News & Views from 465 California Street

Wall Street’s Big Bailout

Clint Reilly

March, 2008 will go down in history as a turning point in finance. The delusion of deregulated financial markets has been exposed.

For decades, the titans of Wall Street have demonized government regulation meant to protect the public interest and the integrity of our financial system. They framed their case against intervention as “innovative public policy.” But as the financial giants have crumbled, their argument has been revealed as a mere tactic to avoid scrutiny of their unsavory and imprudent practices.

Martin Wolf, writing in the Financial Times of London, describes the current crisis in stark terms: “Remember Friday March 14, 2008,” he writes. “It was the day the dream of global free market capitalism died.”

In recent weeks, the Federal Reserve has been forced to bail out Bear Stearns, guarantee tens of billions of the firm’s losses and loan hundreds of billions to big banks and Wall Street investment firms in order to prevent the collapse of both the domestic and global financial systems.

Breaking a barrier that had never before been broken, the Federal Reserve used the taxpayers’ credit and dollars to save Wall Street from imploding.

Wolf delivers the coup de grâce: “The implication is clear – there will have to be far greater regulation of such institutions.”

Wall Street lobbyists, backed by immense war chests, have spun an improbable fairy tale. The Big Bad Wolf (Government) must stop stalking Little Red Riding Hood (the web of banks, Wall Street firms, hedge funds, non-bank lenders, and other financial institutions responsible for trillions in loans, bonds, mortgages and investments).

Red bonnets on the barons of high finance? Sensible government regulation as the Big Bad Wolf of capitalism?

As improbable as these images seem, government oversight of the financial services industry has been peeled back dramatically by a complicit president, a compliant Congress and complacent state legislatures.

A recent Slate Magazine article by Daniel Gross showed how New Deal-era reforms are helping to manage today’s crisis. The events which precipitated those reforms bear a striking resemblance to our current scenario:

“In the 1930s, Franklin Delano Roosevelt saved American capitalism from its own self-inflicted wounds by erecting a new financial infrastructure – often over the vociferous opposition of the bankers and investors whose poor judgment had helped precipitate the Great Depression. During the New Deal, the government reacted to a disastrous systemic failure by creating the sort of backstops, insurance, and risk-spreading mechanisms the market had failed to develop on its own.”

Roosevelt created a series of new institutions: the Federal Deposit Insurance Corporation, the Federal Home Loan Bank, the Securities and Exchange Commission, the Federal Housing Authority, and the Federal National Mortgage Association combined to regulate lending practices, promote home ownership, oversee stock and bond trading, and watch over banks. They performed successfully, with manageable hiccups, until the end of the twentieth century.

But these vital institutions were gradually degraded. “Wall Street chafed at regulations that limited risk but also limited potential profits,” explains New York Times columnist and economist Paul Krugman. “And gradually it wriggled free – partly by persuading politicians to relax the rules, but mainly by creating a shadow banking system.”

Although this shadow system lacked a safety net, profit-hungry investors flocked to its higher returns. After enjoying the system’s largess, they are finally experiencing its devastating downside.

Now, the anti-regulation activists are begging the “Big Bad Wolf” of government to rescue them from their own imprudence and greed.

Washington, for its part, has obliged to stave off a more dramatic economic meltdown. But there will be strings attached.

Says former Citibank Chairman, Goldman Sachs guru, and Treasury Secretary Robert Rubin, “If Wall Street companies can be rescued like banks, then they need to be regulated like banks.”

As the barons of Wall Street will tell you, “There’s no such thing as a free lunch.”

Comments (3)

  • Even the heads of large banks and other financial institutions said they couldn’t understand the new and “sophisticated” ways of bundling debt. That should have set the alarm bells ringing. The choice appears to be giving Wall Street freebooters full rein or strangling entrepreneurship with government regulation. I don’t look forward to the political hacks of both parties getting their hands on these economic levers.

    Posted by: Jerry Carroll | April 1st, 2008 at 12:03 pm

  • Fairytale is right- the myth of government strangling the American economy with financial sector regulation is just another in a long line of conservative issue-framing. As they have with abortion, gun control, national security etc., instead of debating issues on the merits, conservatives have focused instead on erecting the walls of the debate hall, to great effect.

    The myth of the government “Big Bad Wolf” is repeated often and forcefully, and it has come to be accepted–in total or in part–when we discuss issues pertaining to the American economy. Perhaps wake up calls like the possibly impending collapse of our economy will serve to tear down these false arguments and set us on a more reasonable path.

    Posted by: Mavisha Dierkhorn | April 1st, 2008 at 12:37 pm

  • I agree with Senator John McCain. Don’t rescue them. Pain must occur before there is real healing. Darkness before daylight. There will be daylight when all variables of the housing sector correct to their true market levels. Only the market can unravel this. A free running market.

    I feel for Ben Bernanke and Mr. Paulson. But i feel more for Joe B. Housemaker and Family who will lose his home because he didn’t understand the fine print when his ARM shot the roof off his home mortgage payment.

    Love thy neighbor. We must go back to the fundamental values that make our country great. His pain should be our pain.

    Posted by: Don Nguyen | April 1st, 2008 at 12:56 pm

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