Five years ago, Lehman Brothers, AIG, and the global financial system were not blown up by subprime mortgages, collateralized debt obligations, or credit default swaps. They were not blown up by greed or fraud, alone. The financial crisis that left millions of people still out of work was caused by an idea: the idea that unregulated financial markets are always good and that we can rely on the self-interest of bankers to improve all of our lives.
The ideology of free financial markets gained sway in the 1990s, with Alan Greenspan at the Federal Reserve and Robert Rubin at Treasury, and was not seriously contested in Washington before 2008. It was a Wall Street-to-Washington consensus that spanned bankers, lawyers, lobbyists, journalists, college career counselors, legislators, regulators, and the highest reaches of the Clinton and Bush administrations. It gave us derivatives non-regulation, consumer non-protection, the end of Glass-Steagall, creative capital accounting, regulatory arbitrage, and, ultimately, tens of thousands of empty houses rotting in the desert. Ultimately it delivered a financial shock from which the world has still not recovered.
For a brief moment, when it seemed the economy could grind to a halt, it was unthinkable that we would ever return to business as usual. At a low point, even Greenspan admitted that he had made a mistake. Five years later, however, the ideology of financial deregulation is back. And while not completely uncontested, it appears to be comfortably ensconced everywhere that matters.
Last month, for example, the federal regulators gutted a provision of the Dodd-Frank Act that required securitizers to retain 5 percent of the the risk of the securities that they were creating—on the grounds that we really, really need the market for mortgage-backed securities to come back. This followed on earlier rules issued by the CFPB that, while certainly not all bad, gave lenders an expansive safe harbor from liability—because we really, really want banks to make mortgage loans. Then there are Fannie and Freddie, which are still doing that thing they do—using the federal government’s credit to subsidize home loans—because no one has the stomach to take on the real estate-financial complex.
It’s not just housing. Despite serious-sounding noises from the Federal Reserve, capital requirements for major financial institutions—those that could bring down the financial system—will at best increase from laughable to amusing. The opposition to higher capital requirements is based on the (fallacious) claim that more capital will reduce lending and therefore harm the economy.
In addition, federal regulators are woefully behind the curve when it comes to technology risk. In just the past year and a half, we’ve seen the BATS IPO debacle, the Facebook IPO fiasco, the Knight Capital implosion, the London Whale disaster (enabled by faulty risk modeling, done in part in Excel), and the Goldman options snafu. On a bigger scale, at a bad time of day, these shocks could seriously destabilize the financial system. In China, they ban people for life for this sort of thing. Here, where we claim to be so much better at protecting the integrity of the markets, not so much.
Then there is Larry Summers—who, apparently, continues to be President Obama’s first choice for chair of the Federal Reserve. Summers is certainly not devoid of qualifications. But if you actually understood the connection between financial deregulation in the 1990s and the financial crisis of 2008, Summers is just about the last person you would pick (falling somewhere between Greenspan and Rubin on the inappropriateness scale) for one of the two most important financial regulatory positions. Summers was the Clinton administration’s point person for financial deregulation and treasury secretary for both the Financial Services Modernization Act of 1999 and the Commodity Futures Modernization Act of 2000. There’s little reason to think his beliefs on the subject have changed.
If anything, it seems like Obama prefers Summers because of his “crisis-fighting” skills. That’s crazy. Not because Summers doesn’t have crisis-fighting skills, but because it’s a return to the bad old days of the Greenspan put: the idea that you don’t have to worry about downturns because the Fed chair can always bail everyone out. That this thoroughly discredited idea (eight million jobs, anyone?) is back—the Summers put instead of the Greenspan put—is as clear a sign as any of how little we learned.
Why are we behaving as if the past five years didn’t happen? Ideas don’t invent and propagate themselves. They are promoted by economic and political interests. Financial deregulation became the Washington consensus in the first place for a few basic reasons. Business interests dominated the Republican Party. Democrats, in order to compete for campaign cash, had to cultivate Wall Street. Community bankers and real estate agents wanted to sell houses to everyone. Lobbyists became power brokers inside the Beltway. Regulators who cared about their self-interest realized that the long-term money lay in being friendly to industry. And everyone wanted growth and low interest rates.
Fast forward to 2013—skipping over that bit of unpleasantness in 2008—and little has changed. Republicans live in a fantasy world where regulation is always bad and deregulation is always good. Democrats scramble to make nice with hedge fund managers and investment bankers. Everyone wants the housing market to recover. The long-term money is still in industry and lobbying. And everyone—especially Democrats—wants growth and jobs more than ever.
Financial stability has no lobby. It has its advocates and academics, like Elizabeth Warren and Anat Admati, but it has no super PAC or 501(c)(4) organization. For a brief moment in 2009 and early 2010, everyone wanted to tame the financial sector, but the Obama administration—led by Summers and by Tim Geithner—chose not to press for the structural reforms that could have made a difference. Today, the media and the public have moved on. Either President Obama truly believes in the deregulatory rhetoric of the 1990s, or he is picking up nickels in front of the bulldozer, betting that the next financial crisis will not occur on his watch.
Simon Johnson and I argued in 13 Bankers that Wall Street’s greatest and most important accomplishment was convincing everyone (who mattered) that unregulated finance was good for the world. Five years later, their victory endures.