The Deep State (17 page)

The identification of Wall Street's interests with the national interest reached an apotheosis of sorts in the 1920s, when, as Calvin Coolidge said, “The business of America is business,” the stock market reached unheard-of heights, and the fabulously wealthy financier Andrew W. Mellon became secretary of the treasury so that he could rewrite the nation's tax laws to the benefit of himself and his friends. This was also a time when the pseudoreligious wealth gospel was at its most popular. The long American tradition of conjoining wealth, Christian morality, and the American way of life reached a crescendo in Bruce Barton's 1925 book
The Man Nobody Knows
. The son of a Congregationalist minister, Barton, an advertising executive, depicted Jesus as a successful salesman, publicist, and the very role model of the modern businessman.

The Crash of 1929 and the New Deal

This peculiarly American creed took a severe hit after the Crash of 1929, when wealth ceased to be equated with godliness. While the number of Wall Street suicides has been exaggerated in national memory, Jesse Livermore, perhaps the most famous of the Wall Street speculators, shot himself, and so did several others of his profession. There existed then a lingering old-fashioned sense of shame now generally absent. While many of the elites hated Franklin Roosevelt—in a famous
New Yorker
cartoon of the era, a rich socialite tells her companions, “Come along. We're going to the Trans-Lux to hiss Roosevelt”—most had the wit to make a calculated bet that they would have to give a little of their wealth, power, and prestige to retain the rest. Even a bootlegging brigand like Joe Kennedy reconciled himself to the New Deal and became FDR's man on the Securities and Exchange Commission to police Wall Street. (The president must have been operating on the theory that it takes a thief to catch one.)

The New Deal was the first comprehensive attempt to tame Wall Street in the nation's history. The Banking Act, the Glass-Steagall Act, and the establishment of new regulatory agencies such as the Securities and Exchange Commission, the Federal Energy Regulatory Commission, and the National Labor Relations Board were just some of the measures designed to claw back Wall Street's power that went into effect. While the titans of Wall Street may have grumbled about Roosevelt's “socialist experimentation,” most were chastened by a popular mood that was borderline revolutionary. There was a real question as to the survivability of democratic institutions. Communism and fascism were then viable alternatives—even in capitalist America. Besides, anything was better than the horrible period between November 1932 and March 1933, the interregnum between Presidents Hoover and Roosevelt, when the circulation of cash nearly ceased in some areas of the country. Dangerous as the New Deal was to the entrenched interests, at least it offered lucrative construction contracts for work on projects like the Tennessee Valley Authority and the Grand Coulee Dam.

For the next several decades, until the 1970s, Wall Street became the servant of the American economy rather than its master. While fortunes could still be made on the Street, the restless animal spirits of capitalism were contained by a skein of laws and regulations. The share of national wealth possessed by the superelite—the top one-tenth of the wealthiest 1 percent—fell steadily until the post–World War II years, leveled off, and did not rise significantly until 1978. Those decades also saw some of the most impressive economic growth rates in our history and the making of the American middle class.

Fabulous fortunes were made in World War II (we need only think of Henry J. Kaiser, the shipbuilding king who turned out Liberty ships like sausages), but they were subject to a windfall profits tax. Tycoons like Kaiser constructed ships, planes, and the critical infrastructure, such as the “Big Inch” oil pipeline and the Alaska Highway, that were necessary to win the war (and incidentally put in place the infrastructure required for the postwar boom), rather than concocting synthetic CDOs and other fantastic instruments of the type that precipitated our latest economic collapse.

During the 1950s, many Republicans pressed President Eisenhower to lower the prevailing 91 percent top marginal income tax rate, but, citing his concerns about the deficit, he refused. In view of our present $17 trillion gross federal debt, perhaps Ike was right. Characteristic of the era was the widely misquoted and misunderstood statement of General Motors CEO and later secretary of defense Charles E. “Engine Charlie” Wilson that “what was good for the country was good for General Motors, and vice versa.” He was expressing, however clumsily, the view that the fates of corporations and citizens were conjoined. His view was a world away from the present regime of downsizing, offshoring, and profits without production. The now-prevailing economic dogma first evangelized by Milton Friedman, an acolyte of Friedrich Hayek, holds that a corporation that acts responsibly toward the community in which it does its business is shirking its only duty: to maximize its short-term stock
valuation.
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Yet during the 1950s the country managed to achieve higher average GDP growth rates than Americans have experienced in the last dozen years.

Back to the Gilded Age

The median level of inflation-adjusted household income peaked in the United States in 1973. Around the time that the Powell Memo called on big business to liberate itself from the suffocating embrace of government, an extraordinary ferment of pro–Wall Street pamphleteering commenced: from Louis Rukeyser at the popular level to George Gilder's ideological tracts to Friedman and his colleagues in the Chicago school of economics, the propagandists of neoliberal ideology skillfully advocated free markets, which is to say, fewer restraints on Wall Street and privatization of key government activities. Across-the-board deregulation, tentatively nurtured under Carter, would become one of the two core beliefs of the Reagan revolution (the other was its faith in a large military buildup, and the deficit be damned).

By the first decade of the twenty-first century, the Gilded Age had returned. As in the days of John D. Rockefeller, Sr., legislatures could be bought, even our national legislature. Only it was now camouflaged as campaign contributions, rather than arriving in black bags full of cash. On those occasions when money wasn't quite enough, and things had to move fast, Wall Street and its emissaries could rely, just like the military-industrial complex, on a healthy dose of fear.

During the late afternoon of September 18, 2008, the Senate had
wrapped up its work for the week. It was a Thursday, so senators were “smelling the jet fumes,” as the saying goes. They were eager to leave the Capitol complex and fly back to their home states (much of the time, Friday's schedule in the Senate consists of a pro forma session with only a handful of members in attendance). But on this Thursday evening, the secretary of the treasury, Henry (Hank) Paulson, asked the congressional leadership and senior figures on the key committees of both houses for an emergency meeting in the Speaker's office with him and Federal Reserve Board chairman Ben Bernanke. Although there had been bad economic news all spring and summer, apparently it hadn't registered with some in Congress.

In the hastily called meeting, Paulson and Bernanke depicted a financial system on the verge of collapse, predicting 25 percent unemployment if something wasn't done immediately. I was detained on Capitol Hill that evening, and although I was not in the room, and participants were not supposed to talk about specifics, the Hill's grapevine telegraph instantly transmitted the gist. I sensed a crisis atmosphere, much as there had been after the news of the airliners striking the World Trade Center and the Pentagon.

When Paulson said that he needed action immediately, he didn't mean after hearings and committee reporting of legislation. Bernanke supposedly said, “If we don't do this tomorrow, we won't have an economy on Monday.” What “this” turned out to be was a Treasury draft of legislation that arrived at the Hill the next day. Congress was supposed to pass it at once and without amendment. It was barely three pages long, and it was the greatest grant of power to the executive that I had ever seen: $700 billion—the largest single-purpose request for money in history up to that time—would be handed to the Treasury Department with no strings attached to bail out the banks as Paulson saw fit (Paulson's subordinate Neel Kashkari was to be the administrator of the money; he later told an economist friend of mine that the $700 billion figure was “a number plucked out of the air”).
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Congress actually took a bit more time than the executive branch demanded. The bill, officially named the Emergency Economic
Stabilization Act, but often called the TARP bill, for the Troubled Asset Relief Program that it authorized, was not enacted until October 3, after the House had rejected the bill on a previous vote. Congress put in some safeguards, like an inspector general to oversee the disbursements, as well as a few other window-dressing items, but Paulson and company got pretty much what they wanted. There had been rumblings from consumer groups and some Democrats that the bailout plan should help keep mortgage holders in their homes, that courts should be given the power to write down mortgages, and that the bill should set compensation limits on executives of the bailed-out banks, but all those proposals somehow fell by the wayside.
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It is remarkable what you can get out of a legislature when you cultivate an atmosphere of panic.

“We Didn't Want to Do It, but We Had To”

Retrospectively, proponents have justified the bailout as preventing another Great Depression. That debatable counterfactual is the leitmotif of Bernanke's memoirs, and of Timothy Geithner, Paulson's successor as treasury secretary, as well as Paulson himself. They and other Washington operators insisted that as personally distasteful as overseeing the bailout supposedly was to them, it was imperative to save the financial sector in order to rescue the broader economy: in short, saving Wall Street saved Main Street. Besides, the bailed-out banks repaid the money with interest, so what was the problem?

First, the interest on TARP loans to the banks was far below prevailing market interest rates, giving the banks a subsidy. Second, in the initial round of TARP payouts, the Treasury paid $254 billion for bank assets worth only $176 billion, giving the banks a $78 billion taxpayer-funded windfall.
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Third, bailing out Wall Street did not bail out Main Street: the
banks not only took money from the Treasury, they also borrowed billions at a near-zero interest rate from the Federal Reserve System. But these funds did not translate into consumer or business loans as intended. Instead, the banks used the money to buy higher-yield foreign financial instruments and pocketed the arbitrage. In addition, an obscure provision in the bailout bill authorized the Fed, contrary to all sound banking practices, to pay banks a higher interest rate on deposits from banks than the banks had to pay to get loans from the Fed: banks could then borrow money from the Fed and turn right around and park their excess reserves back at the Fed. Instead of stimulating the economy, the money became a risk-free arbitrage mechanism for our biggest banks.

Finally, credit ratings agencies from then on have priced in the likelihood that the bailed-out institutions would always get rescued in the future; that assumption means those banks have a built-in competitive advantage over smaller banks and are able to borrow funds at lower cost. What TARP and the other bailout programs accomplished, then, was to recapitalize the banks, further concentrate them (the five largest American banks had assets equal to 43 percent of U.S. gross domestic product before the crash; by 2012 they made up 56 percent), and send them mostly unreformed on their merry way to the next asset bubble.
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Why this entire process was preferable to operating the failing big banks that had commercial depositors under the conservatorship of the Federal Deposit Insurance Corporation so as to protect those depositors, and concentrating Treasury and Federal Reserve resources directly on boosting consumer demand, illuminates how Wall Street has captured and assimilated the decision-making process at the upper levels of government. There is no question that the economy was in a grave state in September 2008, but Paulson's comments were still hyperbolic and, by panicking investors, likely helped create a self-fulfilling prophecy.

It is not clear to me whether the 778-point drop in the Dow Jones Industrial Average after the House's initial rejection of the TARP package was a rational market response or whether the groundwork for a panic sell-off had not already been laid by Paulson's pronouncement that the sky
would fall if the bill were not passed. The treasury secretary's handling of the crisis appeared intended to foreclose options other than those he wanted. Seeing bank CEOs among the ranks of the unemployed was apparently such an intolerable outcome that it was necessary to use fear of an economic Armageddon to stampede Congress into approving a virtual no-strings-attached package.

Proponents of the bailout attribute the recovery from the 2008 crash to Paulson's, Bernanke's, and Geithner's actions. But an examination of income and wealth statistics shows that the recovery, if that's the name it merits, was different from that of the recovery from the Great Depression in one key respect. After the earlier crash, inequality of wealth was narrowed for the next forty years. But TARP, the Fed's lending programs, and the other measures that supposedly saved us from an economic abyss set the stage for a rapid wealth rebuilding by those at the top income levels, while people in the bottom 90 percent have seen their personal holdings stagnate or decline.

Although I had worked on the House Budget Committee since 1995 and the Senate Budget Committee since 2005, the financial crisis of September 2008 was my first full immersion into the world of Wall Street. My usual portfolio had been national defense, but from September 18, 2008, onward it was “all hands on deck” for anyone with a pulse to gather information and try to make sense of the catastrophe. To be sure, some people on the Hill stood around numbly, watching the stock ticker on CNBC as their 401(k) accounts melted down like a snow cone in a blast furnace. But the whole affair seemed oddly familiar to me. Although the financial jargon, such as TARP, TALF, and repo, was new, the modus operandi of those in charge bore an eerie resemblance to national security crises of times past. There is a striking similarity between Wall Street and “War Street,” the national security state, when they really need to get things done in a hurry.