The relentless revolution: a history of capitalism

by Joyce Appleby

  We might dub this the world of virtual investment whose material reality was a stream of electronic messages issuing from some sixty thousand terminals around the world. Technological advances made possible the increasing volume of financial transactions. There was also some double duping, when mortgage salesmen encouraged people to assume mortgages they couldn’t afford and financial firms talked pension fund managers and municipalities into buying their asset-backed securities without sharing information about the risk.

  During the last ten years, financial services grew from 11 percent of our gross national product to 20 percent. Some otherwise sober men and women were able to leverage at a ratio of 1:30 for money invested, spreading risk without tracking it. The really daring investor would nest several forms of leveraging into a single investment vehicle. More damaging to the nation in the long run, physicists, mathematicians, and computer experts were drawn away from their original work to join the high-earning financial wizards. At least 40 percent of Ivy League graduates went into finance in the early years of the twenty-first century. With million-dollar annual incomes commonplace, Wall Street formed a tight little winners’ circle where all the incentives were thrown on the take-more-risk side and positive disincentives discouraged caution or even candor.

  Those working for the Securities and Exchange Commission feared offending the leaders of the major firms they hoped would hire them later. Credit-rating agencies like Standard & Poor’s and Moody’s were similarly disinclined to lower the ratings of bank customers that took on too much risk. In retrospect, people who were making decisions affecting the economies of dozens of countries were sealed into a cozy club of high-fiving camaraderie where there was no tomorrow.5

  The wild card in this scenario was psychological and endemic: the feeling of confidence that encouraged people—in this case institutional investors and hedge fund managers—to purchase the new asset-backed securities. In retrospect, their misperception of the risk seems bizarre. Pretty mindless during an upswing, optimism is contagious. Working the other way around, rumors and foolish public statements can cause a precipitous fall in confidence just about as easily as reports of disappointing earnings or turbulence in foreign markets. Whether upbeat or downbeat, these responses from traders and investors introduced a degree of risk that impinged on the whole global economy because of the easy access the world’s investors had to these “good deals.” One could add that the United States benefits from this selective blindness because of the world’s indifference to the country’s annual seven-hundred-billion-dollar trade deficit.

  A Nobel Prize–winning chemist named Frederick Soddy had some ingenious observations to make about debt when he turned from chemistry to economics during the great bubble of the 1920s. People buy debt (i.e., lend money) because they want to realize more wealth in the future. The rub is that no one knows what will happen in the future. If I lend a farmer $100 in the expectation of getting back $110 when the harvest comes in, I am banking on good weather and no visit from locusts. If there are in fact more claims upon future wealth than can be redeemed, then some of those with claims on future earnings are going to lose out. The market in futures not only is volatile but must always cope with this uncertainty.6 And in the case of the securitized mortgages, the number of claimants grew exponentially.

  The American Dialect Society voted “subprime” the word of 2007.7 During the euphoria over rising housing prices, the lexicon of global finance migrated out of Wall Street into daily newspapers, where you could find references to option adjustable interest rate mortgages, collateralized debt obligations, interest rate swaps, swaptions, and special purpose vehicles! Hedge funds grew fivefold in the first decade of the twenty-first century, attracting managers of pension money, university endowments, and municipal investments, all now suffering with the retraction. Those people who ran hedge funds, established derivatives, and created option adjustable rate mortgages had built a house of cards with mortgage paper. Their initial success with rising house prices bred the “irrational exuberance” noted in an earlier bubble by the former Federal Reserve Bank president Alan Greenspan, himself a somewhat repentant opponent of regulation. Ignoring their conflicts of interest, credit rating agencies gave artificially high ratings to mortgage securities. Thus even those created to assess risk failed the system.

  When house prices started to fall in late 2007, the securities they backed fell too. Like a boa constrictor, deleveraging—i.e., paying for securities bought on the margin—squeezed all along the financial line from bankers to insurers, hedge fund investors, and their institutional and private customers. Liquidity dried up; money became tight. Even legitimate business borrowers couldn’t get loans. So bad were things that Goldman Sachs and Morgan Stanley sailed into the safe harbor of greater regulation and scrutiny by becoming commercial banks and leaving the shark-infested waters of investment banking. Of course they also gained access to government aid and lending sources.

  Financiers who wanted a free hand are not alone responsible for the 2008 crisis. It also took public officials, from city councillors to members of Congress, mayors to presidents, to dismantle the regulatory system that had monitored financial firms. The U.S. government went from being a more or less neutral umpire of economic relations to an advocate of business interests. Changes in political campaigning promoted the collusion between economic and political leaders. With the emergence of television as the principal medium for election campaigns forty years ago, money—never negligible—took on a new importance. The expense of TV spots threw officeholders and their challengers into the arms of business interests. As slick Willie Sutton once explained, he robbed banks because that’s where the money was. And that’s why candidates of both parties went to the wealthy to seek contributions.

  A toxic combination of greed and need—greed on the part of the high-flying engineers of finance and need from politicians to pay for their ever more expensive campaigns—made officeholders beholden to business executives who wanted government off their backs. The free market ideology dominating public discussions gave cover to those in government. Even so, after the passage of the Gramm-Leach-Bliley Act, some legislators still tried to limit the trade in derivatives. They accurately predicted the cascading effect of any downturn. Representatives proposed measures to combat predatory lending, like those the Ohio cities had passed, but the leave-enterprise-alone advocates blocked their efforts. When regulation has been discredited as it was in the 1980s, even those regulatory agencies left intact become faint of heart and inattentive.

  Complacent administrative officials and legislators defended the relaxing of regulation on the ground that American bankers would have taken their money out of the country and built their securitized mortgage empires elsewhere. Competition, the elixir of capitalism, worked inexorably to promote risk taking. When more cautious bankers saw their rivals riding high, they wanted to do the same thing. Raining on a parade has never won popularity. Shorn of oversight, the banks’ trade in credit default swaps ballooned from $900 billion in 2001 to $62 trillion in 2007.8 Hedge funds grew in one decade from $375,000 to $2 trillion in 2008, plunging losses into the trillion-dollar column. The figures are hard to grasp, but not the dimension of the problem. Nor should consumers be let off the hook, if blame is to be assigned, for many Americans demanded easy credit and cheap mortgages.

  As befits a litigious people, homeowners began sueing their banks, mortgage lenders, Wall Street banks, little banks, big banks, and those same banks’ loan specialists. Even municipal governments got sucked into buying high-yielding shares of securities backed by mortgages, subprime and prime. Some as far away as Australia took investment banks to court for hiding the risks of the securities that they were selling. Such a respectable firm as General Electric, expanding into financial services, got hit with a suit from an insurance company for following fraudulent standards. Recent Supreme Court rulings have favored Wall Street, but that won’t stop the march of people into lawyers’ offices to se
ek retribution, if not full compensation.9

  Housing prices did not need to decline very much before many homeowners owed more on their mortgages than their houses were worth. By 2009 more than one-quarter of all homes with mortgages—about thirteen million properties—were “underwater” foreclosures averaged five thousand a day! Investors lost upward of four hundred billion dollars. Mindful that the Japanese government had not acted swiftly enough to stem the losses in its 1990 depression, the U.S. government struggled to get a handle on the recovery process and to speed the return of confidence. The Federal Reserve Bank and the Treasury Department at first offered seven hundred billion dollars for “troubled assets.” “Bailout,” with its strong suggestion of a sinking boat, lost favor as a term. Soon people were talking about stimulus, followed by promises of recovery. The new administration of President Barack Obama put in place the largest public works program since the Great Depression. All official efforts aimed at convincing ordinary market participants that the worst was over, or, as Franklin Roosevelt’s 1932 campaign song had it, “Happy Days Are Here Again.”

  Meanwhile the long-brewing decline of the American automobile industry led to calls for infusions of taxpayers’ funds. General Motors and Chrysler had run out of money, and Ford was barely limping along. The carmakers’ intractable problems challenge one of economists’ strongest convictions: that we can rely on the rationality of market participants. Enlightened self-interest should have whispered into the ears of Detroit leaders back in the 1970s that something was amiss when Hondas, Nissans, and Toyotas made their American debuts. Of course most people in Michigan “buy American,” so they didn’t see those natty new cars on the freeways of California and New York. Being large enough to control a whole region, the automakers’ CEOs could indulge themselves in pipe dreams, responding to short-run tastes for gas-guzzling SUVs while exporting their innovative designs to showrooms abroad. In 1989 Michael Moore’s popular film Roger and Me, mocked the studied myopia of GM’s CEO Roger Smith after the layoff of fifty thousand auto workers in Moore’s hometown of Flint. And there must have been regular reports on their dwindling market share. Such willful ignorance can’t last forever. When all the sick chickens finally came home to roost in 2009, when both General Motors and Chrysler went into bankruptcy.

  Among the woes of the heads of General Motors, Ford, and Chrysler, which employ 75 percent of the nation’s some three hundred thousand auto workers, are their escalating payroll costs. When they went to testify before Congress in 2008, the head of the United Auto Workers of America went with them. This troubling entanglement of caring for present and retired workers is ironic because their predecessors had opposed national legislation for health insurance. Proposed in the 1940s, a bill would have funded the universal care through the Social Security Administration. Fearing that such a provision would undermine workers’ loyalty, Detroit’s leaders worked against the measure, pushing unions to fight successfully for their members’ benefits at the bargaining table.10 The fact that workers in American plants making Hondas and Toyotas didn’t earn the equally high wages and benefits of Detroit’s workers rankled with members of Congress and their constituencies. In an earlier time, the public might have wondered why those other workers weren’t doing better. Three decades of slow wage growth and the success of low-wage employers like Walmart had effected a marvelous change in perceptions.

  To counter these attitudes, labor leaders have awakened to the need to rebuild the solidarity that once existed between the public and organized labor. With the goal of representing a third of the American work force, as it did in its heyday in 1950, the AFL-CIO began a campaign explaining how a strong labor movement energizes democracy and keeps alive a moral commitment to living wages and decent working conditions worldwide. The facts on the ground back it up: Between 1978 and 2008 CEO salaries went from levels 35 times those of an average worker to 275 times. Nor have corporate heads been generous to their workers, as Henry Ford once was. Although the rate of American productivity has risen since 2003, wages have not, and benefits have declined in value.

  Organized labor backs the Employee Free Choice Act, which Republicans blocked with a filibuster in the Senate in 2007. EFCA would protect workers’ right to organize their plant once a majority of them had signed cards expressing their intent to form a union. Statistics indicate that one-quarter of all employers have illegally fired at least one person for union organizing, so unions consider EFCA essential to organizing new plants. Reports of flat wages coupled with escalating incomes in the top tenth of the top 1 percent of American earners have brought much of the public back to the union side. The disgrace into which laissez-faire economic theory fell during the fancy-free years that opened the twenty-first century bodes well for organized labor too, but it will have to contend with the countervailing force of shuttered shops and the monolithic opposition of American business.11

  Missing warning signs of disaster apparently is a human trait found in capitalist and noncapitalist countries alike. In his study Collapse, Jared Diamond showed that failed societies invariably clung to their value systems long after they were dysfunctional.12 The insistence that the market has its own self-correcting mechanism may be a fresh example of an old human failing. It certainly sounds now like whistling through the graveyard. Does each generation have to learn its own lessons? It would seem so. The post-World War II fiscal arrangements ushered in a quarter century of widespread prosperity in the capitalist homelands. Maybe it can be done again. The French president and the prime minister of Great Britain have called for a Bretton Woods agreement for the twenty-first century to rebuild the financial foundations of the world economy. For them evidently the accords hammered out in New Hampshire in 1944 represent a symbol of a shared appreciation of the clout of cooperation.

  Although the center of the subprime mortgage debacle was in the United States, the meltdown of credit credibility spilled over the entire globe. The trouble brewing in lower Manhattan quickly reached cities and towns across the nation, not to mention foreign investors who took a ride with America’s financial Evel Knievels. Even America’s cockiest center of enterprise, Silicon Valley, felt the cascading effect of the credit crunch as orders dropped off, no small matter considering that computer and software sales account for half the capital spending of businesses in the United States. Normally awash in venture capital, the technology sector saw that dry up some as well.

  When people who had borrowed against the rising value of their houses in the frenetic days of the real estate boom stopped spending, it hurt big and little exporters who counted on the dependable American consumer. Latin American leaders, often critical of the Goliath to the north, engaged in a bit of schadenfreude until they saw the looming danger in their own countries from collapse of the housing market in the United States. Like a booby trap with a trip wire that catches a walker unawares, this financial blowout caught everyone. Only India, saved by its conservative banking traditions, escaped relatively unscathed. The unexpected fragility of these securities—an oxymoronic term—that American banks were pushing worldwide left leaders of many emerging economies angry at the perpetrators of the debacle.

  Globalization got another notch in its belt with the first worldwide Ponzi scheme, one that came a cropper at the end of 2008. Named after Charles Ponzi, the notorious swindler of the Roaring Twenties, such flimflams rely on enticing ever more people to invest in order to pay off those who have already bought into the fake firm. Buoyed by strong earnings, the shareholders then become informal salesmen of their remunerative investment. Bernard Madoff, a respected Wall Street financier, acknowledged that he had bilked fifty billion dollars from his clients, selling shares in one of his firms across a large swath of the world, including the United States, Canada, Europe, Middle Eastern countries, and China, before he ran out of new prospects.13 So indifferent to its charge was the Securities and Exchange Commission that despite an insistent expert who told it repeatedly that the emperor Madoff had no clot
hes, it refused to investigate.

  The dominance of the financial services industry in the last fifteen years is a classic case of the tail wagging the dog. Financial institutions developed initially to facilitate enterprise, but at the end of the twentieth century they became venture capitalists themselves. Stock markets, begun more than two hundred years ago, have acted as mediators between the public and publicly traded companies. Once the preserve of the wealthy, the stock market now serves thousands of institutions and millions of small investors. Banks too funneled funds into the production of goods and services. Power accrued to them. In the twenty-first century, financiers increasingly intruded into the affairs of the companies whose stock they traded and whose loans they negotiated. This shift of authority from company managers to debt holders had a profound impact on corporate decisions because of an emphasis on immediate gains. Shareholders have benefited from this—at least in the short run—while many values associated with strong firms have cratered.

  If the goals of financial capitalism differ too much from those of enterprise generally, then the public suffers, as became apparent in 2008. When President Dwight Eisenhower chose General Motors CEO Charlie Wilson to be secretary of defense in 1953, Wilson made headlines by saying he thought: “What’s good for the country is good for General Motors, and vice versa.” Wilson got pilloried for that remark, made at his confirmation hearings, but there was sense in what he said. Then America’s automakers were paying auto workers good wages and making consumers happy with their cars. The enormous profits to be made from the dexterous leveraging of paper transactions like mortgages pushed all the incentives into the short run, as have the complicated and generous CEO salaries of the early years of the twenty-first century. With hindsight, perhaps firms will put executive bonuses in escrow accounts to be paid after a spell of good years instead of a couple of flashy seasons.