Arnold Kling  

A Useful Narrative of the Crisis

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Matt Taibbi writes,

What had brought us to the brink of collapse in the first place was this relentless instinct for building ever-larger megacompanies, passing deregulatory measures to gradually feed all the little fish in the sea to an ever-shrinking pool of Bigger Fish. To fix this problem, the government should have slowly liquidated these monster, too-big-to-fail firms and broken them down to smaller, more manageable companies. Instead, federal regulators closed ranks and used an almost completely secret bailout process to double down on the same faulty, merger-happy thinking that got us here in the first place, creating a constellation of megafirms under government control that are even bigger, more unwieldy and more crammed to the gills with systemic risk.

In essence, Paulson and his cronies turned the federal government into one gigantic, half-opaque holding company, one whose balance sheet includes the world's most appallingly large and risky hedge fund, a controlling stake in a dying insurance giant, huge investments in a group of teetering megabanks, and shares here and there in various auto-finance companies, student loans, and other failing businesses. Like AIG, this new federal holding company is a firm that has no mechanism for auditing itself and is run by leaders who have very little grasp of the daily operations of its disparate subsidiary operations.

It is long. Because it is Rolling Stone, it has many four-letter words. But it is worth reading. I could have included many excerpts. It is one of many interesting links that can be found in the latest column by David Warsh.

My one disagreement with Taibbi would be in his emphasis on the elimination of Glass Steagall. I think that if you re-ran history with Glass-Steagall intact, you would have perhaps a slightly different cast of institutional characters (Citigroup would not have existed in its current form) but almost exactly the same outcome.

I think that Taibbi's basic "power play" narrative is correct. His view that the government money going to AIG is more of a bailout of Goldman Sachs than of AIG strikes me as on target. However, his implication that it is a one-way takeover of Washington by Wall Street is incorrect, in my view. I think that all along we have had a Washington/Wall Street industrial complex, particularly with regard to housing finance.

For quite a while, but especially over the last nine months, the best way to predict developments in politics and finance has been to ask: what will do the most to increase the concentration of power? Every headline, from the Geithner regulatory plan to the proposed cap on the charitable deduction, to the resignation of the General Motors CEO, should be viewed in that light.

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COMMENTS (13 to date)
The Snob writes:

There's two things about Taibbi's piece that turned me sharply off, perhaps wrongly:

1. The villains weren't just greedy and foolish, they also had to be obese, sweaty, bald, and sausage-fingered. While there were some facts, it was hard to hear them over all the axe-grinding, which leads one to wonder which of the two is really the point.

2. In the first dozen or so paragraphs, we were treated to almost nothing but quotes from unnamed sources who we are told are Government Officials and Industry Sources. There's only one good reason for a source to be unnamed, and a whole lot of bad ones.

I'd forgive all this if he managed to shift the narrative more in your direction. But the message I got from it was that our problems will be solved once we get rid of these nancy-boy regulators and put some proper commissars with real power in charge.

Lance writes:

I think Taibi's treatment of CDSs is a problem in the article. He essentially alleges that they were created by drunken execs after a round or two of golf seeking to increase JP Morgan's profit margins. This is absolutely false.

CDSs had their origin in interest-rate swaps which have been around for over 25 years.

The AEI had a good article on them:

You can easily say it was a problem with rating agencies and their risk models, but then that's an argument on a different playing field without the dialectical materialistic arguments about a system that enslaves the middle class to the Wall Street casino.

As for Fed secrecy, I think this is a red herring. The reason repo agreements were no longer used widely is because companies no longer could roll over their asset positions (which is required with repo purchases). It's not some secret conspiracy to hide what the Fed is doing.

Gary Rogers writes:

If you buy this argument, it seems like you would have to agree with the strong anti-trust arguments of the past. I am not ready to do this. Big is not necessarily better or worse, but a "too big to fail" policy does keep the marketplace from eliminating failed policies.

bjk writes:

The problem with the power grab argument is that presumably at some point these stakes will be sold or the banks will hand back the cash, and we'll return to the status quo. Or arguably, if there was a power grab, it occurred years ago. If this crisis inaugurates a new policy in which there is a Fannie like guarantee for all the big banks, that's bad. But that isn't inevitable, and it's not obvious what's happened exactly. Best case scenario is that a consensus develops of "no more Fannie, no more Citis, no more housing based economy."

Roy writes:

bjk - I'd love to think you were right but it sure looks to me like there is now a "Fannie like guarantee" for all the big banks. Constant descriptions of banks as being "too big to fail", etc etc etc.

A Wall Street-Washington complex sounds about right to me. And if the reaction is to install some "proper commissars" then it'll make the situation 100 times worse.

Chris Bolts Sr. writes:

"If you buy this argument, it seems like you would have to agree with the strong anti-trust arguments of the past. I am not ready to do this. Big is not necessarily better or worse, but a "too big to fail" policy does keep the marketplace from eliminating failed policies."

However, you cannot dismiss his central point: Washington will always favor the large, institutional businesses at the expense of the smaller businesses. I too am not ready to concede an anti-trust argument, but I would definitely be in more favor of deregulating the market to allow newer entrants with fresher and new ideas to compete with established businesses. My point is that regulation is almost always reactionary and almost always grandfathers the bad actors and large businesses in and lock out the small guy.

fundamentalist writes:

Regardless of the greed and scheming at AIG and the big banks, few people would care if the state refused to bail them out. Without the bailouts, no one gets bonuses or even salaries. Those who created the mess go broke, just like Enron.

Bryan writes:

Taibbi provides a narrative of the story that occludes market distortions caused very substantially by Congress. The assets underlying the securities, and thus underlying also risks involved in the portfolios of credit default swaps, became overpriced for a reason, and that reason was primarily the failure of Congress to reign in its twin monsters Fannie and Freddie. Without Fannie and Freddie, and incidentally also without the Community Reinvestment Act and the enforcement thereof, much less bad mortagage debt would have been created, and above all the prices of the houses would not have been bid up as much. Yes, if you re-run history in a world where other unattractive men sitting on certain committees in Congress had not been idealistic and/or corrupt as regards reigning in Freddie and Fannie, we would not be here. But Taibbi prefers to rehash caricatural Hollywoodesque =corporate= villains: greedy greasy sweaty white men running mad finding ways around regulation and morality. Other unnattractive, openly corrupt villains of the story, such as Chris Dodd and Barney Frank(protectors of Fannie and Freddie and misbehaving banks who were on those banks payrolls), get a pass for their obvious and preponderant role in distorting the market itself.

Marker writes:

It isn't deregulation that causes market concentration and the elimination of small businesses. Quite the opposite. It is the growing list of regulations that have weeded out smaller companies and let the big companies get larger and more dominant.

Troy Camplin writes:

People often identify deregulation with the creation of megacorporations (and monopoloies), but in fact it is regulations which cause their creation. Regulations create environments of favoritism. If there is a too-large corporation, you may rest assured that the government was involved in making it that large. The same is true of monopolies. They do not arise naturally in free market conditions, but are created by governments, either directly or indirectly. I have also noticed that too often what is being called "deregulation" is nothing of the sort, but is in fact merely a different regulatory regime. I challenge anyone here to show me something that was truly deregulated rather than placed under different kinds of regulations.

El Presidente writes:

The simple solution, as was pointed out, is to balance the size and scope of the regulated firms and the regulating authority so that neither grows bigger or more powerful than is good and proper for the healthy functioning of markets and the general welfare of the people those markets affect. This is why it baffles me to hear people rail against FDR's sentiment (here and elsewhere) that a good way to empower more individuals was to reign in malevolent private sector actors. It is only when their baser instincts are effectively held in check that regulatory governance can safely be scaled down. I thought we would have learned that by now.

The challenge, of course, is to reign in the regulator as well. This can best be done with transperency and accountability which both require an active participatory electorate that is educated about the matters placed before them. Sometimes people cast an ill-advised vote though for want of better information or simply out of shortsightedness. For instance, tax reform in California shifted the MRTS in favor of land (as opposed to labor or capital) in a manner which only encourages less efficient use of it and attendant fiscal stress (more taxes, less value). That was all done by provoking voters who didn't really understand what they were voting for and probably didn't care enough to figure it out. They could have had better service with lower taxes, but they chose a policy that would enrich land owners and reduce both public and private sector efficiency. So, with complicated matters like regulating financial markets, there is a great need for educating the public. Who is advocating _that_ and how can we support them?

Steve writes:

"Taibbi provides a narrative of the story that occludes market distortions caused very substantially by Congress."

It might be worthwhile to read what he wrote, because he explicitly attacks the nexus of Wall Street and government.

sam dixon writes:

Tabbi's rant is entertainment pure and simple. There's some good observations (e.g. Wall St. behavior similar to that of crack heads.) The best visual rendition I've seen is a youtube vid created by a Wall St broker:
I don't agree with his statement that we are all 'still in denial' particularly if you notice what happened to your 401k. Where I feel the real 'denial' is the American conscience dependence on mainstream media and so called reality.

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