Thursday, November 15, 2007

FDR vs. Citigroup: Managed Capitalism Beats Laissez-Faire, Over and Over Again

Businessman and philanthropist Sir John Templeton—as in Templeton Funds, the Templeton Foundation, and the annual, financially stunning Templeton Prize for Progress Towards Research or Discoveries about Spiritual Realities (the 2007 winner got $1.5 million)—once observed that the four most dangerous words in the English language are, “This time it’s different.”

This tidbit we learn from Robert Kuttner in an op-ed piece entitled
“Painful truth: Free-market ideology has failed the test,” in yesterday’s Houston Chronicle and originally in the Los Angeles Times.

Kuttner, author of “The Squandering of America: How the Failure of Our Politics Undermines Our Prosperity,” is a fellow at Demos, a nonpartisan public policy research and advocacy group.

What was supposed to be different this time? Starting in the 1970s, Kuttner says, “Free-market economists and financial elites convinced Congress and presidents of both parties that a deregulated economy would be a more dynamic one; that something new about technology or trade or ideology meant that markets were at last truly self-governing.”

But the subprime mess revealed this to be a “failed fantasy.” As Kuttner puts it succinctly, “We have just had a full field test of free-market ideology, and once again it failed.”

Not only did it fail. The failure involved some of the same mistakes that culminated in the stock market crash of 1929—and even more telling, some of the same players.

The repeated mistakes? “Revisit the financial abuses of the laissez-faire 1920s and you will find different details but the same essentials: deceptive claims about stocks, bonds and balance sheets; conflicts of interest on the part of insiders; excess leverage to finance speculative bets; financial engineering that extracts wealth and does nothing for the real economy.”

And who was one of the players in the 20s? National City Bank—of which Citigroup is lineal successor! Like Citigroup and other huge financial institutions today, National City Bank turned dubious loans into bonds.

Kuttner continues: “In the subprime affair, unregulated mortgage lenders threw away underwriting rules and made teaser loans to people with sketchy credit histories. In more than half the cases, they didn’t even ask for the borrower’s income.

“But in the Alice-in-Wonderland world of financial deregulation, a Wall Street bank could turn the loan into a bond; a credit rating agency using obscure alchemy could bless the bond with a triple-A rating, and some consenting adult could be found to buy it. At each step, bankers, brokers and bond-raters could conveniently extract fees.”

The whole episode shows anew that FDR was exactly right to build a system of managed capitalism. “Government mandated extensive disclosures and bank supervision, and it prohibited a broad range of conflicts of interest. Commercial banking was separated from the underwriting and sale of securities.

“That regulatory system anchored 30 years of broadly distributed prosperity after World War II, an era when the financial economy played its appropriate role as servant rather than master of the real economy.”

The final irony is that Congress passed a law in 1994 that should have headed off the entire subprime debacle. It required all mortgage lenders to use prudent underwriting standards. “But the Federal Reserve, a devout believer in the magic of markets, refused to issue regulations.”

Kuttner notes there is one crucial difference between 1929 and 2007—a difference that, hopefully, ensures “only” a bad recession and not another depression: the Federal Reserve is a lot better now at bailing out Wall Street’s speculative failures.

But even that has downsides: imprudently lower interest rates, which risk higher inflation, increase pressure on the dollar and enable more cheap money, to fuel “the next round of speculative excess.”

Cogently and wryly, Kuttner can’t resist noting that even this level of Fed activity “is one more piece of proof that markets don’t regulate themselves.”

Congress needs to reverse the dismantling of FDR’s managed capitalism. As the last 80 years of U.S. history have shown over and over again, it is the only system capable of saving capitalism from itself.

No comments: