Capital City

January 6, 2010

235

Intro, courtesy of David at The Deipnosophist:

No other way to state this, but baldly: The article, Capital City, is phenomenally brilliant and insightful. Its author, Kevin Drum, not merely knows his stuff, he did his homework and lays bare the connections for all to see.

And it comes with my strongest recommendation to read, despite its length. Not only will you learn a thing or two (I did), but it also is likely to bring your blood to a boil.

(I do wish, though, that writers and their editors would learn the difference between "danger" and "peril" — they are not synonyms for the same notion. When Kevin Drum says, "dangerous" in fact he means "perilous.")
— David M Gordon / The Deipnosophist

Capital City

A year after the biggest bailout in US history, Wall Street lobbyists don’t just have influence in Washington. They own it lock, stock, and barrel.

By Kevin Drum | January/February 2010 Issue of Mother Jones

THIS STORY IS NOT ABOUT THE origins of 2008’s financial meltdown. You’ve probably read more than enough of those already. To make a long story short, it was a perfect storm. Reckless lending enabled a historic housing bubble [1]; an overseas savings glut and an unprecedented Fed policy of easy money enabled skyrocketing debt; excessive leverage made the global banking system so fragile that it couldn’t withstand a tremor, let alone the Big One; the financial system squirreled away trainloads of risk via byzantine credit derivatives [2] and other devices; and banks grew so towering and so interconnected that they became too big [4] to be allowed to fail. With all that in place, it took only a small nudge to bring the entire house of cards crashing to the ground.

But that’s a story about finance and economics. This is a story about politics. It’s about how Congress and the president and the Federal Reserve were persuaded to let all this happen in the first place. In other words, it’s about the finance lobby—the people who, as Sen.Dick Durbin [5] (D-Ill.) put it [6] last April, even after nearly destroying the world are "still the most powerful lobby on Capitol Hill. And they frankly own the place."

But it’s also about something even bigger. It’s about the way that lobby—with the eager support of a resurgent conservative movement and a handful of powerful backers—was able to fundamentally change the way we think about the world. Call it a virus. Call it a meme. Call it the power of a big idea. Whatever you call it, for three decades they had us convinced that the success of the financial sector should be measured not by how well it provides financial services to actual consumers and corporations, but by how effectively financial firms make money for themselves. It sounds crazy when you put it that way, but stripped to its bones, that’s what they pulled off.

There’s more to say about how they accomplished this, but to understand just how extravagant the finance lobby’s power is, you need to understand some background first. There are a lot of places we could start: the election of Ronald Reagan and the beginning of the great era of financial deregulation. The collapse of Continental Illinois National Bank and Trust in 1984. The $100 billion bailout of the savings and loan industry. The Mexican crisis of 1994. The Asian crisis of 1997. But for our purposes, the best place to start is 1998. That was the year a hedge fund called Long-Term Capital Management [7] imploded and very nearly took the global financial system down with it. It was, if you will, a dry run for 2008…

Unleashing the Banks

It’s hard to directly observe any lobby at work—by nature, it’s not business typically done out in the open—but in the same way that a meteor leaves behind a crater that lets you know its size and force of impact, so does the finance lobby. Sometimes these are laws passed by Congress. Sometimes they’re tax breaks kept in place by friendly senators.

Sometimes they’re rulings by the Federal Reserve. Sometimes they’re green lights from federal watchdog agencies. All of these are part of our story, but it starts with Congress, which left behind the two biggest craters of them all in 1999 and 2000, a little more than a year after the LTCM collapse. The first was the Financial Services Modernization Act [11]. The follow-up was the Commodity Futures Modernization Act [12].

The FSMA was designed to tear down a Depression-era law, the Glass-Steagall Act [13], that had set up the FDIC to guarantee commercial bank deposits and put up a fire wall between commercial banking and investment banking. The idea behind the 1933 law was pretty simple: Commercial banks should use their government-backed funds only for reasonably safe activities. Investment banks could take more risks, but they were on their own if things fell apart.

But starting in the 1980s, that became increasingly intolerable to Wall Street. Commercial banks were sitting on an enormous pile of money that they were prohibited from investing in anything more interesting than business and home loans. So they lobbied Congress. They lobbied the Fed. They lobbied the Treasury. They lobbied tirelessly for 20 years, and finally, after spending $209 million in 1998 alone, they got what they wanted: The wall was torn down and they were free to gamble customers’ funds in any way they wanted. In essence they became the world’s biggest hedge funds. And if LTCM was too big to fail, suddenly Citigroup [14] and JPMorgan Chase were way too big to fail.

By itself, this was dangerous enough. But then Congress made things even worse…