Beyond No-Fault Finance

It Takes a Pillage: Behind the Bailouts, Bonuses, and Backroom Deals from Washington to Wall Streetby Nomi Prins, Wiley, 296 pages, $25.95

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastropheby Gillian Tett, Free Press, 293 pages, $26.00

Managed by the Markets: How Finance Re-Shaped Americaby Gerald F. Davis, Oxford University Press, 304 pages, $29.95

From the beginning of the great financial panic of 2007-2008, efforts at understanding the crisis have been hampered by the likely bias of the people in the best position to know. Anyone sufficiently "inside" the financial world to understand what was happening was also inside enough to have suspect motives. That's why someone like Nomi Prins, a former managing director at Goldman Sachs turned muckraking lefty journalist, comes to seem invaluable. And this is never more so than when, as with her new book It Takes a Pillage, she's confirming the suspicions of those of us on the outside that there's something fishy and a bit fraudulent about the world of high finance.

Relative to the voices of the establishment, both in the political world and in the mainstream financial press, Prins is admirably clear and direct about the basically corrupt nature of many of the dealings between the government and the large banks. As she lays out, regulatory failures aren't something that just happened; they were made to happen by the political power and influence that high finance came to wield across party lines. The result has been to create a situation in which ties to major players in the banking world became a prerequisite for making economic policy at the highest levels.

Much less convincing, however, is the sweeping nature of her condemnation of the various bailouts and rescue measures propagated over the past 18 months. These government interventions into the economy have discomfited purists of the right who fear (accurately, I think) that they'll legitimate state intervention for other purposes. Progressive critics are mostly animated by the evident injustice involved in responding to a crisis by shoveling more money at the very institutions that caused it. Still, the fact remains that, as Berkeley economist Brad DeLong said to me last fall, "you can't bail out the financial system without bailing out those who are long financial assets" -- banks and bankers -- and there's a substantial historical record of government responding to financial panics in this way. Discussion of the entire subject would benefit from a less binary mentality in which policies are said to be either for the benefit of Wall Street or for the benefit of the rest of us, and unfortunately Prins doesn't really do nuance.

Her insistence that the bailouts won't work seems to be a victim of publication delay. Since she finished her book, it's come to look like the Bernanke-Geithner-Paulson policies have, in fact, stabilized the financial system and set the conditions for a return to economic growth. Prins also does not enhance her own credibility by continually referring to the face value of government loans or loan guarantees as if they represent the net cost of federal assistance. Ultimately, it would have been more credible to claim that although something in the neighborhood of the bailouts was necessary, the chosen policies have been consistently tailored to fit the interests of politically powerful financiers.

Near the end of her book Fool's Gold, Gillian Tett gives us an admirably lucid explanation of the disaster that policy-makers averted. The economy is now in sorry enough shape that it's hard to recall how much worse it seemed likely to be. In late 2008, it looked like there would be runs on money-market accounts, and businesses would find it impossible to meet payroll. Tett is an outsider turned insider. A Ph.D. in social anthropology who became a Financial Times reporter, she benefited, as the promotional material for her book explains, from "exclusive access to J.P. Morgan Chase CEO Jamie Dimon and a tightly bonded team of bankers known on Wall Street as the 'Morgan Mafia.'"

Both strengths and weaknesses result from this reportorial method. On the good side, Tett is able to leaven her book with amusing anecdotes, real insight into how things looked to key players as they were happening, and the dose of nuance that Prins lacks. Yet Tett could have used a bit more Prins-like skepticism about her sources. In particular, she ought to have questioned the idea running through the book that the crisis was caused by something good that the unscrupulous later "corrupted." Tett describes the original Morgan collateralized-debt-obligation scheme, known by the proprietary term Broad Index Secured Trust Offering (BISTRO), as "akin to an insurance company offering insurance on a home worth $1 million, when it holds just $75,000 in its kitty." Which is to say that the main point of these innovative offerings was to allow financial institutions to get around regulations regarding their permitted degree of leverage. Tett herself explains that a later elaboration of the plan "was so clever that some bankers started to joke that 'BISTRO' really stood for 'BIS Total Rip Off,' referring to the Bank for International Settlements (BIS), which had overseen the Basel Accord," the international agreement concerning bank leverage.

This vision was corrupt from the get-go, and the fact that these financial subterfuges were permitted at all illustrates many of Prins' points about corruption. It's true that under Dimon's leadership, Morgan pushed the envelope far less aggressively than its main competitors, but the basic vision of regulatory arbitrage remained the same throughout. Indeed, it's striking that even Tett ends her book with a lament that "in the last two decades, as finance spun so out of control, it stopped being a servant of the economy but became its master."

A fleshing-out of this concept is provided by Gerald Davis' Managed by the Markets, an ambitious, magisterial, and yet not-too-long effort to sketch the social consequences of a finance-driven economy. Davis sees hegemonic financial markets as intimately linked to a broad array of social and economic transformations over the past 30 years -- de-industrialization, the decline of job security and the corporate-provided welfare state, the unraveling of conglomerates, the tendency to outsource government work to contractors, declining social mobility, and so on.

In Davis' telling, the midcentury economic landscape was dominated by large corporations with their roots in manufacturing. These companies had owners, but ownership was broadly diffused. In practice, they were run by autonomous boards and executives, who managed their firms in their own interests but also with an eye to the concerns of a broader community of stakeholders that included their workers and the communities where their factories and offices were located. All this changed around 30 years ago, as the business landscape was transformed by the rise of the "shareholder value" movement, a brief but intense wave of hostile takeovers, and other changes that made the real world more closely approximate the efficient-markets hypothesis (which holds that sufficiently liquid financial markets will always find the "right" price for assets).

In today's world, it is no longer the stakeholders but the abstract forces of financial markets that hold the whip over companies. These forces press firms to be narrowly specialized on core competencies, to the point where many companies are just in the business of managing a brand with the actual work of making products outsourced to subcontractors, a trend Davis evidently deems ridiculous. Concurrently, the main locus of employment has shifted from manufacturing to services and from firms with long-term employees to firms that provide less in the way of job tenure and benefits. At such companies it is difficult to work one's way up the ladder -- Davis refers nostalgically to the days when one could rise from the mail room to the executive suite -- contributing to growing inequality and social stratification.

One limitation of Managed by the Markets is the lack of a broader comparative perspective, which makes it difficult to disentangle causal lines. Davis does briefly concede that things are different abroad, arguing that "no one would describe Japan or Germany, or India or Brazil, as a 'portfolio society' ... Few people in such settings would confuse their home with a stock option, or see their children as 'social capital.'" That seems true enough, but few Americans view their children as social capital either or see the United States as a "portfolio society." Financial markets are also an odd place to look for the sources of divergence between the United States and Europe. Such markets are highly international, as are the major financial firms, and the post-deregulation rise of American universal banks and financial supermarkets represents a convergence of American practice with what had long been the rule in Europe and Canada.

In some respects, the general preoccupation with the world of finance seems misguided. Under-regulation unquestionably led to a major financial crisis, which in turn has led to a severe recession, and it is both crucial to prevent a repeat of this series of events and reasonable to worry that the banks' continued political clout will make it impossible to do what needs to be done. But the driving factor behind the sentiment of outrage at financial malfeasance that animates Prins and pops up at times in the other books is not so much the difficulty of macroeconomic management as the problem of injustice. How is it that we live in a country where illness often leads to bankruptcy, but gross mismanagement of a major bank leads to a generous retirement package? A country where people take home seven-figure bonuses for finding regulatory loopholes but where we "can't afford" decent schools or mass-transit systems in our cities?

This seems to be an area in which the Europeans have hit upon some smart ideas. Private wealth is taxed to finance generous public services, while strong labor unions help ensure a reasonably equitable division of even pre-tax income. Or compare the past decade in the United States to the Blair/Brown years in the United Kingdom. The British experienced much the same trajectory of finance-led and somewhat bubble-based growth. But the Labour Party put policies into place that reduced income inequality and drastically reduced child poverty. If we could say something similar about the Bush years in the United States, we would have good reason to feel less alarmed about the state of play in finance. But we can't.

The fault here, however, is with our policies regarding labor markets, social investment, and public revenue, not financial regulation. Fundamentally, it would be a shame if the only lessons progressives took away from the great crash were narrow points about leverage ratios. The collapse ought to be a teachable moment to the effect that the actual operations of a modern economy bear little resemblance to the "free market" of right-wing political rhetoric. Even Hank Paulson recognizes that reality when pushed to the limit. But if systematic government intervention is necessary to keep the economy running smoothly, there is a clear moral case for systematic intervention to ensure that it also runs fairly.

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