Debt and Credit:The Opiate of the Masses

The following is an excellent excerpt from the book “MAKERS AND TAKERS: The Rise of Finance and The Fall of American Business” by Rana Foroohar from Chapter 1: “The Rise of Finance” on page 55 and I quote: “Debt and Credit: The Opiate of the Masses – Surging assets prices in the 1980s and ’90s were the root of a debt-fueled consumption boom that turned Americans into the “buyer of last resort” for the global economy.  At the start of the 1980s, personal savings as  a percentage of GDP was about 12 percent; by 1999 it had free-fallen to near 2 percent, as people took on second mortgages, home equity loans, more credit card debt, and other kinds of personal credit lines to fuel consumption.  The growth in asset values, though based more on financial wizardry than real economy metrics, enabled another major change in the financial markets: the shift from a fixed corporate pension system to a market-driven 401(k) system.  Such a system was, of course, relatively easy to sell in an era when all market boats were rising.    In the 1950s, when retirement money was property, savings, or company-run pensions rather than private 401(k)s, fewer than one in ten households directly owned shares in corporations.  Back then, investing was for stockbrokers and financial wizards, not the common man.  But by 1983 one in eight families held stock, and by 2001 it was half.  Today, 44 percent of Americans are in the market via a 401(k) or 403(b) plan, while only 18 percent have fixed pensions, a shift that has actually made retirement less secure (see chapter 8).  The result, according to sociologist Gerald Davis, who wrote extensively about this shift in his 2009 book, Managed by the Markets, was that “the bonds between employees and firms have loosened, while the economic security of individuals is increasingly tied to the overall health of the stock market.”  Suddenly we all had a stake in the money game.  With these changes, individuals have come to rely not on companies or government for their well-being, but on the markets–a dangerous proposition, given that stock gains benefit mostly the top tenth of the population, which holds most of these assets.

Instead of worrying about labor’s ever-decreasing share of the pie, which began shrinking in the late 1970s (thanks to the same toxic combination of globalization, technology-related job destruction, and financialization), households hoped for market hikes.  Over time, they came to rely on the value of their stock portfolios and their homes–which had themselves become financial assets–rather than on salary raises.  Personal debt and business debt have grown at two and a half times the rate of Americans’ total income over the past forty years.  We are only now beginning to grapple with the full ramifications of these shifts, as stagnant wages become a major dampener on economic recovery.

The political and cultural environment has reflected the market’s rise in prestige.  Bill Clinton’s lead strategist, James Carville, joked in 1993 about wanting to be reincarnated as the bond market, a nod to Alan Greenspan’s market-friendly policies.  Later, George W. Bush tried to institutionalize the transition to an “ownership society” by trying to privatize Social Security (thankfully, that plan was unsuccessful) and increase home ownership by lowering lending standards, which was of course one of the factors that precipitated the housing market collapse in 2007.  And throughout the entire period, public obsession with the markets grew.  The financial media burgeoned.  Traders became stars, shareholder value became the guiding force for corporate America, and, as Gordon Gekko put it so famously in the 1987 movie Wall Street, greed was good.  Our economic orbit has been realigned.

Too Big To Fail – It was a revolution that benefited financiers the most.  Even though [Walter] Wriston’s blunders in the emerging markets haunted Citi balance sheets for years, requiring the sort of government interventions that Wriston deplored for other industries, he retired on a high note in 1984.  His successor, John Reed, continued many of the same risky lending practices, giving easy money to leveraged buyout kings, real estate developers, and cash-hungry governments around the world.

He also championed a new wave of high-tech finance, which relied more heavily on complex algorithms that promised to predict future trends from shallow historical data–an assumption that would come back to bite Citi during the crash of 1987 and the bursting of the dot-com bubble in 2000 and the housing bubble in 2007.  Many underlying problems in the bank’s business model were papered over by rising asset prices in the 1980s and ’90s, relatively low interest rates, and ample profits from corporate mergers and acquisitions.  (Bankers cashed in on both ends of these deals, of course, by putting them together and then breaking them back apart, despite the fact that only about half of them ever succeeded, even when judged solely by share price.)

But inevitably, it all blew up again.  By the late 1990s, the world was in the midst of yet another emerging-market crisis, this time brought on by the further deregulation of global capital flows orchestrated by the Clinton administration.  (Treasury secretary Rubin and his deputy and then successor, Lawrence Summers, were principal architects of these measures, and finance lobbied vigorously for them.)  Too much money had flowed into the markets too quickly, ending up in speculative projects that were now going bust.  Dominoes were falling in Asia, Brazil, Russia, and the West, eventually toppling an infamous hedge fund, Long-Term Capital Management (LTCM), which nearly tanked the US financial system.  Citigroup alone lost half its quarterly profit, year over year, as a result.  The Fed was once again left to pick up the pieces–though in that case, unlike with the bailouts of 2008, the banks themselves had to take responsibility for their losses.

All of this underscored just how complex the system and its most powerful institutions had become.  Amazingly, though, instead of widespread criticism for their choices, Greenspan, Rubin, and Summers got a love letter in the form of a 1999 Time cover story entitled “The Committee to Save the World.”  So fully were the media and the government enthralled with finance that nobody seemed to raise an eyebrow when Citibank’s Reid and Travelers Group’s Sandy Weill announced the creation of the world’s largest financial institution–Citigroup–in the midst of a crisis that showed just how risky such entities could be.  The two CEOs had followed the strategy of acting first and asking questions later and moved ahead with their deal even though it was unclear whether the Fed and regulators would approve it.  Yet the New York Times heralded the merger with a fawning editorial that could only have been written in the go-go nineties: “Congress dithers, so [Reed and Weill] grandly propose to modernize financial markets on their own.”

In their retroactive attempts to get the Fed to sign off on the merger, which dealt the final blow to the dividing wall between commercial and investment banking, Reed and Weill employed another time-tested strategy, telling government that banks needed more room to roam precisely because of the problems in the market.  If banks kept hurting in the wake of LTCM’s collapse, Reed and Weill argued, the broader economy would, too.  Banking had to get bigger in order to thrive.  This line, coupled with vigorous personal lobbying, yielded the ultimate triumph for finance: in November 1999, Clinton abolished Glass-Steagall, eliminating the last vestiges of Depression-era regulation.  A month earlier, Rubin (fresh off his Treasury job) became cochairman of Citigroup, a move that would net him $15 million and 1.5 million shares of stock in his first year.

Brightness Falls – Weill made plenty of money, too, thanks in large part to the symbiosis between the high-tech boom and banking.  Until 2001, before the dot-com crash, Citi was one of the most aggressive players in the high-tech IPO market.  The bank made huge fees helping firms go public (and even bigger money trading shares in those companies via early and preferential access).  At the same time, it performed research for investors, advising them on the growth potential of various companies.  These “buy” and “sell” functions within banks are very different and were supposedly insulated from one another.  The people selling clients on IPOs weren’t supposed to be in cahoots with the people publishing research, the risk of course glowing reports to get their customers to buy whatever stocks the firm was selling.

But that’s exactly what happened.  In fact, it was one of the core triggers for scandals such as Enron and WorldCom: investors were told a completely false story by the companies’ own bankers–of which Citi was one.   Analysts created positive reports about the companies that traders were hawking, enticing clients to buy more stock, which pushed up stock prices, which made the firm more money, and so on and so forth in a whirl of cash and exuberance that never seemed to end.   One colorful misdeed involved a telecom analyst named Jack Grubman, who in 1999 worked for Salomon Smith Barney, then a division of Citi.  Grubman, who had previously propped up the WorldCom stock with positive reports, conveniently upgraded his negative rating on AT&T stock after Weill asked him to “take a fresh look” at the Company.  Grubman raised his rating and AT&T chose Citi as one of three underwriters on a huge sale of its wireless subsidiary’s shares five months later, netting the bank $45 million in fees.  And, in an only-in-New-York twist, Weill helped Grubman get his twins accepted into one of Manhattan’s most prestigious nursery schools.  Of course, it all ended in tears.  New York attorney general Eliot Spitzer took Grubman and Weill down.  Grubman was fined $15 million and barred from the industry for life, and Weill had to agree to never again speak with his own analysts one-on-one without a company lawyer present.  Citi and nine other banks signal new rules barring their analysts from participating in any effort by outside firms to solicit investment-banking business, especially during IPOs.  They also paid $1.4 billion in fines, which was supposed to be a way of making sure everyone stuck to it (which they didn’t).

Still, those were the halcyon days for Citi.  Very soon afterward, things really began to go south, thanks to Citi and other major banks’ role as key players in the overheating of the housing market between 2000 and 2007, and the biggest holders of toxic assets following the implosion.  Many of the spliced-and-diced securities were now held off banks’ balance sheets altogether, in quasi-shell entities known as structured investment vehicles, which Citibank had invented two decades earlier to circumvent capital requirement rules.  The upshot was that in the midst of the crisis, it was difficult for bankers themselves to know where the next tranche of exploding debt would come from.

We know how that story ends, of course.  I won’t recount the details of the 2008 financial crisis here, since many excellent books have already done so.  Suffice it to say that all the elements of financialization were in play in 2008: a skewed playing field that led policy makers to put the interest of bankers above that of taxpayers and to absolve the financial industry of most of the responsibility for the debt; extreme levels of leverage and complexity; and a false narrative about who was to blame.  The culprit certainly wasn’t the spendthrift homeowner, but you wouldn’t know that from the story Wall Street was telling.  The elites kept more than their money following the bailout; the also kept control of the narrative.  “I think that’s the heart of the problem,” says Senator Elizabeth Warren, the fiercest financial reform advocate of recent years.  “The economic elite decided they had their own theory of the case.  But it wasn’t the right story.  And without the right story about what went wrong, we won’t fix what needs to be fixed.”

That’s a big reason not much has changed in our financial system since the Great Recession.  In 2014, two years after Sandy Weill issued his mea culpa, the US Financial Industry Regulatory Authority fined ten major banks, including Citi, $43.5 million for breaking Spitzer’s rules and allowing their supposedly independent analysts to push positive research during a planned IPO of Toys ‘R’ Us.  Yet the fines were minuscule compared to the windfall the banks helped to make from fees and trading; flouting the rules was a risk clearly worth taking.  This calculus has held true in nearly all other areas of finance–witness the $139 billion in fines paid by the industry between 2012 and 2014, for everything from Libor interest rate rigging, to insider trading, to knowingly selling bad mortgages to unsuspecting clients.  Rather than deterring rule breaking, the occasional penalty was considered a mere cost of doing business.

Capital in the Twenty-First Century – The scariest part of it all is that finance has yet to be properly reregulated in the wake of the crisis.  While it’s true that some institutions have since offloaded risk, our system is most decidedly not safer.  In fact, the exercise in public theater that is the banking stress tests is actually counterproductive, since it makes people think that new rules have been introduced to protect them from the next meltdown–which might be the case, if only these rules could be enforced, and if they could encompass the complexity of the financial system, which tends to morph too quickly for regulators to keep up.  But in reality, the clean bill of health for the financial sector presented to the American public is false.  In fact, I’d argue that the complexity of the Dodd-Frank rules–itself a result of vigorous industry lobbying–makes it as easy as ever to continue to hide risk, as long as you have a smart team of traders and lawyers.

What we need are simpler banking rules that would re-moor finance in the real economy, and there are other countries that provide models for how this might be done (a topic I will return to later).  And it’s a task that must begin now.  Because, as the rest of this book will show, the triumph of financial capitalism is taking a toll on our businesses and our livelihoods that we can no longer afford.”

(ONE OF THE BIGGEST WEAPONS THE BIG, UNREGULATED INVESTMENT BANKS USE WERE THE OFF-BALANCE-SHEET VEHICLES TO DELIBERATELY CONFUSE THE RECORD KEEPING, WHICH COULD CAUSE RUNAWAY INFLATION OVERNIGHT, IF IT WAS DISCOVERED THAT THE BIG INVESTMENT BANKS DIDN’T HAVE ENOUGH CAPITAL RESERVE TO COVER THEIR BET.  ALSO THE FAILURE OF THE AUDITORS AND THE REGULATORS TO DO THEIR JOB, LEADING TO THE BANKRUPTCY OF LEHMAN BROTHERS, AS WELL AS THE ACCOUNTING FIRM OF ARTHUR ANDERSEN GOING OUT OF BUSINESS.

LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member

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About tim074

I'm a retired dairy farmer that was a member of the National Farmer's Organization (NFO). Before going farming, I spent 4 years in the United States Air Force where I saved up enough money to get my down payment to go farming. I also enjoy writing and reading biographies and I write about myself as well as articles and excerpts I find interesting. I'm specifically interested in finances, particularly in the banking industry because if it wasn't for help from my local Community Bank, I never could have started farming which I was successful at. So, I'm real interested in the Small Business Administration and I know they are the ones creating jobs. I have been a member of Common Cause and am now a member of Public Citizen as well as AARP. I have, in the past, written over 150 articles on the Obama Blog (my.barackobama.com) and I'd like to tie these two sites together. I'm also on Twitter, MySpace and Facebook and find these outlets terrifically interesting particularly what many of these people did concerning the uprising in the Arab world. I believe this is a smaller world than we think it is and my goal is to try to bring people together to live in peace because management needs labor like labor needs management. Up to now, that hasn't been so easy to find.
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