Learning from the Meltdown

by Bill Kavanagh:  How the financial collapse of 2008 is understood and dissected will be of crucial import as Americans draw lessons from the painful experience we’re now enduring.  On the right, there’s no shortage of pundits who are ready to blame the whole thing, amazingly enough, on poor people.  After all, they claim, it was giving loans to those who can’t now pay them back that started this mess, wasn’t it?

 If we fall into the trap of believing that kind of simplistic and misleading claptrap, we stand a good chance of being mired in a long and stagnant economic mess for years to come.  It’s critical that we draw the right lessons from the collapse.  Fortunately, Joseph Stiglitz, Nobel laureate and former Chairman of the Council of Economic Advisors, has outlined five crucial causes of the collapse in January’s Vanity Fair magazine.

 Stiglitz’s piece is a very readable tour through the era of neocon economics—and it shows how a belief in markets over prudence led inevitably to the meltdown.  From throwing over competent management of our central banking, as Reagan did when he replaced Paul Volker with Ayn Rand devotee Alan Greenspan, to the refusal of Greenspan’s Fed and the SEC to regulate the WMDs of economic instruments, derivatives, Stiglitz makes the case that the belief in market “innovation” as a greater good than prudent regulation sits at the core of our current disaster.

 In addition, the ferocious combination of investment banking with commercial banks, accomplished by the repeal of Glass-Steagall during the 1990’s, allowed the alpha dogs of investment markets to dominate the financial services sector.  This hasty power shift away from the traditional separation of banking and trading spelled the demise of an era of financial firewalls, without any real discussion of new regulations that might have prevented a collapse.  To hasten this seismic cultural shift, the SEC decided in 2004 to allow investment banks to increase their debt-to-capital ratio from 12:1 to 30:1 or higher.

 Stiglitz points out that during the early part of this decade, the aftermath of the tech bubble would have ordinarily been a time of serious economic retrenchment and realignment. Instead, Greenspan hit the gas pedal, dramatically lowering interest rates.  Simultaneously, Bush’s tax cuts for the rich and a cut in the capital gains rate led to more “innovative” approaches to real estate speculation and derivatives trading, at just the moment reasonable people should have been looking for safer ground during tough times. 

 Of course, even with all the incentives for the well-to-do, the stock market wouldn’t have been as attractive an investment if there hadn’t been for another incentive: the prizes given to top executives who fudged their numbers with inflated earnings and off-balance-sheet assets.  As long as the markets rewarded CEO’s and other top execs with stock options and huge bonuses, based on constantly increasing valuations, the incentive to find a way, any way, to inflate quarterly earnings figures with every report was just too tempting to resist for many. Go ask Bernie Madoff if you think constant investment gains are easy to accomplish in the real world.

 Finally, we’re in a worse mess because geniuses like Hank Paulson and the Bush White House wouldn’t take off of their rose-colored glasses when the whole thing started to crumble.  They thought letting Lehman Brothers fail would show the rest of Wall Street the way to salvation— and that simply giving the taxpayers a bag of toxic mortgages to hold would fix the problem.  They didn’t get it till way too late, even into the fall of 2008, that the whole scenario was a house of cards and was tumbling fast. Paulson didn’t realize that letting even one card go was going to collapse the entire deck.  Paulson’s belief that bad mortgages were identifiably separable from the complex of indecipherable derivative products based on them and the insurance swaps that the market was betting on to protect those derivatives was sadly mistaken.

 Even now, the conservatives are still baying at the markets-are-always-right moon.  They lament that the whole mess goes back to legislation like the Community Reinvestment Act of 1977, once again attempting to identify the poor as the problem.  They conveniently forget that CRA loans in low-income neighborhoods have actually defaulted at a lower rate than other mortgages.  The conservatives are now also constantly repeating the mantra, “Freddie Mac and Fannie Mae did it,” even though these mortgage lenders are, surprisingly enough, on better financial footing than most of the Wall Street finance giants the government hasn’t actually taken over, but merely bailed out to the tune of $700 billion and counting (see “Fannie Mae’s Last Stand,” also in Vanity Fair).

 No, the mess is far more systemic than the conservatives would like to pretend.  But don’t think that won’t keep them from continuing to work at rewriting economic history.  They know that a simple lie, repeated endlessly, grabs more news headlines than a complex truth.  So they’ll be busy shaping simple slogans for the press and looking for demons in all the usual places.  The challenge for journalists and observers seeking real answers will be to ask themselves, “Are these the same guys we listened to before the collapse”

 Since the meltdown (and before it), observers like Stiglitz, Daniel Roubini, Paul Krugman, and other critical thinkers have done an excellent job of doing forsenic accounting on the decades-long American deregulatory experiment.  We need to take their advice and learn from the mistakes that were made in the name of a convenient combination of conservative ideology and economic self-interest for the most powerful.  Once we begin to take serious stock of how the supercapitalists got us where we are, it will be easier to make decisions on a rational basis about how we want to go forward into the post-collapse future.

Comments

[James Stripes]

I'd say there are three places to begin looking for the cause of the meltdown:

1. Reaganomics under Reagan
2. Voodoo Economics under the high priest of recklessness, George I
3. The apex of irresponsible deregulation under George II

Of course, the devil is in the details, part of which includes seeing through the digested grasses that pass for calling the dot-com boom in the Clinton years real prosperity. The point is this: not much of the economic growth we've seen since the malaise of the Carter years has been what we once termed real.

[Bill]

James,

Thanks for your comment. I'm in agreement with #'s 1 and 3 on your list. The market shenanigans we are dealing with certainly started with Reaganomics. I think we've been all been increasingly serving the top echelon of the wealthy since Reagan began the national experiment of turning our economy over to them.

I'm not as clear on Bush 1's major contributions (to much of anything, really) to greasing the skids, but he kept Voodoo economics alive alright, even after naming the phenomenon... and as you say, the Clinton years were not as much a lasting boom, more of a bubble...

The last few months have certainly been an incentive to look closely at economic history, no?

Let's hope America begins building a real 21st century economy, now that we have no choice but to think about what we need to invest in-- and what investment will provide lasting jobs and value.