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Money in the Banks

Why do we bail out Wall Street bankers?
Because for nearly 30 years our politicians have done anything they've asked.

Ben Bernanke’s Federal Reserve and Timothy Geithner’s Treasury Department continue to sink billions of dollars into the black hole of Wall Street, but those billions have not prevented the US economy’s nosedive toward a crash and burn ending. And what is Bernanke’s solution? More of the same, as he recently testified to Congress that the economy will not recover until we resolve the problems in the financial sector. In other words, expect more billions to be thrown at Wall Street’s carcasses.

One has to wonder why the policies to “cure the crisis” are mainly focused on saving Wall Street bankers? A report released last week answers this question: Over the last 10 years Wall Street “invested” $5 billion in campaign contributions and lobbyists in order to repeal or prevent regulations that could have significantly reduced the severity of the crisis. Given that Wall Street contributes more money to politicians than any other sector, and our top economic policy makers typically come from Wall Street, how could anyone be surprised by the choices taken?

While the report focused on the past 10 years, I would argue that the roots of this crisis go back even further, specifically to the resurgence of conservative free-market policies that began with the election of Ronald Reagan in 1980. These policies paved the way for the dominance of financial interests over all other economic interests in the US, including labor and industry, and the consequences have been the destruction of our industrial base, along with it the middle class, and the worst economic crisis since the Great Depression.

From the end of World War II to 1980, a simplified form of Keynesian economics dominated economic theory and policy, and its basic premise was that the federal government, along with the Federal Reserve, could push the economy in any desired direction by managing the level of total demand for goods and services, and thus the level of employment. This could be done via changes in federal expenditures or taxes, and managing the level of interest rates. Keynesian theory became so dominant that even Republican president Richard Nixon proclaimed, “We are all Keynesians now.”

However, throughout the 1970s both unemployment and inflation started to rise, and the simplified Keynesian theory was unable to explain this phenomenon known as stagflation. This opened the door for the re-emergence of the conservative free market ideology, in the guise of “supply-side economics,” a.k.a. “trickle down economics,” which had been discarded after the last depression. Supply-side economists argued that deregulation and tax cuts would lead to low inflation and high growth. Deregulation would increase competition and lower prices, and tax cuts, for those who save and invest, would lead to increases in productivity-enhancing investments, the source of growth. Thus began the assault to undo most of the big government safeguards put into place since the last depression, and the force at the heart of this assault was Wall Street.

What followed for the next 28 years were changes that helped put Wall Street’s interests above all others. The saying “What’s good for General Motors is good for the economy” was replaced by “What’s good for Citigroup is good for the economy.”

We can break this process into three phases associated with the administrations of Reagan, Clinton, and Bush the Younger.

Reagan’s key advisors were supply-side economists who quickly pushed through tax cuts (mainly for the upper brackets) and deregulation. The first change in financial deregulation actually began under the Carter administration with the Monetary Decontrol Act of 1980, which eliminated caps on interest rates. In 1982, the Garn-St. Germain Act was passed, which allowed savings and loan outfits to expand from their traditional home mortgage market into commercial real estate.

While Reagan supporters will argue to the death that his economic policies were a success, the truth is always a bit more complex. The tax cuts and increased spending created the largest deficits in history up to that point; deregulation of the S&Ls led to speculation in commercial real estate and their eventual bailout; and there was also a bailout of the banking system due to the international debt crisis.

However, nothing characterized the 1980s more than debt-financed leverage buyouts (LBOs) and the “greed is good” philosophy. LBOs made millions for Wall Street, but they created a focus on short-term profitability which hastened the deindustrialization of America—it’s a lot easier to create quick profits by moving production to low-wage countries than to invest in long-term productivity-enhancing technology. And, even if a corporation wasn’t taken over, it was forced to focus on short-term profits in order to raise its stock price, since higher stock prices made hostile takeovers more expensive and difficult. These quick gains were great for investors and Wall Street, but not for industry and middle-class Main Street.

In retrospect, the supply-side policies of the 1980s were a precursor to the current crisis: large deficits, greed and speculation, followed by bailouts.

Clinton’s chief economic advisor was Robert Rubin, who was previously co-chairman of Goldman Sachs (He is currently an Obama advisor.) Under Clinton NAFTA was signed and the movement toward globalization accelerated. Again, the easiest way to increase profits is to move production to where wages are cheaper. The 1990s also witnessed the movement toward paying managers with stock options, as it was argued that stock options would make managers’ interests coincide with investors. This caused managers and investors to have the same short-term profit focus. It was during this period that the final constraint on finance was ended with the passage of the Gramm-Leach-Bliley Act in 1999, which effectively ended the separation of banking and other financial services, put in place by Glass-Steagall in 1933. According to its proponents like former Fed chairman Alan Greenspan and Clinton Treasury Secretary Larry Summers (currently one of Obama’s main economic advisors), finance would be “self-regulating.”

The election of George W. Bush in 2000 gave us supply-side economics on steroids: more tax cuts combined with unfettered belief in markets. On one side of the aisle, Republican federal regulators blocked states from pursuing predatory lenders, and on the other Democrats pushed Fannie Mae and Freddie Mac into the subprime mortgage business. And the results? The largest federal deficits in history; greed and speculation on scales never before seen; and the costliest bailout in history.

What was the overall outcome of this reversal to 19th-century free-market ideology combined with a Wall Street-centered economy? Given the incentive to maximize short-run profits by both investors and management, corporations outsourced high-paying, working-class jobs to low-wage countries; and tax cuts for the rich led to rising deficits and speculation, not productive investments. The end result was an economy focused on short-term gain that rewarded a few at the top, without any improvement in long-term growth.

During the Keynesian period (1947 to 1980), real GDP grew by 3.7 percent per year, and the share of family income for the richest 20 percent of Americans remained near 41 percent, with the share of the richest five percent actually falling from 16.4 percent in 1967 to 14.6 percent in 1980. From 1981 to 2006 real GDP increased at an average of only 3.1 percent, and the share of income for the richest 20 percent increased to a peak of 48.5 percent, with almost the entire gain going to the top five percent, whose share increased to 21.5 percent.

Essentially, this deregulated Wall Street era has mortgaged off our future in order to reward its “captains of finance” and their Congressional whores.

Dr. Ted P. Schmidt is an associate professor in the Department of Economics & Finance at Buffalo State College.

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