was much more a scientist and a skeptic than this essay lets on.
There are also particular errors and omissions. The discussion of Friedman’s desire to eliminate social programs does not mention that he wanted to replace them with a guaranteed annual income. It is wrong to claim that “the instability of velocity is what finally undid monetarism in the 1980s” when volatile interest rates were a much bigger problem, and in open economies such as Switzerland the exchange rate became the issue (monetary velocity moves in strange ways but it does so slowly). Few economists would agree with Madrick’s claim that “Friedman and Schwartz . . . made little advance over what was already known” or that their Monetary History had little empirical basis. Contrary to Madrick’s view, it is now widely accepted that inflation—or at least ongoing inflation, as Friedman made clear—is always a monetary phenomenon. These aren’t mere accidental oversights; they contribute to a systematic downgrading of Friedman’s legacy of scholarly depth and impact.


Mal June 13, 2011 at 2:34 am
The discussion of Friedman’s desire to eliminate social programs does not mention that he wanted to replace them with a guaranteed annual income.
Interesting. I did not know that. Is there a particular level of minimal annual income that was proposed/promoted? Who are the present-day adherents of a guaranteed annual income? Is the whole thing actually a good idea? At what level? So many questions…
Andrew' June 13, 2011 at 5:39 am
Was it some kind of Georgist expedient? I think we’d do better legalizing barter, understanding barter as an ‘inferior good.’
Geoff June 13, 2011 at 10:13 am
In both “Free To Choose” and “Capitalism & Freedom” I remember he discussed the idea of negative income tax as an alternative to programs like social security, which would be calculated based on witholding allowance. I don’t recall him going into specifics as to how the funds would be distributed. If you haven’t read those two books, I highly recommend them, despite both of them being a little dated at this point.

Hondo69 June 13, 2011 at 7:22 am

An excellent book on this:
In Our Hands by Charles Murray

Bill June 13, 2011 at 7:41 am

I following your link and found that the he IMF has its own book review section.
Link to: How to Cut Government Spending

NNM June 13, 2011 at 7:47 am

Albert Einstein was also a fanatically religious Jew for a period of his youth. It did not seem to affect his reasoning abilities as an adult.
Also, at the risk of being a chauvinist, Madrick not only misrepresents Friedman, he misrepresents Judaism. Judaism is a religion in which one can be both a “fanatic” and also a doubter, skeptic, and mind-changer (cv the Talmud).

mac June 13, 2011 at 9:26 am

Dr Cowen, you are very kind in your review. It sounds like this guy took a page out of Naomi Klein’s narrative on Friedman.

Lance June 13, 2011 at 9:38 am

I don’t believe Friedman was an Orthodox Jew past the age of 13. Ebenstein’s biography of Friedman reports that he was a strong agnostic starting around the age of 13.

TGGP June 13, 2011 at 10:32 am

I had also heard that he was irreligious from an early age. Interesting to hear that at one time he wasn’t.
What is Madrick’s degree in? Looking him up on Wikipedia, he has been an economics journalist but apparently was visiting professor in the humanities.

albert magnus June 13, 2011 at 10:44 am

Professor, have you considered writing a book on Milton Friedman? You seem to know a lot about him, you like to write books and you are an economist. I’m sure you could get some people help research things for you.

Jeff June 13, 2011 at 11:56 am

If you want to know what Milton Friedman thought, it’s easy enough to find out. His books Capitalism and Freedom and Free to Choose are both quite accessible, and you can find any number of his other writing online very easily. There are also a bunch of videos available on YouTube.
So why should anyone care what Jeff Madrick thinks?

Cahal June 13, 2011 at 2:46 pm

Doesn’t ‘inflation is always and everywhere a monetary phenomenon’ completely contradict the NAIRU? Am I missing something?

Jim S June 14, 2011 at 12:16 am

Friedman may have proposed the negative income tax, but those who claim to have inherited his mantle reject it violently.
Comments on this entry are closed.
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Jeff Madrick on How Wall Street Won and America Lost

POSTED: June 24, 3:04 PM ET | By Julian Brookes
Jeff Madrick on How Wall Street Won and America Lost
Courtesy of JeffMadrick.com
In his latest book, Age of Greed, former New York Times economic columnist Jeff Madrick tells how Wall Street triumphed and America paid the price. It's the story of how, starting in the 1970s, right-wing economics – a mystical cult centered on small government, low taxes and financial deregulation – and human greed teamed up to produce not shared prosperity but obscene economic inequality and financial instability, through the ideas and doings of a bipartisan roster of politicians, financiers, and economists, some obscure, others prominent (hello, Robert Rubin, Larry Summers!). We recently got him on the phone to talk about the triumph of finance and the decline of America in our age of greed.
In the book you say the roots of our economic troubles are in the 1970s. What happened in those years?

The American people turned against government, and the catalyst was the confusing and painful period of high unemployment and high inflation that struck harshly in 1973 and didn't really subside until 1980-81.
And right-wing politicians and economists blamed government.
The right wing claimed the government had become too big, that deficits caused the problem, and that the Federal Reserve had allowed the money supply to run amok. And this idea got ingrained in the public imagination and in the media. America began to doubt government, and that opened the door for business to abuse regulation and change regulation, a chance for right-wing politicians to get more power.
But you point out in the book that government wasn’t all that large at the time.
Government wasn’t very big, and federal budget deficits were much smaller, as a proportion of GDP, under Carter than they were under Ronald Reagan, when inflation was falling.
But the idea took hold anyway that government was the problem and deregulated markets the solution.  And Milton Friedman was the big intellectual force behind this view.
Yes. He started out as something of a New Dealer but became a right-wing advocate of the idea that the free market will solve almost all social problems. He thought all you had to do was control money, and there was no way you could really affect the unemployment rate. He was very articulate, especially in journalism and in debates, and his simplistic way of thinking captured minds and hearts at a time of enormous confusion, in the 1970s.
And meanwhile, the financial industry was starting to develop new kinds of securities, derivatives and so on, that would change the nature of investing.
Right. And nobody in Washington started talking about regulating these derivatives. On the contrary, Jimmy Carter - the first really conservative Democrat in economic matters - was very much in favor of deregulation.
Reagan and Bush continued the trend toward deregulation, obviously, but so did Clinton.
Clinton played the game and made matters even worse. His treasury secretaries, Lloyd Bentsen and then Robert Rubin, really believed that Wall Street had the answers – that if we give them their head they will create prosperity in America. They also knew that Wall Street is a place Democrats can get campaign financing. Republicans had lots of other areas of business sewn up, and the Democrats went for entertainment, Silicon Valley, and finance.
So let's turn to the consequences.
The consequence was a misallocation of capital for 40 years. In the 1980s, the S&Ls were deregulated. They made absurd investments for which they had to be bailed out. That's when the corporate takeover movement got crazy, financed by banks and junk bonds, which in turn received tax benefits because the interest was deductible. I think the evidence shows the takeovers mostly wasted money. And then the high-tech fantasies of the 1990s, the WorldComs and Enrons, the enormous accounting frauds, and finally all that wasted money in housing.
Wouldn't free-market types say you have to allow finance to make these mistakes in order to get the benefits of their good investments and of overall growth?
Well, but what happened over this period? There were only a few years here and there where productivity grew rapidly. Capital investment was weak as a proportion of GDP for the most part, except for a few years here and there. And wages as we know basically stagnated. So no, the benefits did not outweigh the costs; we've had enormous waste and then a failure of public investment because taxes have been so absurdly low.
What do you have in mind when you say "failure of public investment"?
A lack of investment across the board – in energy, in new kinds of R&D, new kinds of manufacturing, general public investments in health care and transportation infrastructure, broadband and so forth. I think we're going to see America have a very hard time climbing back to serious prosperity in the future because of this lack of investment.
You call this period an "age of greed" but couldn't you as easily call it an "age of ideology" – of true believers?
Well, you always have to worry when ideology somehow lines your pockets. And I supposed some of them truly believed and some of them still truly believe, but clearly these were large-scale rationalizations, and as greed went unchecked, a climate of greed grew. And greed received approbation. Nobody began to question if you had gigantic houses anymore - once upon a time, people used to be a little bit embarrassed. Now, nobody was embarrassed.
What's your take on the Dodd-Frank financial reforms?
I think Dodd-Frank has some good points, but it's not going to be enforced well, and anyway they're still writing the rules. I think there's been way too much emphasis on "too big to fail." That's really not the issue; the issue is too much speculation, too much leverage and too much incentive to promote investment.
What would you like to see, regulation-wise?
I think we need seriously higher capital requirements, we have to prohibit certain kinds of securities that cannot be truly understood or are very easily given to speculation, like collateralized debt obligations. I think we probably have to limit what big institutions can do – not because of size but because of conflict of interest. And then I think we have to do something which is a no-no in America: We have to recognize that Wall Street is a monopoly, or at least an oligopoly. They get away with charging ridiculous fees – 7 percent for an IPO! – because there's no real competition.
Lastly, what do you make of the deficit fight in Washington?
I think austerity economics now are a disaster in Washington, because we may be facing another recession. We're going to get a very slow recovery – because of private debt, not so much public debt. And I think this argument about balancing the budget right away, right now, will prove to be one of the great follies of American history.
Related: How Alan Greenspan Helped Wreck the Economy (Book Excerpt: Age of Greed)
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COMMENTS

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  • Julie Gervais |July 31, 10:13 AM ET
    There's a (very homemade) soft rap about aspects of this topic on youtube, filed under 'Bankster Gangs'.
    Because when you feel powerless to do anything about any of this stuff, you just start rhyming.
  • Lucky Lieberman |June 27, 11:24 AM ET
    Capitalism is flawed. We allowed a private banking system to devise an economy that only enriches the bankers, who by the way have all of our money and compete against all Americans to earn a dollar.
    If you borrow money as a government it stands to reason that you will have to print more money to pay the interest and the principal back. The Federal Reserve Banking System prints all the money they want and we by law cannot know what they are doing with our money.
    If the U.S. Treasury can give the Federal Reserve Banking System free money, the U.S. Treasury can directly loan every credit worthy American or business money and collect the interest that will be used to pay our Government’s bills (obligations), instead of having the interest go to the unnecessary Banker’s greedy pockets.
    With the U.S. Treasury as our National Bank, which is the way it should and must be, no more income taxes, no more borrowing to pay the Governments bills, hence no National Debt. Ban currency trading in America and by Americans and have our U.S. Government set the value of our money between all the other nations of the world. The Federal Reserve Banking System mistake has cost us 95% of the value of our U.S. Dollars since they were left in charge of our money since 1913.
    Wake up America!!!
  • Gtpills R'us |June 26, 9:18 AM ET
    Wall Street Hedge Funds have caused most havoc to the American way of life. We don't have to pay $4 for a gallon on gas. Gas prices are manipulated by Wall Street Hedge Funds, aided by price gorging oil companies.
    Simple solution: Show consumer power. Boycott one gas company for a month. I say don't buy Exxon Mobil for a month. I assure $2 gas!
    Gary Hassay | June 26, 8:54 PM ET
    I think we should demand that the CFTC revoke the bona-fide hedge exemptions that have been given out to firms who are using these exemptions for speculation purposes. Firms are creating artificial demand by taking ultra-long positions on commodities; this has been jacking up prices even as OPEC is having difficulty in selling their oil supply.
Read more: http://www.rollingstone.com/politics/blogs/national-affairs/jeff-madrick-on-how-wall-street-won-and-america-lost-20110624#ixzz1mrYQzKyK

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Lynn Parramore

Lynn Parramore

Editor of New Deal 2.0; Co-founder, Recessionwire
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Conversation With Jeff Madrick, Author of Age of Greed (Part One)

Posted: 05/31/11 04:15 PM ET
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Cross-posted from New Deal 2.0.
Roosevelt Institute Senior Fellow Jeff Madrick recently sat down with ND20 Editor Lynn Parramore to discuss his latest book, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present, which hits stands today. If you're in the New York City area and want to learn more, catch Jeff at Cooper Union on Thursday, June 2nd. Click here for more information on the event.
Lynn Parramore: You called your book Age of Greed, tracing the antecedents and activities of a four-decade period starting in the 1970s. Why did you choose greed as the central theme? Why not "Age of Risk" or "Age of Delusion", for example?
Jeff Madrick: I think greed always exists. It rises and falls with the times. But when it's unchecked by government, which has been happening since the 1970s, it festers on itself. It becomes outsized and it badly distorts the economy. That is to say, self-interest rises to a level of greed that overwhelms the economic invisible hand. When self-interest turns into greed, people start using the power of business to undermine the way markets should work. What happened in this era was that people worked in their self-interest. They didn't just take more risk. They were not deluded. Many of them took more risks than they should and merely did it because they made a buck. So greed really drove this decade: money and self-interest in the extreme drove very bad decision-making on Wall Street, which in turn, it's important to emphasize, deeply harmed the American economy.
LP: Walter Wriston, a name perhaps unknown to many Americans, gives the title to not one but two chapters of your book? Why is this figure pivotal?
JM: My writing career began in the 1970s, so he was a big name to me. I interviewed him several times. Walter Wriston was the pioneer in the effort to deregulate financial markets. He was a talented, very bright man who ran a very powerful bank and had enormous access to the Republicans who took over in 1969 through Richard Nixon's victory. And he is the one who began unraveling the regulations -- the way controlled commercial banks, which took FDIC-insured savings deposits, could invest their money. In fact, as people read the book, they'll see that he was a free-market ideologue. He really hated the New Deal. His father, a prominent conservative historian who ultimately was president of Brown University, hated the New Deal. Wriston inherited that from him in my view. But he also used it for his company's own gain. In the 1970s, Wriston really began to whittle down the famous "Regulation Q", which controlled the interest rate that could pay savers to attract money. And therefore the banks could get more aggressive about where they lent the money. He also developed an enormous international business. What was remarkable about Wriston -- to the detriment of the American economy to a degree but especially to the third world -- was that he took the petrodollars of the Arab nations. The Arab nations got a lot of dollars when they tripled, quadrupled and again doubled the price of oil. All of that was paid in dollars to them. They had to do something with those dollars. Wriston leaped in to recycle them by making loans to the third world --especially by developing nations. Especially in South America. Government could just as easily have been handled by the I.M.F., the World Bank, or some ad hoc group of governments to oversee the use of that money, and even to make it equity money, not loan money -- investments and productive business. Instead it was lent to countries, and, to some degree, companies that had exported commodities. Wriston heralded how well his loan officers could manage that money and the loans almost all turned bad in the 1980s -- so bad that the banks chose to stop lending to countries in trouble, particularly Mexico in 1982. The Fed and the I.M.F. had to rescue, in effect, the American banks.
LP: Wriston started his career -- and remained for some time -- a rather unassuming man who lived in a middle class housing project. But by the end of his career he was living among celebrities and driving fancy sports cars. Does that trajectory reflect a key change in American banking and financial culture?
JM: A good friend of mine told me back in the '70s that financiers never became wildly rich in American history. Take J.P. Morgan, the greatest financier in American history. When he died, Andrew Carnegie said, "I didn't know he had so little money." In the 1970s that began to change. Financiers became enormously wealthy. Wriston was the leading edge of that, but he wasn't the man to make by any means the most money. He wanted to make a bank into a growth company, like Xerox or IBM or Johnson & Johnson, which were the great growth companies. Or later, Microsoft, Apple. But should banks have been growth companies? In the meantime, he began to travel in a very powerful world and he began to live the good life. I think it was the beginning of that kind of thing, but others took it to excesses that made him look like a piker.
LP: That brings me to Ivan Boesky. He's the first character in the book who really seems to capture the very essence of greed. He's a bandit with no pretense that he's working on behalf of anyone else. Was he the beginning of this era's greed in its purest form?
JM: Ivan had no illusions about what he was doing. Now, I don't know if that's as un-admirable as it sounds. Because many of the other guys created a pretense to allow them to seek their self-interest -- and, in my view, become excessive, even corrupt. Ivan knew he was corrupt. He intended to be corrupt. Where he was stupid is that he really didn't even try to seriously cover his tracks.
LP: Was he an outlier? Did this type of behavior become something others wanted to emulate?
JM: He was the leading edge of the culture. Few people were quite as crude as Boesky. They disguised it. They didn't brag about it that much. But they were very aggressive in their own way and Ivan occasionally talked about that famous line from Adam Smith that greed is healthy. He thought he was emulating Smith. By greed he meant self-interest. But he wasn't really concerned about those bigger things. He had certain psychological issues, some of which I trace in my book. He needed constant social affirmation. He needed it. In my view, he couldn't walk into a room anonymously. It just was too much for his shallow and very weak ego. He needed that money and would do anything for it. He was a mobster. He was addicted to money and he would commit financial crimes to get it with no qualms.
LP: You outline how the hatred of government intrusion drove many of the early proponents of the free market model. This seems a great irony, given that financiers who hate government need its cooperation -- its guarantees, its bailouts -- in order to get and stay rich. How do you explain this contradiction?
JM: Self-interest means that you will do anything, even utilize government, to make your money and to retain your place in society. There are many examples of people who think that the rules apply to others but not themselves. Wriston was a classic example of this. It wasn't only the bad bank loans. In 1970 when Penn Central went bankrupt, his bank made the most commercial paper loans to Penn Central. He was scared to death everything was going to fall apart. He called the Fed - I don't know if he spoke to the Chairman, Arthur Burns, but the Fed opened its window like it did in 2007. This happened many times with Wriston. He talked this game of free competition, but when he needed to be bailed out, he got bailed out. So it's an extreme hypocrisy -- not an unusual characteristic of egotistical, ambitious men and women. There are double standards.
LP: Many argue today that government has been captured, or even restructured through the influence of the financial and banking industries. Is this true? If so, how can trust in government -- trust in its ability to intervene in crises -- be restored?
JM: There is no explanation for the deregulation and lack of oversight on the part of Washington except that they were snookered, beholden, or saw where their bread was buttered because of the rise of Wall Street and how much money you could make. Something we have to be cautious about: we're snookered by a simplistic ideology. The people who adopt ideologies and idealism do so often because it favors themselves and their own pocketbooks. The history of this period is a history of the abdication of government authority. Part of it was the result of this rising ideology in the '70s. Part of it was because Americans became convinced that big government and some kinds of regulations are problems. A lot of it had to do eventually with the sheer power of business to attract and influence these decision makers.
LP: Could government have done anything to stop greed?
JM: Greed would have remained checked had government been doing what it should be doing. And that's a tragedy of the age. One point we have to make clear is that the nation did not start wasting its money and losing its precious resources in 2007, 2008 and 2009. The financial community has been ill-serving the nation since the 1970s. I talked about the bad loans Wriston made. There were also all kinds of bad real estate loans made in that period. In the 80s the banks and other financial institutions financed the corporate takeovers - that was billions and billions of dollars. The S&L's made all kinds of bad loans because they were deregulated. In the early 90s banks and securities firms began using derivatives to make tricky loans to companies like Proctor&Gamble and Orange County. In 1994, when the Fed raised interest rates, those financial structures fell apart and Wall Street almost with it. In the late 1990s, Wall Street financed all kinds of high-tech fantasies. There was bad accounting. Outright lies by financial analysts on Wall Street. You could not keep your job and make your fame on Wall Street unless you lied. Accounting fraud and unaccepted accounting practices were rife throughout American in the late 1990s.
LP: So greed is the central problem, but deceit is the handmaiden?
JM: When you sell a product -- Electrolux vacuum cleaners, Avon hand lotions -- it would be naïve to think that there isn't some kind of exaggeration. But Wall Street became imbued with deceit at very high levels of transactions. The cost to the economy -- the misallocation of resources -- was huge. In the 1970s there were the bad loans in Central America. In the 1980s, the outrageous investments made by S&Ls with federally insured money. In the 1980s again -- huge hostile takeovers financed with tax-deductible dollars that were not ameliorated by government. In the 1990s, the high-technology fantasies -- Enron and WorldCom, telecom companies rife with accounting frauds. This amounted to hundreds of billions of dollars of bad investment. Even trillions of dollars. And then, of course, the 2000s -- there were the subprime mortgages and other bad mortgages. Trillions, literally.
LP: What have these losses meant to America's economy?
JM: This is all a misallocation of resources in America. When Alan Greenspan said his great mea culpa -- "I have this model of the economy and it worked for forty years and then it didn't work" -- that is nonsense. It did not work. There was constant misallocation of losses. He would argue, well, we need those losses in order to have the good. But look what happened to the economy during this period. We had 22 or 23 years of low-productivity growth. When productivity did start to rise, typical workers benefited from it only for a few short years in the late 1990s. Wages over this period of the Age of Greed have stagnated. They're actually down for men. They're up for women but only moderately over time, and women still make significantly less than men do with the same qualifications on average. What kind of economy is that? We haven't invested in transportation, education, health care advances, energy. The list goes on and on. And who knows how much manufacturing innovation we failed to invest in because of what happened on Wall Street.
**Stay tuned tomorrow for Part Two of this interview and find out what we need to do to change course.




Follow Lynn Parramore on Twitter: www.twitter.com/LynnParramore




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HUFFPOST SUPER USER
montemalone
oenophile, aquarist, francophone, radical moderate
07:12 PM on 06/01/2011
If we had a truly independen­t judiciary, we could indict, try, imprison, and claw back the ill gotten gains from the perpetrato­rs of the financial frauds of the past 30 years.
As it is now, we all know the who, what, when, where, and how, but nothing will happen.


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HUFFPOST SUPER USER
joebhed
Greenback Revolutionist
03:38 PM on 06/01/2011
There's a certain irony to the degree of anecdotal personal and corporate immorality in Jeff’s observatio­ns.
Jeff doesn't comprehend that the ebb and flow of regulation is in itself more symptomati­c of the money system that allows the greed of the financiali­sts to ebb and flow along with the the rules.
The Austrians have the classic example of the central bank - privileged banker relationsh­ip as the real cause of this problem - much more true than the basic problem being that of greed sans regulation­.
Wriston and Paulson go to the Fed for a bailout because they MUST do so periodical­ly under the government­-insured, implicitly unsound, fractional­ly-reserve­d debt-money system.
This debt-based money system of fractional­-reserve banking requires the government­'s deposit guarantee and the central bank's status as lender-of-­last-resor­t(to the banks).
That's the nature of this parasitic system. The Austrians have this part exactly right.
The solution to all this pro-cyclic­al immorality is NOT getting back to Glass-Stea­gall and a healthier understand­ing of MMT by those in government­.
The solution lies primarily in Part A of that offered by the Austrians - the end and purging forever of the goldsmith-­Rothschild connivance known as fractional­-reserve banking, and its replacemen­t with a sound monetary system that ensures the salvation of capitalism through a fully-rese­rved system of bank loans and deposits.
Cong. Dennis Kucinich says it all right here:
http://www­.monetary.­org/hr6550­bill.pdf
Thanks.




 

Book review: ‘Age of Greed’ by Jeff Madrick


By David Greenberg, Published: July 29, 2011


Once they’ve been carved out and stamped, reiterated in books and taught to schoolchildren, the units of historical time can seem as natural and apparent as the continents and oceans on a map of the Earth: the Progressive Era, the Gilded Age, Reconstruction. We know that each of these names is a human invention, each year dividing these periods a matter of human choice. But we don’t notice the invention when it’s happening; we never see anyone decide when an era begins, or what to call it, or what qualities mark it as an epoch.
What has defined our time — America since the 1960s? Historians are now trying to figure it out. In “Restless Giant,” James T. Patterson placed prosperity and freedom at the center of our fin de siecle journey. For Sean Wilentz, it was “The Age of Reagan,” a time of ascendant conservatism. Daniel Rodgers calls it an “Age of Fracture,” when old and widely shared verities splintered into a jumble of irreconcilable premises.
(Knopf) - ‘Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present’ by Jeff Madrick. Knopf. 464 pp. $30

Jeff Madrick, in his compelling new history, dubs it an Age of Greed. Madrick is not a professional historian but an accomplished economic journalist known for his essays in the New York Review of Books. Nor is he surveying all of American politics since the 1960s, just the major changes in business, finance and policymaking. Yet his book tries, like the others, to define and explain the long era, creating a larger framework by which future generations will understand our time. Ambitious in its scope and frequently persuasive in its arguments, “Age of Greed”abounds with powerful men, ugly fights, infamous scandals, twists and turns, and, true to the book’s title, lots of shameless cupidity.“Age of Greed” chronicles how Americans ended up with the highly unregulated financial system that produced the meltdown of 2008 and the fallout that lingers three years later. What’s most novel about the book, which relies heavily on other secondary accounts, is that unlike other recent treatments of the financial crisis, it traces the origins of the problem not to the Bush or Clinton or even Reagan years, but all the way to the late 1960s.
Back then, in the heyday of the post-World War II economy, a handful of bankers, businessmen, economists and politicians began campaigning to discredit, repeal and, when necessary, evade the controls that had governed lending and borrowing since the New Deal. Steadily, they made inroads, taking advantage of hard times, such as the stagflation-plagued ’70s, as well as good times, such as the tech-fueled ’90s. By 2008, as Madrick tells it, a once-worthy regime of safeguards had ceased to meaningfully police Wall Street or many other realms of American business.
A 40-year march through the world of Eurodollar CDs, greenmail and credit default swaps might strain a general reader’s comprehension, let alone interest. To relieve the tedium, Madrick breaks his story into 20 chapters, each a biographical thumbnail of one or more key players. Laying out these sketches in a strategic order, like a bridge player setting down his cards, Madrick constructs a more or less coherent tale out of his many political, financial and business-world fragments.
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Editorial Reviews

From Publishers Weekly

Mason (Live Working or Die Fighting), the economics editor of BBC Newsnight, relies on accessible and pithy language to lay out the time line of the meltdown of the U.S. economy in September 2008 and its global reverberations. He details the root causes, names names with impunity and place the blame squarely on the shoulders of policymakers. He argues that when the law governing debt to capital ratios was quietly changed in 2004, this gave banks carte blanche to do whatever they needed to do to make money. Mason writes, Had the old capital restrictions been in place, it is unlikely that any of the Wall Street banks could have built up toxic debts on the scale that eventually sank them. With a quick history (and refutation) of neoliberal ideology, he makes his case that we are seeing the closing of an era; the future heralds the end of the old world banking system business model in favor of low-profit, utility-style banking. This is an instructive and succinct play-by-play of the global crisis, helpful for anyone in finance, economics or even policy. (June)
Copyright © Reed Business Information, a division of Reed Elsevier Inc. All rights reserved.

Review

"Brilliantly conceived and beautifully written book...[Mason] has found a way to make his book vividly accessible...without compromising its intellectual force." Guardian "A page turning account - Mason is refreshingly clear-eyed - and angry." Will Hutton, Guardian "What people need is a reliable guide to the financial crisis - Meltdown is the book they are looking for." John Gray, New Statesman "A lucid and sharply polemical account of the crisis." Oliver Kamm, The Times "A reporter's eye-view of key events, enlivened by colourful brushstrokes." Sunday Telegraph

About the Author

Paul Mason is the economics editor of the BBC’s flagship current affairs program Newsnight and has been nominated for an Emmy for his work with BBC World News America. Twice shortlisted for the Orwell Prize for his BBC blog (bbc.co.uk/paulmason), he is the acclaimed author of Meltdown: The End of the Age of Greed, Live Working or Die Fighting, and the novel Rare Earth. He has covered globalization and social justice stories from locations around the world, including Latin America, Africa and China. Follow Paul on Twitter @paulmasonnews.



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Should Some Bankers Be Prosecuted?

November 10, 2011

Jeff Madrick and Frank Partnoy

Wall Street and the Financial Crisis: Anatomy of a Financial Collapse
by the Majority and Minority Staff, Permanent Subcommittee on Investigations, US Senate
639 pp., available at hsgac.senate.gov
Money and Power: How Goldman Sachs Came to Rule the World
by William D. Cohan
Doubleday, 658 pp., $30.50
Report of the Business Standards Committee
Goldman Sachs
63 pp., available at www.GoldmanSachs.com/BusinessStandards
madrick_1-111011.jpgBrian Zak/Sipa/AP ImagesLloyd Blankfein, chairman and CEO of Goldman Sachs, and Al Sharpton at the Cooper Union, where President Barack Obama was giving a speech on financial regulation, New York City, April 22, 2010
More than three years have passed since the old-line investment bank Lehman Brothers stunned the financial markets by filing for bankruptcy. Several federal government programs have since tried to rescue the financial system: the $700 billion Troubled Asset Relief Program, the Federal Reserve’s aggressive expansion of credit, and President Obama’s additional $800 billion stimulus in 2009. But it is now apparent that these programs were not sufficient to create the conditions for a full economic recovery. Today, the unemployment rate remains above 9 percent, and the annual rate of economic growth has slipped to roughly 1 percent during the last six months. New crises afflict world markets while the American economy may again slide into recession after only a tepid recovery from the worst recession since the Great Depression.
In our article in the last issue,1 we showed that, contrary to the claims of some analysts, the federally regulated mortgage agencies, Fannie Mae and Freddie Mac, were not central causes of the crisis. Rather, private financial firms on Wall Street and around the country unambiguously and overwhelmingly created the conditions that led to catastrophe. The risk of losses from the loans and mortgages these firms routinely bought and sold, particularly the subprime mortgages sold to low-income borrowers with poor credit, was significantly greater than regulators realized and was often hidden from investors. Wall Street bankers made personal fortunes all the while, in substantial part based on profits from selling the same subprime mortgages in repackaged securities to investors throughout the world.
Yet thus far, federal agencies have launched few serious lawsuits against the major financial firms that participated in the collapse, and not a single criminal charge has been filed against anyone at a major bank. The federal government has been far more active in rescuing bankers than prosecuting them.
In September 2011, the Securities and Exchange Commission asserted that overall it had charged seventy-three persons and entities with misconduct that led to or arose from the financial crisis, including misleading investors and concealing risks. But even the SEC’s highest- profile cases have let the defendants off lightly, and did not lead to criminal prosecutions. In 2010, Angelo Mozilo, the head of Countrywide Financial, the nation’s largest subprime mortgage underwriter, settled SEC charges that he misled mortgage buyers by paying a $22.5 million penalty and giving up $45 million of his gains. But Mozilo had made $129 million the year before the crisis began, and nearly another $300 million in the years before that. He did not have to admit to any guilt.


The biggest SEC settlement thus far, alleging that Goldman Sachs misled investors about a complex mortgage product—telling investors to buy what had been conceived by some as a losing proposition—was for $550 million, a record of which the SEC boasted. But Goldman Sachs earned nearly $8.5 billion in 2010, the year of the settlement. No high-level executives at Goldman were sued or fined, and only one junior banker at Goldman was charged with fraud, in a civil case. A similar suit against JPMorgan resulted in a $153.6 million fine, but no criminal charges.
Although both the SEC and the Financial Crisis Inquiry Commission, which investigated the financial crisis, have referred their own investigations to the Department of Justice, federal prosecutors have yet to bring a single case based on the private decisions that were at the core of the financial crisis. In fact, the Justice Department recently dropped the one broad criminal investigation it was undertaking against the executives who ran Washington Mutual, one of the nation’s largest and most aggressive mortgage originators. After hundreds of interviews, the US attorney concluded that the evidence “does not meet the exacting standards for criminal charges.” These standards require that evidence of guilt is “beyond a reasonable doubt.”
This August, at last, a federal regulator launched sweeping lawsuits alleging fraud by major participants in the mortgage crisis. The Federal Housing Finance Agency sued seventeen institutions, including major Wall Street and European banks, over nearly $200 billion of allegedly deceitful sales of mortgage securities to Fannie Mae and Freddie Mac, which it oversees. The banks will argue that Fannie and Freddie were sophisticated investors who could hardly be fooled, and it is unclear at this early stage how successful these suits will be.
Meanwhile, several state attorneys general are demanding a settlement for abuses by the businesses that administer mortgages and collect and distribute mortgage payments. Negotiations are under way for what may turn out to be moderate settlements, which would enable the defendants to avoid admitting guilt. But others, particularly Eric Schneiderman, the New York State attorney general, are more aggressively pursuing cases against Wall Street, including Goldman Sachs and Morgan Stanley, and they may yet bring criminal charges.
Successful prosecutions of individuals as well as their firms would surely have a deterrent effect on Wall Street’s deceptive activities; they often carry jail terms as well as financial penalties. Perhaps as important, the failure to bring strong criminal cases also makes it difficult for most Americans to understand how these crises occurred. Are they simply to conclude that Wall Street made well- meaning if very big errors of judgment, as bankers claim, that were rarely if ever illegal or even knowingly deceptive?
What is stopping prosecution? Apparently not public opinion. A Pew Research Opinion survey back in 2010 found that three quarters of Americans said that government policies helped banks and financial institutions while two thirds said the middle class and poor received little help. In mid-2011, half of those surveyed by Pew said that Wall Street hurts the economy more than it helps it.
Many argue that the reluctance of prosecutors derives from the power and importance of bankers, who remain significant political contributors and have built substantial lobbying operations. Only 5 percent of congressional bills designed to tighten financial regulations between 2000 and 2006 passed, while 16 percent of those that loosened such regulations were approved, according to a study by the International Monetary Fund.2 The IMF economists found that a major reason was lobbying efforts. In 2009 and early 2010, financial firms spent $1.3 billion to lobby Congress during the passage of the Dodd-Frank Act. The financial reregulation legislation was weakened in such areas as derivatives trading and shareholder rights, and is being further watered down.
Others claim federal officials fear that punishing the banks too much will undermine the fragile economic recovery. As one former Fannie official, now a private financial consultant, recently told The New York Times, “I am afraid that we risk pushing these guys off of a cliff and we’re going to have to bail out the banks again.”
The responsibility for reluctance, however, also lies with the prosecutors and the law itself. A central problem is that proving financial fraud is much more difficult than proving most other crimes, and prosecutors are often unwilling to try it. Congress could fix this by amending federal fraud statutes to require, for example, that prosecutors merely prove that bankers should have known rather than actually did know they were deceiving their clients.
But even if Congress does not, it is not too late for bold federal prosecutors to try to bring a few successful cases. A handful of wins could create new precedents and common law that would set a higher and clearer standard for Wall Street, encourage more ethical practices, deter fraud—and arguably prevent future crises.
Basic financial fraud involves a financial firm’s relationship with its clients, investors, or trading partners. The securities laws of 1933 and 1934 require full and fair disclosure of material risks, those that reasonable investors would consider important. Moreover, even if the securities laws did not exist, the employees of the financial firms could be charged with violating a variety of other federal and state antifraud statutes, which prohibit making false statements in various circumstances. New York State passed an especially aggressive law in 1921, which gives prosecutors expansive powers to fight financial fraud. The common law, created through rulings over the years by judges, also prohibits fraud under many conditions.
Many people may understand that crimes typically have two central elements: actus reus, a guilty act, and mens rea, a guilty mind. To convict someone of criminal fraud under any of the laws we have mentioned, a prosecutor must prove both that the defendant misrepresented important facts to investors and also that he or she knew those facts were false. In other words, failure to disclose pertinent facts to investors out of sheer negligence can’t give rise to prosecutable fraud; there must be full knowledge that such essential information is not being disclosed.
But it is difficult to prove criminal knowledge. For one thing, the facts in financial cases are usually complicated. Not very many jurors, for example, would feel competent to assess the correlations in a mathematical model that misled investors about the riskiness of subprime mortgages.
Moreover, bankers almost always protect themselves from the possibility of lawsuits and prosecutions by warning their clients, often in pro forma statements, about hidden risks and conflicts of interest. And Wall Street banks typically require that any person or institution buying their products sign a statement saying that they are sophisticated enough to understand the risks of the investment. In the SEC’s cases against Goldman Sachs and JPMorgan, the clients who bought the complex investments backed by subprime loans received just such warnings, and some courts in the past have held that those warnings protect the banks from liability, even if they sold investments that were too risky, or unsuitable, for their clients.
For a prosecutor to prove criminal charges, there must be solid evidence “beyond a reasonable doubt” that bankers knew what they were telling clients was false. This standard is less rigorous in civil enforcement cases, but any such charge must still be proven, and government agencies often prefer to settle for a fine rather than risk losing in court. Bringing these cases is costly, and the Justice Department must use its resources carefully, as must the SEC and other federal agencies in making civil cases.
In fact, the one criminal case brought by federal prosecutors in 2008 against two hedge fund traders working at Bear Stearns resulted in a verdict of not guilty. Although some e-mails showed that the traders did not disclose important risks to their investors, other e-mails showed that they had hoped the markets would correct. The jury found these persuasive enough to determine that the traders were not completely deceitful.
But the Bear Stearns case did not go to the heart of the unethical behavior at the core of the financial crisis. The most useful compilation of new evidence about this behavior is Wall Street and the Financial Crisis, the recently published report by the United States Senate’s Permanent Subcommittee on Investigations. Created in the 1950s, the PSI is the most important investigative body of Congress and has pursued wrongdoing in organized crime, money laundering, child pornography, and the United Nations Oil-for-Food program. Typically, when the PSI gets involved, criminal convictions soon follow.
  1. 1" Did Fannie Cause the Disaster? ," The New York Review , October 27, 2011. ↩
  2. 2Deniz Igan and Prachi Mishra, "Making Friends," Finance and Development , June 2011. ↩

  3. Did Fannie Cause the Disaster?

    October 27, 2011

    Jeff Madrick and Frank Partnoy

    Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon
    by Gretchen Morgenson and Joshua Rosner
    Times Books, 331 pp., $30.00
    madrick_1-102711.jpgPBS NewsHourJoshua Rosner and Gretchen Morgenson, Washington, D.C., June 2011
    Amid the current financial turmoil, the causes of the crisis that just preceded it—the bursting of the housing bubble—are being badly distorted. Some analysts, including the authors of the book under review, are arguing that the housing and financial crises of 2007 and 2008 were the direct result of federal guarantees of mortgages, a program first created in the 1930s, and therefore less so the result of the aggressive creation of mortgages by private business than has been widely reported.
    In particular, the authors accuse two quasi-public but profit-making companies, Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation), of adding risks to the mortgage markets that resulted in disaster. Much the same criticism has been made by Peter Wallison, a fellow of the American Enterprise Institute, who wrote an angry dissent to the findings of the Financial Crisis Inquiry Commission (FCIC), which was appointed by Congress to investigate the causes of the crash.1 Contrary to Wallison, the nine other members of the commission, including three others appointed by Republicans, concluded that Fannie and Freddie were not the main causes of the crisis.
    Along with many other experts, the nine members pointed to considerable evidence that, despite large losses, these government-sponsored enterprises (GSEs), as they are known, bought or guaranteed too few highly risky loans, and did so too late in the 2000s, to cause the crisis. But in their new book, Reckless Endangerment, the New York Times reporter Gretchen Morgenson and mortgage securities analyst Joshua Rosner try to revive the issue of their responsibility.
    The book boldly and passionately asserts that the risk-taking of Fannie Mae and Freddie Mac was a major element in causing the housing bubble. In particular, the authors blame the crisis on the goals set by the Clinton administration in the early 1990s to make lending “affordable” to more middle- and low-income home buyers. These goals were raised several times over the next dozen years so as to include more people, with the result that loans became cheaper. The authors write, “The homeownership drive helped to plunge the nation into the worst economic crisis since the Great Depression.” They add, “How Clinton’s calamitous Homeownership Strategy was born, nurtured, and finally came to blow up the American economy is a story of greed and good intentions, corporate corruption and government support.”


    This bold claim, however, is not substantiated by persuasive analysis or by any hard evidence in the book. The GSEs did generate large losses, but their bad investments in housing loans followed rather than led the crisis; most of those investments involved purchases or guarantees made well after the subprime and housing bubbles had been expanded by private loans and were almost about to burst.
    Even then, the GSEs’ overall purchases and guarantees were much less risky than Wall Street’s: their default rates were one fourth to one fifth those of Wall Street and other private financial firms, a fact not made clear by the authors. A further review of other literature shows that Clinton’s goals to increase “affordable lending” had little to do with the risks the GSEs took. The FCIC, for example, argued that in several years these goals were largely met by the GSEs’ standard loans with traditional down payments.
    Although they were set up originally by the federal government, the GSEs have been private companies for roughly the last forty years. They are traded on the stock market and were on a hunt for profits like much of Wall Street, in part because their executives’ bonuses were linked to earnings per share. Even so, by comparison with other companies they restrained their risk. Private firms on Wall Street and mortgage companies across the nation, uncontrolled by adequate federal regulation, unambiguously caused the crisis as they expanded in the 2000s. They were the ones who “came to blow up the American economy.”
    This is not to say that the GSEs’ way of doing business was sensible or that their losses—up to $230 billion—can be justified. The hybrid business model of a quasi-public but profit-making company, whose bonds were treated in the financial markets as if they were guaranteed by the federal government, was likely to lead to abuse and careless investment. Financial markets assumed that the GSEs were relatively safe partly because they were regulated by a federal agency, the Office of the Federal Housing Enterprise Oversight (OFHEO) and were subject to a web of rules. They also had a long record of backing safe mortgages. The authors describe well how, beginning in the 1990s, Fannie in particular betrayed its responsibilities. It aggressively minimized federal regulation of its activities and it fought off attempts to tax its profits, partly through extravagant favors to influential lawmakers. This is a story that needed telling. Reform of the GSEs should be an urgent part of a new federal housing agenda.
    But the book’s unjustified thesis that Fannie and Freddie were major causes of the financial crisis is being used by politicians and pundits to soften criticism of private business and by lobbyists and others who would water down the new regulations passed by Congress under the Dodd-Frank Act. The book is also being exploited by those who believe the federal government should have little if anything to do with support for the mortgage market, a view we find unfounded.
    Reviving the housing market was a high priority for Franklin Delano Roosevelt when he took office in 1933. In 1934, he created the Federal Housing Administration, which guaranteed mortgage payments, and provided insurance for savers’ deposits in the thrift institutions that then were the nation’s leading mortgage writers. He had also created a government bank, the Home Owners’ Loan Corporation, to make new loans to distressed home owners and buy bad mortgages from failing financial institutions. Finally, in 1938, he established Fannie Mae to guarantee mortgages that met adequate standards or buy them outright from private financial institutions; it issued its own debt to major investors to support its practices. The goal was to maintain a stable mortgage market with reasonable borrowing rates in all regions of the country.
    For roughly fifty years, Fannie Mae did its job. Home ownership rates rose from about 40 percent in the 1920s to about 60 percent and, in contrast to earlier, far more volatile history, the mortgage market was mostly stable. Freddie Mac was created in 1970 as a private company to package mortgages into securities that could be sold to institutional investors like pension funds.
    That the GSEs were private began to draw increasing criticism as they grew larger. The implied federal guarantee of the debt of these private, profit-making companies, which lowered their borrowing rates, made it easier for them to grow and make new and riskier loans. Some urged that the GSEs be fully privatized and stripped of any advantage they might have because of federal regulation. Wall Street and mortgage firms wanted for themselves the business Fannie and Freddie were doing, including the packaging of mortgages into securities.
    In the early 1990s, Congress recognized that Fannie and Freddie, which were growing rapidly, required closer regulation. President Clinton and Congress also were eager to channel more loans to lower-income Americans. Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, which established a new agency to oversee the GSEs and set affordable lending goals.
    From the beginning, the new oversight agency—OFHEO—was weak. And this is essentially where Reckless Endangerment begins, with sordid details about how James Johnson, Fannie’s chief executive and an influential Democratic insider, fended off control by OFHEO during its first seven years. Johnson established an expensive twelve-person lobbying office, gave campaign money to powerful politicians, and made contributions to the favorite charities of influential congressmen. He opened local development offices in congressional districts as a public relations campaign to show how congressmen were helping their local constituents get mortgages.
    By means of such measures, Johnson won congressional support and repeatedly resisted attempts by a handful in Congress to rein Fannie in, as did his successor in 1999, Franklin Raines, President Clinton’s former budget director. Perhaps most important, Johnson tied his own CEO bonuses and those of other executives to the earnings of the company.
    Morgenson and Rosner make a strong if one-sided case against Johnson. We never hear from any of his defenders, and he refused, the authors write, to be interviewed. But as they make clear, Johnson, partly by his egregious self-promotion, made Fannie virtually untouchable politically. Above all, he exploited the Fannie mandate to lend to lower-income Americans in order to expand the company’s reach, and in the process increase both its earnings and his personal wealth.
    They also note that Democrats ranging from Congressman Barney Frank, who got his partner a job with Fannie, to former Clinton adviser Lanny Davis were strong supporters of Fannie Mae. William Daley, a high-level adviser to President Obama, was on Fannie’s board. They cite Republicans who were Fannie supporters or executives as well, including Newt Gingrich, Senator Christopher Bond, and Robert Zoellick, legal counsel of Fannie and currently head of the World Bank.
    The authors make no serious charges of outright fraudulent corruption on the part of these people, however. The one potential exception is Angelo Mozilo, the flamboyant head of Countrywide Financial, the nation’s largest mortgage originator, who offered beneficial mortgage rates to some influential politicians. But the authors add nothing new here. The “friends of Mozilo,” who got cut-rate VIP loans, included Johnson, Senators Chris Dodd and Kent Conrad, and the late Ambassador Richard Holbrooke, among others. But while Mozilo did favors for them, Morgenson and Rosner cite no specific favors returned to Mozilo by Dodd, Conrad, Holbrooke, or the others mentioned.
    In these and other cases, the authors tar with a broad brush. They write that they conducted interviews over more than a decade and amassed a “mountain of notes,” but many sources quoted are anonymous and the book does not cite references in footnotes so there is no way to assess many of their assertions. They almost never deal with counterarguments to their many claims, if only to show them wrong.
    They make some odd errors as well, such as stating that Walter Mondale was “sitting out” the 1980 presidential election, when as vice president he ran again as Jimmy Carter’s running mate. Their scathing criticism of a Federal Reserve Bank of Boston study published in 1992, which demonstrated prejudice against minorities in the distribution of mortgages in the Boston area, is an especially disturbing example of their one-sided reporting. They assert that this study, which they say influenced Congress’s adoption of affordable lending goals, was deeply flawed. They mock the primary author of the study, the economist Alicia Munnell, and state that the Boston Fed made “a fool of itself.”
    1. 1Peter J. Wallison, " Dissent from the Majority Report of the Financial Crisis Inquiry Commission, " American Enterprise Institute, 2011. ↩

    2. The Busts Keep Getting Bigger: Why?

      July 14, 2011

      Paul Krugman and Robin Wells

      krugman_1-071411.jpgNicole Bengiveno/The New York Times/ReduxCharles Prince, left, in 2003, when he took over as chief executive of Citigroup after the resignation of Sanford Weill, right
      Suppose we describe the following situation: major US financial institutions have badly overreached. They created and sold new financial instruments without understanding the risk. They poured money into dubious loans in pursuit of short-term profits, dismissing clear warnings that the borrowers might not be able to repay those loans. When things went bad, they turned to the government for help, relying on emergency aid and federal guarantees—thereby putting large amounts of taxpayer money at risk—in order to get by. And then, once the crisis was past, they went right back to denouncing big government, and resumed the very practices that created the crisis.
      What year are we talking about?
      We could, of course, be talking about 2008–2009, when Citigroup, Bank of America, and other institutions teetered on the brink of collapse, and were saved only by huge infusions of taxpayer cash. The bankers have repaid that support by declaring piously that it’s time to stop “banker-bashing,” and complaining that President Obama’s (very) occasional mentions of Wall Street’s role in the crisis are hurting their feelings.
      But we could also be talking about 1991, when the consequences of vast, loan-financed overbuilding of commercial real estate in the 1980s came home to roost, helping to cause the collapse of the junk-bond market and putting many banks—Citibank, in particular—at risk. Only the fact that bank deposits were federally insured averted a major crisis. Or we could be talking about 1982–1983, when reckless lending to Latin America ended in a severe debt crisis that put major banks such as, well, Citibank at risk, and only huge official lending to Mexico, Brazil, and other debtors held an even deeper crisis at bay. Or we could be talking about the near crisis caused by the bankruptcy of Penn Central in 1970, which put its lead banker, First National City—later renamed Citibank—on the edge; only emergency lending from the Federal Reserve averted disaster.


      You get the picture. The great financial crisis of 2008–2009, whose consequences still blight our economy, is sometimes portrayed as a “black swan” or a “100-year flood”—that is, as an extraordinary event that nobody could have predicted. But it was, in fact, just the most recent installment in a recurrent pattern of financial overreach, taxpayer bailout, and subsequent Wall Street ingratitude. And all indications are that the pattern is set to continue.
      Jeff Madrick’s Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present is an attempt to chronicle the emergence and persistence of this pattern. It’s not an analytical work, which, as we’ll explain later, sometimes makes the book frustrating reading. Instead, it’s a series of vignettes—and these vignettes are both fascinating and, taken as a group, deeply disturbing. For they suggest not just that we’re seeing a repeating cycle, but that the busts keep getting bigger. And since it seems that nothing was learned from the 2008 crisis, you have to wonder just how bad the next one will be.
      The first thing you need to know about the cycle of financial overreach, crisis, and bailout is that it was not always thus. The United States emerged from the Great Depression with a tightly regulated financial sector, and for about forty years those regulations were enough to keep banking both safe and boring. And for a while—with memories of the bank failures of the 1930s still fresh—most people liked it that way. Over the course of the 1970s and 1980s, however, both the political consensus in favor of boring banking and the structure of regulations that kept banking safe unraveled. The first half of Age of Greed describes how this happened through a series of personal profiles.
      To some extent Madrick covers familiar ground here. He recounts the economic turmoil of the 1970s, as the country was caught in the grip of stagflation. And as he points out, Nixon and Ford—like today’s Republicans—blamed the economy’s troubles not on the true culprits but on big government. Madrick stresses a key point that is often forgotten or misunderstood to this day: the surging inflation of the 1970s had its roots not in some general problem of “big government” but in largely temporary events—the oil price shock and disappointing crop yields—whose effects were magnified throughout the economy by wage-price indexation. Yet constant policy shifts by the Treasury and the Federal Reserve (remember wage-price controls?) under Nixon, Ford, and Carter, Madrick argues, made the American public lose faith in government effectiveness, creating within it a ready acceptance of the antigovernment messages of Milton Friedman and Ronald Reagan.
      While we believe that there were deeper reasons for Reagan’s rise, Madrick is right that the economic malaise of the 1970s gave Reagan his big opening. As Madrick describes, Reagan’s enormous capacity for doublethink and convenient untruths enabled him, the front man for business interests, to convince a credulous public that “government had become the principal obstacle to their personal fulfillment.” In possibly the best chapter of the book, Madrick recounts the irony of how Reagan, the great moralizer, made unchecked greed and runaway individualism not only acceptable, but lauded, in the American psyche.
      Madrick also does an especially persuasive job of demythologizing Milton Friedman, who provided intellectual heft for the antigovernment movement. As Madrick points out, although Friedman offered some important economic insights, he often shoehorned real-life data to fit into a one-sided narrative, gaining his theories wider acceptance than was ultimately justified. And Friedman, like Reagan, preferred “overly simple assertions of free market claims,” discarding the caveats.
      In Friedman’s worldview, free markets were the solution to practically every problem—health care, product safety, bank regulation, financial speculation, and so on. And Friedman squarely blamed government for the Great Depression, a view that is at odds with the data. (Although it is almost certainly true that mistakes by the Fed made the situation worse.) As Madrick quotes him, “The Great Depression, like most other periods of severe unemployment, was produced by government management rather than by inherent instability of the private economy.” Replace “Great Depression” with “the financial crisis and its aftermath,” and it could be John Boehner today, rather than Friedman in 1962, speaking these words. Like Reagan, Friedman proclaimed a creed of greedism (our term)—that unchecked self-interest furthers the common good.
      While 1970s inflation undermined confidence in government economic management and catapulted Friedman to fame, it also undermined the New Deal constraints on financial institutions by making it impossible to maintain limits on interest rates on customer deposits. To tell this part of the story, Madrick turns to an often-neglected figure: Walter Wriston, who ran First National City/Citibank from the 1960s into the 1980s. These days Wriston is best known among economists for his famous quote dismissing sovereign risk: “Countries don’t go out of business.”
      But as Madrick documents, there was much more to Wriston’s career than his misjudgment of the risks involved in lending to national governments. More than anyone else, he epitomized the transformation of banking from cautious supporter of industry to freewheeling independent profit center, creator of crises, and recurrent recipient of taxpayer bailouts. As Madrick deftly points out, “Wriston lived a free market charade,” strongly opposing the federal bailouts of Chrysler (1978) and Continental Illinois (1984) while his own back was saved multiple times by government intervention.
      The transformation of American banking initiated by Wriston arguably began as early as 1961, when First National City began offering negotiable certificates of deposit—CDs that could be cashed in early, and therefore served as an alternative to regular bank deposits, while sidestepping legal limits on interest rates. First National City’s innovation—and the decision of regulators to let it stand—marked the first major crack in the system of bank regulation created in the 1930s, and hence arguably the first step on the road to the crisis of 2008.
      Wriston entered the history books again through his prominent part in creating the late-1970s boom in lending to Latin American governments, a boom that strongly prefigured the subprime boom a generation later. Thus Wriston’s dismissal of the risks involved in lending to governments would be echoed in the 2000s by assertions, like those of Alan Greenspan, that a “national severe price distortion”—i.e., a housing bubble that would burst—”seems most unlikely.” Bankers failed to consider the possibility that all of the debtor nations would experience simultaneous problems—Madrick quotes the head of J.P. Morgan saying: “We had set limits, long and short, on each country. We didn’t look at the whole.” And in so doing they prefigured the utter misjudgment of risks on mortgage-backed securities, which were considered safe because it was deemed unlikely that many mortgages would go bad at the same time.
      When the loans to Latin American governments went bad, Citi and other banks were rescued via a program that was billed as aid to troubled debtor nations but was in fact largely aimed at helping US and European banks. In that sense the program for Latin America in the 1980s bore a strong family resemblance to what is happening to Europe’s peripheral economies now. Large official loans were provided to debtor nations, not to help them recover economically, but to help them repay their private-sector creditors. In effect, it looked like a country bailout, but it was really an indirect bank bailout. And the banks did indeed weather the storm. But the loans came with a price, namely harsh austerity programs imposed on debtor nations—and in Latin America, the price of this austerity was a lost decade of falling incomes and minimal growth.
      This was, then, an enormous bank-led crisis—soon followed by the savings and loan crisis, which Madrick treats only briefly, but which had a higher direct cost to taxpayers than even the current crisis. And the response of the political system to these crises was… to shower more favors on the financial industry, dismantling what was left of Depression-era regulation.
      The second part of Madrick’s book surveys the wide-open, anything goes financial world that deregulation created. This was an era marked by two huge bubbles—the technology bubble of the 1990s and the housing bubble of the Bush years—both of which ended in grief, although the economic damage inflicted by the second bubble’s bursting was vastly greater.
      Again, Madrick’s exposition takes the form of a series of personal vignettes. As in the first part of the book, some of these cover familiar ground. We learn about the career of Alan Greenspan and how he used his reputation as an economic guru—a reputation that in retrospect was entirely undeserved—to push his antigovernment, antiregulation ideology. We meet some of the architects of the 2008 crisis: Angelo Mozilo of Countrywide Financial Services, Jimmy Cayne of Bear Stearns, Dick Fuld of Lehman, Stan O’Neal of Merrill Lynch, and Chuck Prince of Citigroup (created by the merger of Travelers Insurance with—yet again—Citibank). Mozilo was the leading peddler of subprime and other risky mortgages, loans made to people who shouldn’t have been getting loans. The others were all involved in the process of slicing, dicing, and recombining these loans into supposedly safe financial instruments, AAA-rated investments that suddenly turned into waste paper when the housing bubble burst.

    3. The Wall Street Leviathan

      April 28, 2011

      Jeff Madrick

      The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States
      PublicAffairs, 545 pp., $14.99 (paper)
      Inside Job
      a film directed by Charles Ferguson
      Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance
      edited by Viral V. Acharya, Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter
      Wiley, 573 pp., $49.95
      Reforming US Financial Markets: Reflections Before and Beyond Dodd-Frank
      by Randall S. Kroszner and Robert J. Shiller, edited and with an introduction by Benjamin M. Friedman
      MIT Press, 152 pp., $19.95
      madrick_1-042811.jpgRepresentational Pictures/Sony Pictures ClassicsFormer Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, and Treasury Secretary Timothy Geithner; from Charles Ferguson’s documentary film Inside Job
      With its revealing accounts of the Wall Street practices that led to the recession of 2008 and 2009, the recent report of the Financial Crisis Inquiry Commission (FCIC) is the most comprehensive indictment of the American financial failure that has yet been made. During two years of investigations, the commission accumulated evidence of many hundreds of irresponsible, self-serving, and unethical practices by Wall Street bankers and systematic tolerance of them by regulators.
      Written by the six members appointed by congressional Democrats, the FCIC report concludes, “The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire.” Many readers would think the conclusion obvious. But Wall Street professionals repeatedly claimed that similar crises occurred frequently in the history of modern capitalism, that they are merely the price paid for a dynamic and innovative economic system, and that individuals were not to blame. They thus minimized their own responsibility for the events and cast doubt on the need for significantly more intense regulation of their activities. The FCIC majority dismisses such arguments.
      Can we then infer that future crises may be avoided by intelligent and unbiased financial regulators and a chastened Wall Street? A 2,300-page set of regulations—known as the Dodd-Frank Act after its congressional sponsors, Senator Chris Dodd and Representative Barney Frank—was passed last year to accomplish just that. In a television interview with Charlie Rose this March, Frank said he “got better than 90 percent” of what he wanted. The act has some bite. It proposes ways to deal with many of the practices that contributed to the crisis, including inadequate capital requirements, excessive Wall Street compensation, and damaging conflicts of interest in credit ratings agencies that readily assigned their highest ratings to risky debt. It tries to regulate trading of speculative securities like derivatives, which enabled bankers to wage huge bets with little capital on the movement of securities prices.


      Under Dodd-Frank, a new oversight board, composed of members of regulatory agencies led by the Federal Reserve, will now be charged with assessing the level of so-called systemic risk of major financial institutions and imposing stricter capital rules or even shutting institutions down if they are deemed to put the financial system at risk—that is, if their failure might bring down many other institutions with them and endanger the American economy. Now there will be regulation not only of traditional commercial banks, which always fell under the purview of the Federal Reserve, but also investment banks, money market funds, and perhaps even hedge funds, which had been hardly regulated at all.
      The Consumer Financial Protection Bureau has also been established inside the Federal Reserve to write new requirements for mortgages, consumer loans, and the other consumer credit products that were so badly abused. Of particular concern, people with poor credit and low incomes were sold so-called subprime mortgages that were deceptively cheap at the outset, sometimes requiring no down payments, but whose annual interest charges skyrocketed in later years. The availability of mortgage finance drove housing prices ever higher, and when they collapsed, beginning in roughly 2006, the growing amount of bad debt that resulted caused a collapse of Wall Street and then the global economy.
      But the Dodd-Frank Act has largely pushed responsibility for writing and implementing the new rules onto existing regulators, including the Federal Reserve, the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency. This will likely prove a damaging flaw. These regulators are by and large the same agencies that tolerated the excessively risky behavior in the first place. Even if they write effective rules they will face pressure from Wall Street lobbyists and mostly Republican legislators to soften restrictions and eliminate some of the critical ones. If the restrictions remain intact, which is likely in view of the Democratic majority in the Senate, the question remains whether the regulators will enforce them vigorously once the economy recovers and the crisis fades in memory. Several agencies have already missed the deadlines to write new rules. Some are worried that the Consumer Financial Protection Bureau will be neutralized by Congress. Wall Street spent $2.7 billion on lobbying between 1999 and 2008 and is lobbying vigorously again.
      The Dodd-Frank Act could have been much more effective. It could, from the outset, have set high capital requirements—the amount of money that banks and other financial institutions have to put aside for possible losses. It could have broken up today’s enormous banks, which have grown rapidly in size since the crisis. Measured by their profits, the six largest financial institutions in the US now account for 55 percent of all banking assets. It could have divided the banks by function in order to reduce the overlapping of investment activities, which increases the chances of damage to the entire financial system. For example, those banks that accept federally insured deposits from savers could have been restricted to making loans to consumers and businesses. Other institutions that raise money independently of government guarantees could have been allowed to sell more risky stocks or corporate bonds to investors or speculate in securities with their shareholder capital.
      The only action proposed by Dodd-Frank along these lines is known as the Volcker Rule, named after former Federal Reserve chairman Paul Volcker. It would prohibit proprietary trading by banks that typically accept the public’s deposits—that is, it would limit speculative investments with the institution’s own capital. But even the Volcker Rule has not been clearly formulated and applied. The question still not answered is why regulators would perform better in the future than in the past two decades.
      The FCIC report will probably not provoke tougher regulation in Washington. Its strength is its accumulation of fact and example. By contrast, Charles Ferguson’s popular, Oscar-winning documentary Inside Job tells the story of the crisis with directness and clarity, partly because he is willing to make pointed accusations against specific federal regulators and Wall Street bankers. In interviewing some of those he thinks of as culprits, including several prominent economists, he finds that they have hardly anything to say in their defense. Those he did not interview are often shown in revealing congressional testimony. We see Alan Greenspan, the former Federal Reserve chairman, assuring Congress that derivatives, including those guaranteeing subprime mortgage securities, required no federal regulation at all. In fact, unregulated derivatives were a principal source of the risk-taking that brought down the financial system.
      Ferguson never adequately explains derivatives but he makes it clear that Wall Street firms borrowed far too much in order to invest in mortgage debt securities that were far too risky, and no one stopped them. The result was soaring housing prices, which led to more risky mortgages. Then the banks and others sold the risky debt to investors around the world as if it had almost no risk at all. Did Wall Street bankers know they had built a house of cards? Ferguson thinks many did, selling bad products without proper warning to their clients; they didn’t care, he believes, because they were making too much money. But it takes the FCIC report to prove his point by means of carefully accumulated evidence.
      When Ferguson accepted his Oscar in late February, he remarked that no one had yet gone to jail for the worst American financial crisis since the Great Depression. This was a telling observation about the weakness of corporate fraud law as well as the lack of vigor of the US Justice Department. Criminal action against Angelo Mozilo, whose firm Countrywide Financial wrote more subprime mortgages than any other, was dropped this winter. The FCIC report provides many examples of the failure of management to warn shareholders of the risks it was taking—apparent violations of disclosure laws that were never even investigated.
      Still, jail sentences may have little effect. By the late 1990s, countless accounting frauds culminated in outrageous behavior by Enron, WorldCom, and others, abetted by such giants as Citigroup and the Arthur Andersen accounting firm. Some Enron executives went to prison and Andersen closed down, but this did not discourage deceptive practices in mortgage securities in the mid-2000s. Wall Street is now creating outsize values for social media companies like Facebook and Twitter, well before these companies have generated serious profits. While federal regulators are debating among themselves and with financial lobbyists about new rules, another bubble is likely forming before our very eyes.
      Little had been expected of the FCIC because its subpoena power was weak. It was appointed by Congress in the spring of 2009 with the Democrat Philip Angelides as chairman and with a Republican-appointed vice-chairman. Both had to agree if a subpoena were to be served. The nineteen days of public hearings produced angry questions from commissioners and evasive responses from Wall Street CEOs but did not truly expose any major figure. Yet with some six hundred closed-door interviews and reviews of thousands of private documents, the majority report is the definitive history of this period. For the most part, Wall Street made money not by virtue of brilliance but by taking on higher levels of risk—usually by cleverly circumventing existing restrictions on how much it could borrow. Few on Wall Street had to give any money back when losses inevitably escalated.
      The report’s conclusions were attacked by the commission’s Republican- appointed minority in a dissent whose length, it said, was limited by the majority. Even so, it did not challenge any of the majority’s facts, and even agreed with many of its conclusions. (A separate, more extreme dissent was issued by Peter Wallison, a codirector of financial policy studies at the American Enterprise Institute who, without responding cogently to any of its charges, acidly claimed that the majority had proved none of its points.) The minority pointed out that other factors, including low interest rates engineered by the Federal Reserve and large-scale Chinese purchases of bonds, stimulated excessive speculation in mortgage securities and the housing bubble. Thus, Wall Street manipulators were not entirely to blame.
      Fannie Mae and Freddie Mac, federal agencies with implicit government backing, certainly had a large part in the financing of bad mortgages. The FCIC report finds that the business model of these for-profit giants, with implicit federal guarantees of their debt, was deeply flawed, and it observes that the federal bailout of them has incurred enormous costs. But private bankers financed a large majority of subprime mortgage debt. Moreover, the hundreds of examples of damaging and questionable Wall Street practices as well as regulatory negligence outlined by the majority of the commission are simply too large to be taken as secondary causes of the crisis. As for low interest rates and plentiful Chinese capital, just because money was easy to find doesn’t mean excessive risk-taking was inevitable.*
      1. *Peter Wallison believes that government-subsidized housing, including the efforts of Fannie Mae and Freddie Mac, was the major cause of the collapse. His fuller dissent can be found at www.aei.org/docLib/Wallison dissent.pdf . For a more thorough but somewhat more balanced account of these agencies' part in the crisis, see Viral V. Acharya, Matthew Richardson, Stijn Van Nieuwerburgh, and Lawrence J. White, Guaranteed to Fail : Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance (Princeton University Press, 2011) . For a strong criticism of the data used by Wallison and the authors of this book, see David Min, Faulty Conclusions Based on Shoddy Foundations , Center for American Progress, available at www.americanprogress.org/issues/2011/02/pdf/pinto_execsumm.pdf . An interesting account of how the government entities accrued power politically appears in Gretchen Morgenson and Joshua Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon (Times Books, 2011). ↩

      2. How Can the Economy Recover?

        December 23, 2010

        Jeff Madrick

        Seeds of Destruction: Why the Path to Economic Ruin Runs Through Washington, and How to Reclaim American Prosperity
        by Glenn Hubbard and Peter Navarro
        FT Press, 266 pp., $26.99
        Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis
        by Anatole Kaletsky
        PublicAffairs, 396 pp., $28.95
        Aftershock: The Next Economy and America’s Future
        by Robert B. Reich
        Knopf, 174 pp., $25.00
        Madrick-1-122310.jpgDoug Mills/The New York Times/ReduxPresident Barack Obama speaking with local residents in Albuquerque, New Mexico, about the need for education to ensure long-term economic prosperity, September 28, 2010
        Many recent books and articles by economists and policy analysts ask how the US can recover rapidly from the worst economic crisis since the 1930s. They usually merely assume that the ideal objective is to return to the stable economic growth that preceded the crisis of 2007 and 2008. The underlying assumption is that once adjustments are made, the economy will continue again much along the path it had for a quarter-century.
        This optimism isn’t at all warranted. The recession that began in late 2007 was declared over in mid-2009 by the National Bureau of Economic Research, which keeps track of business cycles. But nearly fifteen months later, the unemployment rate remains at 9.6 percent, leaving nearly 15 million Americans out of work. Another 11.5 million, some 7.5 percent of the population who are ready and willing to work, have given up looking for a job or are working part-time because they can’t find a full-time job. The nation’s Gross Domestic Product is growing so slowly that it has not yet reached its prerecession level. By this point in the recovery from all of the nine previous recessions since the end of World War II, GDP had attained its former peak.
        What makes this recovery different is clear. Consumers have record levels of debt compared to income and some $12 trillion in losses on their houses and financial investments. They are not going to spend money as they usually do—perhaps not for a long time. A damaged financial system is also not lending significantly, partly because business clients aren’t seeking loans unless they directly generate more sales, and consumer demand is low. Business investment, propelled by piles of cash on the balance sheets, is nevertheless slowing after rising strongly from low levels for the past year.
        The economy could slide back into an outright recession again. A fragile financial system could also again be pushed to the brink by a new round of mortgage and other defaults. Fortunately, the number of jobs in October rose by 159,000, breaking a trend of even more modest job creation. More jobs will mean more income and perhaps rising consumer confidence. A “double dip” recession may well have been avoided, but as the Economic Policy Institute points out, the economy will have to produce 300,000 jobs a month, twice a many as this October, for several years to return to the unemployment rate of 5 percent in December 2007. Economists at Goldman Sachs calculate that if historical precedents apply, it would require four years of GDP growth of 4 percent a year, after inflation, to return us to full employment. Many economists believe the nation cannot attain that rate.


        The US economy is growing so slowly that the case is strong for another multibillion-dollar investment in government spending to stimulate it. The nonpartisan and usually cautious Congressional Budget Office estimates that the US GDP could easily be 6 percent higher without threatening inflation—that is, it is 6 percentage points below what the CBO estimates as its optimal level. But both the President and Congress are avoiding any substantial stimulus now because of the current surge in the deficit. The Republican leaders of the House in the newly elected Congress say they will demand $100 billion in immediate spending cuts to reduce the budget deficit even as they seek the permanent extension of the tax cuts passed under George W. Bush that are set to expire this year.
        Those tax cuts, if extended permanently, will add considerably to the future deficit. But this contradiction does not deter the politicians who are apparently more interested in reducing the size of government than of the deficit itself. In addition, pressure is growing from nations like Germany, China, and Brazil to reduce the US deficit as a way, they say, for the US to cut its reliance on foreign capital and thereby reduce its trade deficit. They fear that current Federal Reserve policies to reduce interest rates will lower the value of the dollar abruptly and make their exports to the US more expensive.
        Right now, the best hope is that heavy cuts in government expenditures will be postponed for two to three years. But such a delay will probably not be long enough. Erskine Bowles and Alan Simpson, the cochairmen of the fiscal commission President Obama appointed to propose ways of reducing the deficit, are calling for sharp cuts in spending but say they want to delay the first reductions until 2012, when the economy will have sufficiently emerged from the recession. This would be a severe miscalculation. Barring a surge in growth, the unemployment rate in 2012 will probably be at least 8 percent, roughly the highest level reached since the end of the recession of the early 1990s.
        If this poorly considered advice is the best that this commission can give the President, the nation is in trouble. An obsession with taming the deficit, provoked by the rapid rise in the current deficit to $1.5 trillion for 2010, will make a large stimulus impossible. But the sharp surge in the deficit was mostly caused by the recession itself, which reduced tax revenues and raised the level of spending—such as unemployment payments—in response to the recession. President Obama’s stimulus package of $800 billion passed in early 2009 also added to the deficit, but that spending was only temporary and kept the economy from sinking further.1 According to a convincing economic model by the economists Alan Blinder and Mark Zandi, without the stimulus the deficit would have been substantially bigger in coming years.
        If we presume that there will be an economic recovery, almost all of the projected deficit through 2020 will be the result of three factors: the recession, the tax cuts of the early 2000s under George W. Bush, and the hundreds of billions of dollars of war spending. In the 2020s and 2030s, however, projected increases in Medicare and Medicaid spending could raise deficits dramatically—and the amount of government debt and the interest paid on it could grow to alarming levels. Social Security spending will increase only modestly by comparison. But dealing with such long-term problems by abrupt cuts in spending now will likely consign the nation to a decade of slow growth, lost jobs, and low wages—and unnecessary, painful reductions in Social Security and other social programs that Americans value most.
        What is rarely recognized is that even if the US can emerge from a weak economy within a few years, the economic foundation that existed before the cataclysm of 2007 and 2008 may not be adequate to restore the widely shared prosperity the US needs. For more than three decades, economic growth had been largely dependent on rapidly rising levels of debt and on two major speculative bubbles, first in high technology and dot-com stocks in the late 1990s, then in housing in the 2000s. What will now replace them?
        Income inequality widened sharply in these years and average wages stagnated for the many while record high fortunes were made by the few. The financial security and access to adequate health care and education for children that had defined the middle class since World War II have eroded rapidly. Meanwhile, investments in infrastructure such as transportation, as well as clean energy and education, have been badly neglected. All this raises doubts about America’s future economic vitality whether or not it balances its budget, and it does so at a time when international competition from Asia and the Southern Hemisphere will pose serious challenges during this century. How will Americans live a decade from now?
        Few writers are trying to address these future concerns with a new and more hopeful economic agenda. One who has attempted to chart a course for what he considers the next “new economy” is the respected British financial journalist Anatole Kaletsky. In Capitalism 4.0, he makes a thoughtful but moderate set of proposals that are, despite his claims otherwise, largely an extension of pre-crisis thinking, in which he relies heavily on his faith in the ingenuity of capitalism as an adaptive mechanism. “Hoping that ‘something will turn up’ may sound like deluded wishful thinking,” he writes, “but it is really just an extension into politics and macroeconomics of Adam Smith’s arguments about the self-organizing dynamics of the capitalist economy.”
        Kaletsky sees the history of capitalism as a struggle between government and markets. He writes that the first capitalist stage—Capitalism 1.0—lasted from the early 1800s to the Great Depression, a laissez-faire period in which “politics and economics are two distinct spheres.” This is one of those widely accepted pieces of conventional wisdom that needs serious correction. Kaletsky points out exceptions to the laissez-faire approach, but his brush is still too broad. The US, for example, was never such a truly laissez-faire society and its government always actively intervened in the economy. The American authorities regulated all kinds of products in the colonial years, and imposed severe regulations on the labor markets. After all, many US workers were legally indentured servants.
        Thomas Jefferson himself, who persistently warned against the power of central government, was a leading advocate of federal regulations to make land widely affordable to the American masses. Access to land was also a major reason why he bought the Louisiana Territories, doubling the size of the nation, in likely violation of his constitutional powers. State and local government financed and built the canals that were crucial for commerce in the early 1800s, and a remarkable free and mandatory primary school system emerged by the 1850s. Right up until the present day federal and local governments have financed railroads, technical universities, urban sanitation systems, high schools, highways, college tuition subsidies, and much else.
        Underemphasizing this reality, Kaletsky writes that laissez-faire economics did not change significantly until the 1930s with America’s New Deal, Capitalism 2.0. It then reverted to its laissez-faire origins in the 1980s—Capitalism 3.0. The earlier “phase of capitalism, from the 1930s until the 1970s, assumed that governments were always right and markets nearly always wrong,” he writes. “The dominant ideology from the 1980s until the 2007–2009 crisis assumed that markets were always right and governments nearly always wrong.”
        Kaletsky believes that all three stages were on balance successful, including the last one. The American economy beginning in the 1980s benefited from “the spectacular success of macroeconomic stabilization…at least until the crisis of 2007.” But this was also the period of rapidly rising income inequality in the US, with millions of people with no health insurance, and an ever lower savings rate as people borrowed to keep their heads above water. Kaletsky pays relatively little attention to inequality.
        There was also one financial crisis after another, often leading to a recession or slow growth and often requiring federal bailouts. Kaletsky minimizes or neglects the impact on growth of the Mexican crisis of 1982; the stock market crash of 1987; the savings-and-loan and junk bond failures of late 1989 and 1990; another Mexican catastrophe and hedge fund failures in 1994; the Asian financial crisis of 1997; the collapse of Long-Term Capital Management in 1998; and the bursting stock market bubble of 2000–2001. Capitalism 3.0 was hardly an undiluted success.
        1. 1See Kathy A. Ruffing and James R. Horney, "Critics Still Wrong on What's Driving Deficits in Coming Years," Center on Budget and Policy Priorities, June 28, 2010. ↩

        2. At the Heart of the Crash

          June 10, 2010

          Jeff Madrick

          The Big Short: Inside the Doomsday Machine
          by Michael Lewis
          Norton, 266 pp., $27.95
          madrick_1-061010.jpgNatalie Behring/ReutersGoldman Sachs CEO Lloyd Blankfein at a speech by President Barack Obama on financial regulation, New York City, April 22, 2010
          Not the least striking revelation of Michael Lewis’s excellent book, The Big Short, is that this author of financial best-sellers has changed his mind. In a column for Bloomberg News in early 2007, he praised the rapidly expanding market for derivatives. Visiting the annual meeting of financiers and policymakers at the World Economic Forum in Davos, Switzerland, that year, he was exasperated by the fears of some of the participants. “None of them seemed to understand that when you create a derivative you don’t add to the sum total of risk in the financial world,” he wrote, sounding arguments very similar to those made by Alan Greenspan. “You merely create a means for redistributing that risk. They have no evidence that financial risk is being redistributed in ways we should all worry about.”
          As we now know, derivatives were the instruments that enabled Wall Street to stretch capital dangerously far—and were at the center of the financial crisis that began that year. They are investment contracts between two parties based on other securities, which require little capital up-front, enabling buyers and sellers to take temporary large investment stakes inexpensively, including in mortgage securities. “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Greenspan told Congress in 2003. Lewis wrote in 2007: “The most striking thing about the growing derivatives markets is the stability that has come with them.”
          Soon after Lewis’s column, the housing market crashed. Then, in the fall of 2008, the financial markets collapsed as well, business lending worldwide came to a standstill, and Lewis apparently began to reconsider practically everything he had written on this subject. He heard that a hedge fund manager named John Paulson made $4 billion betting against mortgages by means of derivatives. “It was late 2008,” he writes in The Big Short. “By then there was a long and growing list of pundits who claimed they predicted the catastrophe, but a far shorter list of people who actually did.” Lewis, whose first book, Liar’s Poker (1989), was a revealing insider’s account of the beginnings of the new mortgage markets, decided to find out what the handful of people who did “stand apart from mass hysteria” understood that others didn’t.


          Through these contrarians, he untangles in depth the sources of the crisis in ways that none of the recent literature on the subject has matched. Lewis shows that abstract principles govern the affairs of men much less than do plain, homely, and base human motives. The financial crisis, he concludes, was the work of people on Wall Street and mortgage brokers who acted in their self-interest without fear of either legal or economic reprisal. Whereas former treasury secretary Robert Rubin argued that “we all bear responsibility for not recognizing” the “possibility of a massive crisis,” Lewis shows that it was indeed possible to know what was going on—and more to the point, that the most dangerous activities in financial markets could have been stopped.
          The recent Securities and Exchange Commission suit against Goldman Sachs, which alleges that John Paulson chose the risky mortgage bonds that Goldman bundled together and deliberately sold to others, will not surprise readers of this book. Paulson made a billion dollars by betting against derivatives based on those bonds, and Goldman’s investors lost a billion dollars. It was a small drop in a dark ocean.
          Lewis relates in detail the stories of the shrewd leaders of three investment firms who were convinced by the early 2000s that the mortgage market was bound for a downturn if not outright collapse. These were not heroes. If they had a moral conviction that powerful forces on Wall Street were rigging the market, most were more interested in making money than in challenging a bad system. The exception was Steve Eisman, a “strident” Republican who voted for Ronald Reagan twice and had done research on mortgage lenders as an analyst for Oppenheimer & Co. in the early 1990s. He became incensed that these lenders made so many deceptive loans to home buyers who likely would not be able to repay them. Some blamed the homeowners. “‘I’m going to lie on my loan application?’ Yeah, people lied,” he said. “They lied because they were told to lie.” Working on Wall Street turned him into a political liberal.
          Eisman was observing the first round of subprime mortgages—loans made by mortgage brokers, known formally as originators, to people with poor credit scores and generally poor prospects of repayment. He became furious at what he saw. A Harvard-trained lawyer from a well-off family, Eisman went on to bet against what he saw as financial injustice with, to his partners, sometimes uncontrollable intensity. In 2004, he started his own hedge fund, FrontPoint, later to be bought by Morgan Stanley, and his obsession with subprime mortgages only grew.
          It was by now the second stage of the subprime boom, the first having ended in the late 1990s with one mortgage broker’s bankruptcy after another. Not merely tens but now hundreds of billions of dollars’ worth of subprime mortgages as well as hundreds of billions of dollars’ worth of more conventional mortgages were issued each year and they were repackaged into mortgage-backed securities and sold by Wall Street bankers to pension funds, insurance companies, and other investors in the US and around the world. This had become known as securitization. Eisman knew he could sell stocks short, i.e., by selling shares he did not own but borrowed and keeping a profit when their price fell. But he could not yet figure out how to sell short the mortgage market itself, in which hundreds of billions of dollars’ worth of securitized bonds were being issued and used as collateral for the bad loans he saw being written by unscrupulous brokers.
          Meanwhile, Lewis writes, Dr. Michael Burry was also trying to figure out how to sell short the inflated mortgage bond market. Burry had been fascinated with the stock market since he was a boy. And Burry was obsessive, shutting out most of the rest of the world when he could. He attributed his antisocial behavior and single-minded intensity to having lost an eye to cancer as a child. Later, when his son was diagnosed with Asperger’s syndrome, he discovered that he had it also.
          Burry became a doctor and served as a resident at Stanford Hospital, but gave it up to open an investment firm, Scion Capital. By 2004, he had a successful record as an investor in unpopular, undervalued stocks. But now, his analytical interest turned to the mortgage market. He started by observing the rising number of dubious mortgages being written. By doing more research, he came to believe that the huge numbers of mortgage bonds being packaged by Wall Street and sold to investors around the world were ultimately doomed. His own investors were dubious. Why would he turn from investing in undervalued stocks to selling bonds short? But Burry was persistent.
          Charlie Ledley and Jamie Mai started Cornwall Capital Management in a shed behind a friend’s house in Berkeley, California, in 2003. A natural contrarian, Ledley believed, writes Lewis, that “the best way to make money on Wall Street was to seek out whatever it was that Wall Street believed was least likely to happen, and bet on its happening.” But what made Ledley and Mai especially good at what they did was their tenacious research. It did not take them long to decide that they had to invest against the latest and, by sheer volume, the greatest rage of the age, Wall Street’s mortgage bonds. Securitization had gone much too far.
          Lewis traces the thinking of these four men as they try to make sense of the new markets that seemed on the surface to make no sense at all. Trillions of dollars’ worth of new mortgages were written in the 2000s, and, once securitized, they became the primary source of income for many of Wall Street’s major firms, especially after the collapse of high-technology stocks in 2000. As the availability of mortgages increased, house prices rose at a faster pace than ever recorded, and by 2004 the proportion of adults owning homes rose to a record high of nearly 70 percent. Rising home values were also financing consumption, as new mortgages and home equity loans were taken out to buy appliances and cars and to send children to college. Interest on mortgages continued to be tax-deductible, while interest on credit cards and auto loans was not.
          Wall Street began to securitize mortgages in the late 1970s and early 1980s, led by bankers at Salomon Brothers, where Lewis once worked, and at First Boston. The process involved turning mortgages into the equivalent of a straightforward bond, a financial piece of engineering that is harder to do than it may sound. Mortgages usually pay higher interest rates than corporate bonds, but they are often repaid early by homeowners, typically when interest rates fall and they can get a better deal, and, therefore, unlike with conventional bonds, investors cannot count on a guaranteed return. The potential for default on the outstanding interest on a package of thousands of mortgages is also often harder to assess than the riskiness of a bond issued by, say, a single company.
          To make securitization work, the bankers bundled thousands of mortgages into a single package and sold different classes, or tranches, of bonds based on them. Of all the interest paid by the homeowners each year, a portion was first allocated to the highest tranche, usually comprising 80 percent of all bondholders. Thus, even if homeowners repaid early or defaults were higher than anticipated, this top 80 percent would typically get all the interest expected. After they were paid their interest, what was left went to the next tranche, and so forth down the line. The lowest tier, or mezzanine, got the remains and was most susceptible to loss (other than a small sliver at the very bottom of the line). The key to success was that the ratings agencies, led by Moody’s and Standard & Poor’s, agreed to rate the senior tranche, or 80 percent of the bonds, triple-A. The mezzanine got the lowest rating, triple-B.
          Investors around the world poured money into mortgages by buying these seemingly safe and predictable bonds, and Wall Street earned enormous fees for creating and selling them. The triple-A bonds paid 1 to 3 percent more in interest than triple-A corporate bonds. The triple-B bonds were risky but paid considerably more than corporate bonds. Wall Street was able to raise so much money that the scarce commodity was no longer financing for buying bonds but finding home buyers who needed mortgages; originating more and more bad mortgages became inevitable.


How We Were All Misled

December 8, 2011

John Lanchester

Boomerang: Travels in the New Third World
by Michael Lewis
Norton, 213 pp., $25.95
lanchester_1-120811.jpgSteffen Kugler/The New York Times/ReduxFrench President Nicolas Sarkozy, former Greek Prime Minister George Papandreou, and German Chancellor Angela Merkel, Brussels, July 2011
Most people with a special interest in the events of the credit crunch and the Great Recession that followed it have a private benchmark for the excesses that led up to the crash. These benchmarks are a rule of thumb, a rough measure of how far out of control things got; they are phenomena that at the time seemed normal but that in retrospect were a brightly flashing warning light. I came across mine in Iceland, talking to a waitress in a café in the summer of 2009, about eight months after the króna collapsed and the whole country effectively went bankrupt under the debts incurred by its overextended banks. I asked her what had changed about her life since the crash.
“Well,” she said, “if I’m going to spend some time with friends at the weekend we go camping in the countryside.”
“How is that different from what you did before?” I asked.
“We used to take a plane to Milan and go shopping on the via Linate.”
Since that conversation, I’ve privately graded transparently absurd pre-crunch phenomena on a scale from 0 to 10, with 0 being complete financial prudence, and 10 being a Reykjavik waitress thinking it normal to be able to afford weekend shopping trips to Milan.
Many people all over the world went nuts on cheap credit in the years of the boom—a boom that was in large part built on an unsustainable spike in personal and governmental debt. Michael Lewis has already written a very good book, The Big Short, about the mechanics of the crash, by casting around for people who didn’t just foresee it, but who made huge bets that it would happen, and profited vastly when it did.1
Boomerang is about what he has come to see as the larger phenomenon behind the credit crunch: the increase in total worldwide debt from $84 trillion in 2002 to $195 trillion now. The thesis is that “the subprime mortgage crisis was more symptom than cause. The deeper social and economic problems that gave rise to it remained.” It is these deeper problems that are dominating economic news at the moment, and led to the desperate measures announced at the European summit on October 27 and to the aborted Greek plan to hold a referendum that followed. The G20 Economic Summit of November 3–4 was dominated by discussion of the Eurozone crisis, but ended with no coherent plan in view, and none has emerged since. Boomerang tells the story of how we got here, and in the course of doing so gathers together an extensive arsenal of data at the top end of my 0–10 Reykjavik waitress scale: the fact that Greek railways have €300 million in other costs; the fact that the Californian city of Vallejo spent 80 percent of its budget on the pension and pay of police, firemen, and other “public safety” workers; the fact that between 2003 and 2007, Iceland’s stock market went up ninefold; the fact that in Ireland, a developer paid €412 million in 2006 for a city dump that is now, because of cleanup costs, valued at negative €30 million.


Lewis has noticed something important about these excesses: that the precise details of how people ran amok varied from culture to culture. Cultural and historical faultlines were exposed by the boom, and behavior varied accordingly.
The credit wasn’t just money, it was temptation. It offered entire societies the chance to reveal aspects of their characters they could not normally afford to indulge. Entire countries were told, “The lights are out, you can do whatever you want to do and no one will ever know.” What they wanted to do with money in the dark varied. Americans wanted to own homes far larger than they could afford, and to allow the strong to exploit the weak. Icelanders wanted to stop fishing and become investment bankers, and to allow their alpha males to reveal a theretofore suppressed megalomania. The Germans wanted to be even more German; the Irish wanted to stop being Irish. All these different societies were touched by the same event, but each responded to it in its own peculiar way.
Lewis is an unmatched nonfiction storyteller, and a large part of his talent is the way he attaches his stories to the people who help him tell them. Nonfiction has a payload and a delivery system. In Lewis’s work, the delivery system is usually a man, a forthright contrarian who thinks clearly and talks vividly and whose dissent from the mainstream is not a matter of theory but of practice: Lewis likes people who don’t just speak against the conventional wisdom, but who bet against it, and whose bets come off. His first interlocutor, Kyle Bass, is a classic example. Bass is a fund manager who made a fortune “shorting” toxic mortgage assets, and then became preoccupied by the subject of global debt levels. Bass is, to put it very mildly, a pessimist on the subject of sovereign debt:
Spain and France had accumulated debts of more than ten times their annual revenues. Historically, such levels of government indebtedness had led to government default. “Here’s the only way I think things can work out for these countries,” Bass said. “If they start running real budget surpluses. Yeah, and that will happen right after monkeys fly out of your ass.”
The prognostications that ensue from Bass’s analysis are gloomy, and form the basis of Boomerang‘s big-picture overview. “The financial crisis of 2008 was suspended only because investors believed that governments could borrow whatever they needed to rescue their banks. What happened when the governments themselves ceased to be credible?”
Bass thinks that the only reliable investments are guns and gold, and has just bought twenty million nickels, because the metal in a five-cent nickel is worth 6.8 cents, and they are going to be a stable source of value when things go wrong. (If you’re wondering how easy it is to get hold of 20 million nickels, the answer is, not very.) There are many equally vivid pen portraits in Boomerang, usually of forthright contrarians: a super-frank German ex-banker, a doomsaying Irish economist, two Greek tax collectors who hate each other, and the former governor of California.
Schwarzenegger gives an interview while he and Lewis and several advisers go zooming through Los Angeles on their bicycles, part of the governor’s cardio routine:
He wears no bike helmet, runs red lights, and rips past DO NOT ENTER signs without seeming to notice them, and up one-way streets. When he wants to cross three lanes of fast traffic he doesn’t so much as glance over his shoulder but just sticks out his hand and follows suit, assuming that whatever is behind him will stop. His bike has ten speeds but he uses just two: zero, and pedalling as fast as he can….
It isn’t until he is forced to stop at a red light that he makes meaningful contact with the public. A woman pushing a baby stroller and talking on a cell phone crosses the street right in front of him, and does a double take. “Oh…my…God,” she gasps into her phone. “It’s Bill Clinton!” She’s not ten feet away and she keeps talking to the phone, as if the man is unreal. “I’m here with Bill Clinton.”
“It’s one of those guys who has had a sex scandal,” says Arnold, smiling.
Schwarzenegger’s economic adviser gave Lewis some of the facts of the economic scandal:
This year the state will directly spend $32 billion on employee pay and benefits, up 65 percent over the past ten years. Compare that to state spending on higher education [down 5 percent], health and human services [up just 5 percent], and parks and recreation [flat], all crowded out in large part by fast-rising employment costs.
Lewis writes that
the same fiscal year that the state spent $6 billion on prisons, it had invested just $4.7 billion in its higher education…. Everywhere you turned, the long-term future of the state was being sacrificed.
By and large, Lewis’s contrarians tend to be monomaniacs: they are people who have The Answer. It is a feature of the financial world, much remarked by Warren Buffett, that people would rather be wrong in a group than right on their own; the people who insist on being right on their own tend to have the psychological equipment to match. They are hedgehogs rather than foxes, eyes firmly on one big thing. There are times when Lewis himself is a little like that. Boomerang is unlike his previous books, in that it is a series of portraits of whole societies. A writer making society-wide generalizations is picking up a big and very full bag by a single handle; in that position, it’s easy to end up writing about the handle, because it’s the thing on which you have a secure grip.
For the most part, Lewis’s handles are fitted to the heavy lifting he makes them do, with the possible exception of his approach to Germany via the not-at-all unfamiliar idea that the country has a national obsession with excrement. He quotes the American anthropologist Alan Dundes: “Clean exterior–dirty interior, or clean form and dirty content—is very much a part of the German national character.”
That otherwise telling essay is about the state of the euro, a subject of immense importance at the moment for the entire global economy. Since its creation in 1999, the euro has accumulated enormous imbalances between the economies of its member states, with Germany in particular running a big trade surplus and the “peripheral” countries, mainly in Southern Europe, building up an ever bigger mountain of private and individual debt. “There was no credit boom in Germany,” an official told Lewis. “Real estate prices were completely flat. There was no borrowing for consumption. Because this behavior is totally unacceptable in Germany.”
It is, or should be, self-evident that this situation can’t continue forever, but the problem is that the Germans are showing no appetite either for becoming less German—i.e., paying themselves more, consuming more, and importing more—or for open-endedly bailing out the Southern Europeans. “The German people all know at least one fact about the euro: that before they agreed to trade in their deutsche marks their leaders promised them, explicitly, that they would never be required to bail out other countries.” That promise has already been broken, and is set to be broken many times more—though let’s not forget that these “bailouts” are actually loans that in principle must be repaid.
Unfortunately, the bailouts are only the beginning of what is needed to stabilize the euro. The Eurozone summit of October 27 saw the first three steps: a “haircut” imposing losses of 50 percent on creditors who own Greek government debt; a recapitalization of Europe’s banks, to the tune of €106 billion; and an extension of the European Financial Stability Facility (EFSF). Further down the road, some sort of federalization of European debt is surely inevitable. The likely step involves the creation of a eurobond, so that governments can borrow on a continent-wide basis, with continent-wide guarantees of security. Many consequences follow from that, not least, as George Soros has argued in these pages, the need for some sort of Europe-wide treasury to guarantee it.2 That in turn implies the creation of something like a new European ministry of finance, which must surely also have powers of collection and enforcement in relation to taxation.
  1. 1Norton, 2010; see Jeff Madrick, "At the Heart of the Crash," The New York Review , June 10, 2010. ↩
  2. 2"Does the Euro Have a Future?," The New York Review , October 13, 2011. ↩

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How We Were All Misled

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