America's Financial Oligarchy Reigns Unchallenged
â€œThe crash has laid bare many unpleasant truths about the United States. One of the most alarming is that the finance industry has effectively captured our governmentâ€?, says Simon Johnson, a chief economist with the International Monetary Fund in 2007 and 2008. In an article entitled â€œThe Quiet Coupâ€? in the May, 2009 issue of the Atlantic magazine he (with James Kwak) goes on to say that â€œif the IMFâ€™s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reformâ€?.Â
How true! America is in financial crisis but instead of the financial oligarchy being broken up to permit essential reform they are continuing to use their influence to prevent precisely the sorts of reforms that are needed immediately to pull the economy out of its nosedive. Unfortunately, our legislators seem unwilling to act against these powerful financiers opting instead to succumb to their power and influence and continue to give them what they deem to be in their best interest instead of that of the taxpayersâ€™. All this is happening because of the false belief by all concerned that large financial institutions and free-flowing capital markets are crucial to Americaâ€™s position in the world and that whatever the banks say is true and what they want is necessary. The governmentâ€™s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. There is no better time to take such action than now but it is evident that reform is but a pipe dream. Americaâ€™s financial oligarchy is still in control and, as such, the long-term consequences will be dire!
The Powerful Elites have Over-reached
Johnson says that (and I paraphrase an edited version of â€˜The Quiet Coupâ€™ article in the following pages) typically countries in crisis are in a desperate economic situation for one simple reasonâ€”the powerful elites within them overreached in good times and took too many risks. That certainly is the case with the powerful elites - the financial oligarchy - in America. Â In the case of the U.S. economic and financial crisis, global investors, afraid that the country or its financial sector wouldnâ€™t be able to pay off mountainous debt, suddenly stopped lending. That fear became self-fulfilling, as banks that couldnâ€™t roll over their debt did, in fact, become unable to pay and this weakness in the banking system quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.
Financial Industry has Gained Political Power
The American financial industry gained political power over the years by amassing a kind of cultural capital, a belief system in which Washington insiders believe that large financial institutions and free-flowing capital markets are crucial to Americaâ€™s position in the world â€¦ and always and utterly convinced that whatever the banks said was true.
Of course, this was mostly an illusion. Regulators, legislators, and academics almost all assumed that the managers of these banks knew what they were doing. In retrospect, they didnâ€™t.
As more and more of the rich made their money in finance, the cult of finance seeped into the culture at large. In a society that celebrates the idea of making money, it was easy to infer that the interests of the financial sector were the same as the interests of the country and that the winners in the financial sector knew better what was good for America than did the career civil servants in Washington. Faith in free financial markets grew into conventional wisdomâ€”trumpeted on the editorial pages of The Wall Street Journal and on the floor of Congress.
From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing.
The mood that accompanied these measures in Washington seemed to swing between nonchalance and outright celebration: finance unleashed, it was thought, would continue to propel the economy to greater heights.
Americaâ€™s Oligarchs and the Financial Crisis
While many other factors contributed to the financial crisis that exploded last year, including excessive borrowing by households and lax lending standards, major commercial and investment banksâ€”and the hedge funds that ran alongside themâ€”were the big beneficiaries of the twin housing and equity-market bubbles of this decade. Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew. (See the article I wrote entitled â€œOur Worst Nightmare: The Puncture of the U.S Housing Bubbleâ€? back in early 2006 for a detailed account on just how such loans were handled.)
Because everyone was getting richer, and the health of the national economy depended so heavily on growth in real estate and finance, no one in Washington had any incentive to question what was going on.
When the crisis first began the government was slow to react and then did so with a lack of transparency, and an unwillingness to upset the financial sector. The response so far is perhaps best described as â€œpolicy by dealâ€? in that when a major financial institution got into trouble, the Treasury Department and the Federal Reserve engineered a one-of bailoutÂ and then announced that everything is fine without stating what combination of interests were being served, and how. This was late-night, backroom dealing, pure and simple.
Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here. This velvet-glove approach is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change.
The Way Out
We face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support.
Big banks, it seems, have actually gained political strength since the crisis began and this is not surprising. With the financial system so fragile, the damage that a major bank failure could cause is much greater than it would be during ordinary times. The banks have been exploiting this fear as they wring favorable deals out of Washington. (See reference to the new mark-to-market legislation below as a case in point.)
The challenges the United States faces are familiar territory to the people at the IMF.
If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say:
- nationalize the banks,
- limit individual bank size,
- update antitrust legislation,
- cap executive compensation,
- improve banking regulations,
- increase taxation,
- increase transparency and
- increase competition.
(Regretfully, none of the above remedies are going to happen any time soon, if ever. Take a look at what happened just last week on April 2nd, 2009. The financial oligarchyâ€™s lobby group, the American Bankers Association, was successful in having political pressure brought to bear, by legislators from both parties, against the Financial Accounting Standards Board to do their bidding which now gives banks more discretion in reporting the value of mortgage securities. These new mark-to-market rules will enable all financial institutions with such securities to report higher profits by assuming that the securities are worth more than anyone now is prepared to pay for them i.e. avoid recognizing losses from bad loans that they had made. As a result of having their way the financial institutions affected are now free to apply the new rules to their financial statements for the quarter that ended on March 31st. How convenient!)
If no remedies are going to be initiated what does the future hold. According to Johnson it includes a global economy continuing to deteriorate and the collapse of the banking system in east-central Europe and then throughout the Continent This dramatic worsening of the global environment would force the U.S. economy, already staggering, down onto both knees and Â perhaps then, under this kind of pressure, and faced with the prospect of a national and global collapse, the American people will demand in no uncertain terms that their government finally break up the financial oligarchy and implement the abovementioned reforms.
Unfortunately, Johnson concludes, â€œthe conventional wisdom among the elite is still that the current slump cannot be as bad as the Great Depression. This view is wrong. What we face now could, in fact, be worse than the Great Depression because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government financesâ€?.
If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. There is no better time to take such action than now but it is evident that reform is but a pipe dream. Americaâ€™s financial oligarchy is firmly in control and, as such, the long-term consequences will be dire!
What should one do knowing what to expect in the years to come? I think it is safe to recommend having some gold bullion (preferably some gold coins) on hand as insurance against a potential systemic fiscal collapse. Such a debacle may be a few years off but in an economic environment like this I think you would agree that it is better to be safe than sorry.
Simon Johnson is a former chief economist with the International Monetary Fund and is currently a professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. He, along with James Kwak, a former McKinsey consultant, is a co-founder of The Baseline Scenario (www.baselinescenario.com) which is a blog dedicated to explaining what happened in the global economy and what we can do about it.
Lorimer Wilson is an economic/financial analyst and commentator who has written numerous articles on the major economic and financial crises (past, present and impending) of our times, investing in times of crisis, commodities, market timing and other investment philosophies. He is a Contributing Editor to www.preciousmetalswarrants.com and can be contacted at lorimer [dot] wilson [at] live [dot] com.