By Steve Fraser
What is Washington to do as the financial system collapses? Clearly, stark differences in approach as well as in public policy have already emerged. Bail-out Bear Stearns and pump up the brokerage and investment business with new lines of credit. Nationalize Fannie Mae and Freddie Mac on the backs of the taxpayer — but let Lehman drown. Tell the financial community to save itself, after which Bank of America salutes and buys Merrill Lynch. Then, the Fed gets cold feet and decides it can’t let an institution the size of the insurance giant AIG go under as well. Washington is left staring into the abyss. The old rules no longer apply.
And that’s the point. At moments of crisis since the mid-1980s, the relationship between Washington and Wall Street has changed fundamentally, at least when compared to anything that would have been recognizable in the previous century. As a result, the road ahead is dark and unknown.
During the nineteenth century, Washington was generally happy to do favors for Wall Street financiers. Railroad tycoons, who often used those railroads as vehicles of extravagant speculation, enjoyed subsidies, tax exemptions, loans, and a whole smorgasbord of financial fringe benefits supplied by pliable Congressmen and Senators (not to mention armadas of state and local officials).
Since the political establishment was committed to laissez-faire, legerdemain by greedy bankers was immune from public scrutiny, which was also useful (for them). But when panic struck, the mighty, as well as the meek, went down with the ship. Washington felt no obligation to rush to the rescue of the reckless. The bracing, if merciless, discipline of the free market did its work and there was blood on the floor.
By early in the twentieth century, however, the savage anarchy of the financial marketplace had been at least partially domesticated under the reign of the greatest financier of them all, J.P. Morgan. Ever since the panic of 1907, the legend of Morgan’s heroics in single-handedly stopping a meltdown that threatened to become worldwide, the iron discipline he imposed on more timorous bankers, has been told and re-told each time an analogous implosion looms.
Indeed, last week’s news carried its fair share of 1907-Morgan stories, trailing in their wake an implicit wistfulness. They all asked, in effect: Where is the old boy when we need him?
Back then, with Morgan performing his role as the nation’s unofficial private central banker, Teddy Roosevelt’s administration continued to keep its distance from Wall Street, still unready to offer salvation to desperate financial oligarchs. Not normally chummy with Morgan and his crowd, Roosevelt did cheer from the sidelines as the über-banker performed his rescue operation.
As it turned out, though, the days of Washington agnosticism about Wall Street were numbered. The economy had become too complex and delicate a mechanism and, in 1907, had come far too close to meltdown — even Morgan’s efforts couldn’t prevent several years of recession — to leave financial matters entirely in the hands of the private sector.
First came the Federal Reserve. It was established in 1913 under President Woodrow Wilson as a quasi-public authority meant to regulate the country’s credit markets — albeit one heavily influenced by the viewpoints and interests of the country’s principal bankers. That worked well enough until the Great Crash of 1929 and the Great Depression that followed and lasted until World War II. The depth of the country’s trauma in those long years vastly expanded the scope of Washington’s involvement in the financial marketplace.
President Franklin D. Roosevelt’s New Deal did, as a start, engage in some bail-out operations. The Reconstruction Finance Corporation, actually created by President Herbert Hoover, continued to rescue major railroads and other key businesses, while some of the New Deal’s efforts to help homeowners also rewarded real estate interests. The main emphasis, however, now switched to regulation. The Glass-Steagall Banking Act, the two laws of 1933 and 1934 regulating the stock exchange, the creation of the Securities and Exchange Commission, and other similar measures subjected the financial sector to fairly rigorous public supervision.
This lasted for at least two political generations. Wall Street, after all, had been convicted in the court of public opinion of reckless, incompetent, self-interested, even felonious behavior with consequences so devastating for the rest of the country that government was licensed to make sure it didn’t happen again.
The undoing of that New Deal regulatory regime, and its replacement, largely under Republican administrations (although Glass-Steagall was repealed on Clinton’s watch), with what some have called the “socialization of risk” has contributed in a major way to the mess we’re in today. Beginning most emphatically with the massive bail-out of the savings and loan industry in the late 1980s, Washington committed itself, at least under conditions of acute crisis, to off-loading the risks taken by major financial institutions, no matter how irrationally speculative and wasteful, onto the backs of the American taxpaying public…
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Steve Fraser is working on a book about the two gilded ages. A TomDispatch regular and co-director of the American Empire Project series at Metropolitan Books, he is the author of, among other works, the recently published Wall Street: America’s Dream Palace.
Copyright 2008 Steve Fraser