How They Wrecked the Economy

During a break at a recent conference on the future of economics, I was carrying the galleys of Jeff Madrick's new book, Age of Greed, when I got into a conversation with Paul Volcker. At 83, the former Fed chairman is a bit hunched but still sharp as an old hawk. Glancing at the book's title, he asked what it was about. "The recent meltdown on Wall Street," I answered, "and how it evolved from deep origins over the past 40 years."

"Ah, that's a good topic," he replied, "though frankly, I've never thought greed defined just one age in American history." The twinkle in his eye made me realize he'd formulated his answer before asking his question--a valuable talent for a central banker.

Volcker is right, of course, that far too much of American history is a history of greed--for land, furs, minerals, slaves, factories, art, power, recognition, and money without limits. Yet many of us want to believe that America is about something more and that our common effort can lead to a common good, not just the piling up of the latest plutocrats' privileges. Not all eras are defined by greed. For the first 30 years after World War II, for example, greed for a time seemed muted.

But no longer. Three years ago, when the nation plunged into the worst financial crisis since the Great Depression, many of us thought Americans would face up to the devastating real-world consequences of deregulated greed. There has been no shortage of discussion about the issues, to judge from the tsunami of books, articles, official reports, op-eds, and talk-show debates about the crisis. And Congress finally did pass the 2,300-page Dodd-Frank bill last spring--though today, skeptics increasingly outnumber optimists about the bill's ultimate impact, as regulators and lobbyists bow and twirl in their delicate saraband of power, shaping the regulations the law left undefined.

But if we consult the past, what should we expect? To judge from Madrick's excellent history of the decades from the Nixon years to the present, it's fair to say that more trouble lies ahead. His argument is straightforward: The meltdown of the multitrillion-dollar shadow world of collateralized-debt obligations, credit -- default swaps, and offshore special -- purpose vehicles was never the root of the problem. And better management of those instruments by temporarily chastened investors and traders, or regulators with better risk-management tools, won't prevent the next meltdown in a not-too-distant future.

Over the last 40 years, there has been an explosion in global financial markets (and traded assets and liabilities) relative to the size of the global economy. The explosion has been fed from several sources: a continuous stream of petrodollar profits earned by producers and Western oil giants; windfall trading gains piling up in low-wage countries (think China, for a start, or the sovereign wealth funds of Singapore or Dubai); and the creation of an unprecedented pool of private pension savings (401(k)s and individual retirement accounts in the United States, for example) flooding into financial markets every time payroll checks are issued.

Those trillions, in turn, have kept global real interest rates low (Federal Reserve Chair Ben Bernanke's "global savings glut") and encouraged commercial banks, hedge funds, mortgage brokers, and other intermediaries to come up with ever more complicated financial instruments to eke out tiny marginal gains in this low-interest world, a process made riskier through the use of greater leveraging to turn those paper-thin margins into massive gains.

An almost religiously ecstatic celebration of markets has justified this process, at least for the world's elites. And where justification by faith has been insufficient, the defense has invoked justification by unfathomable, mathematical complexity. Can you calculate the value at risk of synthetic derivatives? No? So please don't intrude.

But where did this world come from? Madrick's argument is that it arose from the contradictions of the 1970s, when the global financial system was suddenly destabilized. In 1971, President Richard Nixon cut the dollar free from gold, a connection at the heart of the Bretton Woods system that emerged from World War II. That link, plus global trade and capital controls of various kinds, had maintained a stable but strong economic expansion worldwide. Decoupling from gold, however, led to the dollar's downward drift against other currencies (which was Nixon's intent, since floating the dollar was his attempt at a cheap repair of America's growing trade deficit). Two years later, however, the Organization of Petroleum Exporting Countries--which had angrily watched its own income fall sharply because oil prices were dollar-denominated--struck back by quadrupling the price of oil.

The instabilities that flowed from Nixonomics and OPEC suddenly began to tear apart the once remarkably stable financial sector that had bankrolled America's postwar affluence. In that world, the risks of investment banking had been kept separate from the routines of commercial banking, the Securities and Exchange Commission had brought systematic oversight and disclosure to the nation's largest corporations, and the dollar's hegemonic power--thanks to its postwar emergence as the world's reserve currency--had encouraged American corporations to expand rapidly at home and abroad (the latter was new, in terms of scope and scale).

At the beginning of the Nixon era, a new generation of bankers and investors, untempered by depression and war, were hungry for greater profits than the regulatory regime had allowed them to earn. When Nixon floated the dollar and OPEC followed by quadrupling oil prices, the new generation seized the moment. Most famously, Walter Wriston--the hard-driving, sharp-elbowed chairman of First National City Bank (predecessor to today's Citicorp)--led New York's most powerful commercial bankers into the uncharted waters of Eurodollar arbitrage, negotiable certificates of deposit, unprecedented lending to the Third World, and other then-revolutionary venues in search of superprofits--with a bravura and taste for rule-bending perfectly captured in the title of his memoir, Risk & Other Four-Letter Words.

Brooks Brothers buccaneers like Wriston, though, could never have launched their quest alone. To succeed, they needed academics and politicians, the former to provide the intellectual rationale for the latter's dismantling of the 1930s regulatory architecture that had done so much to sustain postwar America's long, steady, and remarkably egalitarian growth years. As Age of Greed shows, Milton Friedman and Richard Nixon initially served as leaders in this march to the market, to be superseded in the 1980s by Arthur Laffer and Ronald Reagan, and in the 1990s by Robert Rubin, Larry Summers, and Bill Clinton.

But Madrick is also right to look beyond the field marshals at the top to highlight the financial revolution's officer corps and ground troops--the traders, investors, accountants, and lawyers whose innovations often leaped ahead of their commanders, leaving the latter scrambling to catch up.

Thus we meet figures such as Joe Flom, the mergers-and-acquisitions attorney who designed so many hostile takeovers so quickly that in little more than a decade, he and his colleagues shattered the genteel country-club prohibition on such takeovers to which generations of WASP CEOs and their bankers had adhered. We also (re)discover Michael Milken, the sorcerer's accountant with the ill-fitting toupee, who invented the modern junk-bond market, thereby providing the rocket fuel that launched the red-hot leveraged buyout business and helped push stock prices and CEO salaries to astronomical new heights.

There is also the unforgettable Ivan Boesky, king of risk arbitrage. His short-lived Reagan-era reign ended in prison, but not before director Oliver Stone immortalized him in Wall Street as the barely fictionalized Gordon Gecko, author of that eternal 1980s battle cry of the MBAs, "Greed is good."

As Madrick carries us briskly past these characters, past Reagan and Rubin, George Soros and Sandy Weill, Angelo Mozilo and Alan Greenspan, right up to today, we see for the first time clearly how deeply and systematically the entwined ideology, market innovations, and politics of our long Nixon-Reagan-Clinton-Bush era finally brought us to the global economy's shattering near collapse--and its slow and achingly fragile recovery.

It's this ability to move across politics, academic economics, and the intricacies of day-to-day finance at both the personal and institutional level that makes this such a valuable book. Other volumes have admirably captured one or another part of the story; none before Age of Greed has brought all the elements together so clearly and comprehensively. Beyond his scope, however, Madrick's strength is his voice--his ability to present all this complex history in a way that is neither dry nor lurid but rather shrewdly intelligent and easily digested. For the intelligent reader unversed in financial arcana, Madrick's will remain the benchmark book for years to come.

In the end, it's a sobering read, though, because after showing us how we got here, there's little Madrick can offer about the way out. But that is not his fault--and we owe him thanks for what he has done.

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