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Capital Offense: How Washington's Wise Men Turned America's Future Over to Wall Street 1st Edition
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Michael Hirsh and Jonathan Alter: One-on-OneJonathan Alter: Your book starts by tracing three decades of Washington history from the Reagan era on. Why is understanding that history so important?
Michael Hirsh: You can’t understand what happened on Wall Street without first understanding what happened in Washington. Things of this magnitude—the worst financial crash and economic downturn since the Great Depression—don’t just occur because of a subprime mortgage bubble and a bunch of crazy traders in New York. It is only comprehensible as story of an entire era, a zeitgeist that defined the post-Cold War period. That’s my story. It began as the Reagan Revolution of 1981, which launched a deregulation movement that unmoored much of the economy from government oversight and antitrust laws, creating the wild age of finance with which we've all grown up. The failure was huge, systemic and bipartisan. The Clinton administration was as much to blame as the second Bush administration. For nearly 25 years, the facts on the ground seemed to bear out the idea that markets may overreach and go up and down, but they are always smarter than governments. The deregulatory '80s were a boom time. The '90s were better. The end of the Cold War turbo-charged the whole process. Free-market absolutism went from being a mocked, maverick ideology—something identified in the '60s and '70s with Barry Goldwater and William F. Buckley—to a kind of national secular religion. It seized control of the national agenda and shifted the axis of the entire economic debate sharply rightward, turning ordinary Republicans into small-government zealots and liberal Democrats into "Eisenhower Republicans" (that's what Bill Clinton mockingly called himself.) It was only because of this environment – this all-conquering ideology-- that Wall Street and its lobby got away with as much as it did. Remember, the instruments that became notorious after the subprime collapse—collaterized debt obligations or CDOs—didn’t come out of nowhere either. They were allowed to flourish and develop, grow ever more complex, for two decades. Despite regular market blowups – LTCM! Enron! – the only change that occurred was even more deregulation. CDOs were only the latest, “improved” version of a model long in the making, the process of turning dubious or bad assets into better-seeming securities while the adults on the playground—the regulators and central bankers--weren’t watching.
Alter: Larry Summers is the president’s chief economic advisor, yet you argue that his performance both before and since the beginning of the Obama administration make him the wrong choice for the job. Why?
Hirsh: Summers is a fascinating figure in this narrative. He is unquestionably one of the greatest economists of his generation, and he did some of the most path-breaking work on the fallacy of rational markets. After the 1987 stock market crash, for example, Summers wrote that it was impossible to believe any longer that prices moved in rational response to fundamentals. He even advocated a tax on financial transactions. Yet Summers later abandoned these positions in favor of Greenspan’s view that markets will take care of themselves. How could such a powerful intellect continue to believe and advocate this view, despite the plentiful accumulating evidence that the “efficient market hypothesis” did not hold up (including his own work)? Mainly because the near-religious attachment to free-market absolutism had become such a ruling principle that no single senior official in Washington dared to contradict—especially if he was politically ambitious. Not surprisingly, as vested as he was in creating the old system, Summers has taken a minimalist approach to changing it in the current administration, and he argued, for example, for a smaller stimulus than others did.
Alter: Why are people like Summers and Geithner—creatures of the old system—in charge while those who were most prescient and accurate, like Born or Stiglitz or Raghu Rajan, standing on the outside of Washington and looking in?
Hirsh: Barack Obama was slow in understanding just how deep and systemic the problem was. That’s one reason why it took him so long to see that Paul Volcker, for example, might have been right in calling for banks to be banned from proprietary trading. “He didn’t run for president to fix derivatives,” said Michael Greenberger, Brooksley Born’s former deputy at the CFTC. “When he brought in Summers, Geithner and Gensler he just thought he was getting the best of the best. I don’t think he understood that within the Democratic Party there was a great split over regulatory philosophy.”
Alter: In your book women are generally the heroines and men are generally the villains. Moreover the women are generally punished for being heroines and the men are generally rewarded for being villains. How can that be?
There’s a lot to this idea, although some of the heroes of my story are also men, such as the economist Joseph Stiglitz and former Treasury Secretary Paul O’Neill. And occasionally a woman, like Wendy Gramm, must take some of the blame for the failed financial system. But it is true that women are often the gutsiest and most prescient figures in this saga. Women like Brooksley Born and Sheila Bair. Wall Street may be the most macho place on the planet. Brooksley Born, the former chairwoman of the Commodity Futures Trading Commission who warned of the dangers of over-the-counter derivatives a decade ago, was seen by her male colleagues in Washington as an interloper—or a “lightweight wacko,” as they called her at the Fed. The free-market fervor of this era was so dominant, and so admired were its male champions like Robert Rubin and Alan Greenspan, that it took a special kind of person to resist it. An individual of rare intellect, integrity and courage. Born was one of those unusual people. The thinking of the times was like a virus, and Born was one of those immune to it, to the idea that financial markets ought to be unregulated. And that had a lot to do with the sexism she had been battling her entire career. Fighting for derivatives regulation was, for her, just another way of breaking down the male monopoly.
Alter: You believe in capitalism and free markets, and yet you argue that many of your characters let the country down by failing to understand where rigorous supervision was necessary. Why didn’t they strike a better balance?
Hirsh: They let their faith in Wall Street betray them. During the free-market era, people forgot that financial markets behave differently than normal markets in goods and services. They are more prone to manias and panics; the ordinary rules of economics don’t apply. Financial markets simply have to be more regulated. In some ways no one is more culpable in this than Robert Rubin. Rubin was a good man. He always had a big heart and a gentle manner: He was a liberal Democrat who, as a young trader at Goldman Sachs, used to show up at New York community meetings on the inner-city poor. Later on he opposed Bill Clinton’s “workfare” reform -- a much-criticized compromise with the GOP -- as too harsh. But he could not bring himself to lay a restraining hand on his former colleagues from Wall Street. Brooksley Born later told me she blamed Rubin more than Greenspan in the end. Because he knew better that markets were imperfect, yet he had neither the vision nor the courage to act. It was Rubin who had inspired his adoring underlings to compile ten principles—which they later presented to him in a frame—they called “the Rubin Doctrine of International Finance,” the first of which was, “the only certainty in life is that nothing is ever certain,” and the second of which was: “Markets are good, but they are not the solution to all problems.” In one of his last acts as Treasury secretary, Rubin presided over a report of the President’s Working Group on Financial Markets that hesitantly proposed, as a “potential additional step,” the “direct regulation of derivatives dealers.” Rubin himself would later insist that he’d always wanted leverage to be reduced too. But Rubin never did anything about these worries. The “potential additional step” was never taken.
Alter: I’m very intrigued by your portrayal of Milton Friedman as the father of the era in many ways. How relevant are the personal histories of these major economic figures in changing the fate of the country?
Hirsh:Extremely relevant. Friedman was the proud son of immigrants who romanticized the struggle of his mother as a young girl in a Lower East Side sweatshop in the late 1890s, when New York was crowded with European Jews. Friedman described it as a great place for an immigrant “to get started” because there was “no red tape.” Friedman himself had started out wanting to be an insurance actuary. He was tiny, bespectacled and balding. He would have looked more at home in an anonymous office cubicle somewhere-- an obscure worker bee in the vast hive of American capitalism-- than on the world stage. But that was just the point of his personal story. It embodied the American Dream that was the mainspring of all his economic thinking. He was the Nobody from Nowhere who on pure merit, left unencumbered by government meddling, becomes Somebody. Alan Greenspan was a nerdy “math junkie,” as he described himself, who was “groping for a frame of reference” until he met the libertarian writer Ayn Rand, as she herself later recalled. He was, in other words, something of an empty vessel, and Rand gave Greenspan his passion for the morality of capitalism. Joe Stiglitz developed an opposite passion—a deep skepticism about markets—while growing up in one of the grittiest industrial cities in America, Gary, Indiana. Observing the poverty and cyclical layoffs in the steel industry as a small boy, he began to ask questions about why markets didn’t work well. It was no accident that Stiglitz became in some ways the John Maynard Keynes of his era (Keynes himself was shaped by his searing experience of the Depression). Like Keynes, who was ignored when he warned after World War I that the draconian peace imposed on Germany would lead to disaster, Stiglitz stood almost alone against the “Washington Consensus” lorded over by Rubin, Greenspan and Summers.
Alter: What does your book tell us about the economy of today? What do we need to do to recover?
Hirsh:We need to go a lot farther than President Obama has. The book explains how Obama missed a golden opportunity to remake Wall Street, the American economy, and the global economy. Obama was seen by many as the second coming of Franklin Delano Roosevelt. After the 2008 election, Time magazine actually Photo shopped Obama’s face onto FDR’s in the famous Depression-era shot of Roosevelt grinning in his car, his cigarette holder tilted jauntily upward. But instead of “the New New Deal,” as Time called it, Obama faithfully channeled Larry Summers and Tim Geithner and their conservative approach to stimulus and reform. The president distracted himself with less pressing issues like health care and nuclear disarmament. He even flew to Oslo to get Chicago picked for the Olympics (he failed). Early on Obama’s Summers and Geithner argued down Christina Romer, the new chairwoman of the Council of Economic Advisors, when her office suggested that the initial fiscal stimulus be as high as $1.2 trillion. They didn’t want to pile onto the deficit, or at least they didn’t want to face the political consequences of such an increase in government spending. With the recession still darkening the outlook, Summers and Geithner also didn’t want to tamper too much with what they still saw as the economy’s engine room, Wall Street. The president “explicitly decided not to break up all big financial institutions,” another top economic advisor, Austan Goolsbee, told me. Heeding the advice of Summers and Geithner, Obama decided that the cause of the crisis “wasn’t primarily about size.” As a result, little faith was restored in the system—an essential ingredient to full recovery. Not enough jobs were created. Now Obama’s economic team is disintegrating and he’s paying for his lack of dramatic action. More and more it looks like Obama will face grim growth and unemployment numbers going into 2012 -- much less the 2010 election. Distracting himself with health care and other issues, Obama may have politically maneuvered himself out of the only major remedy that could bring unemployment down and growth up enough to assure his reelection: another giant fiscal stimulus.
From Publishers Weekly
There's plenty of blame to spread around for the Great Recession: Wall Street, government regulators, mortgage lenders, and sub-prime borrowers have all, at various times, been held responsible. In Michael Hirsh's view, however, the real culprits are the free-marketeers – economic theorists such as Milton Friedman and Treasury chairmen Alan Greenspan and Ben Bernanke – who placed excessive faith in the self-correcting powers of unfettered markets and failed to anticipate the imminent crisis. Hirsh's understanding of the philosophical and political origins of the credit crunch is considerably broader and deeper than those of most reporters, who merely recount Wall Street's recent failures. Still, it's difficult to directly tie economists and politicians to the mortgage bubble. Milton Friedman's free market principles may have led Ronald Reagan to repeal Glass-Steagall provisions, fomenting the crisis, but regulation alone wasn't responsible for unscrupulous and irresponsible lending or exponential growth in the derivatives market. Still, Hirsh's perspective is valuable, and he acknowledges nuances frequently ignored by others, such as the gender of Washington's derivatives regulator, Brooksley Born, a rare woman among men and thus a "lightweight" to be ignored by swaggering Wall Street veterans like Robert Rubin and Lawrence Summers, who regarded her cautionary pleas for regulation as a failure of machismo. (Sept.)
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Top customer reviews
The other conclusion I drew, in addition to the tragedy of "free maket, deregulatory" argument in vogue since the Reagan administration, is the tragedy that we've never really given liberal or progressive economic ideas a real try. This was especially true of the Clinton and Obama years and certainly accelerated by each Republican adminstration before and between them. The fact that people like Joe Stiglitz, Paul Krugman, and Robert Reich have never been taken seriously by the top policy makers, that they can't get a fair hearing to have their ideas implemented, is perhaps the greatest lost opportunity. Hirsch makes a compelling argument that in order for government finance policy to work, we have to pay attention to all parts of the intellectual spectrum and neither shun nor unconditionally embrace one side or the other.
This is a good fact-filled, connect-the-dots, and relevant overview of why and how, we as a nation, have been badly represented in finance and economy. The situation, unfortunately for us all, continues. A good companion to Matt Taibbi's book. Hirsch gives you the rational facts and Taibbi adds the visceral outrage. And outrage there should be that the Obama administration is complicit in maintaining much of the status quo. Perhaps more than outrage.
Author Michael Hirsh, Newsweek's veteran economics correspondent, also probes the weaknesses stemming from the dominance of Friedman's work. Derivatives went unregulated, unsound subprime mortgage lending practices were permitted, and equity capital requirements were loosened to permit a torrent of leverage to prop up uncertain investments. The result, of course, was the 2007- 2008 financial collapse.
Hirsh's analysis depicts the economic theories that led to the collapse, and the economists and regulators who shaped and executed policy. Excellent portraits are provided of Milton Friedman, Alan Greenspan, Robert Rubin, Larry Summers, Ben Bernanke and Hank Paulson. Hirsh brings the story forward to 2009-10, by discussing the hold that Friedman's worldview continues to exert on the economics team assembled by Barack Obama. As a result, the Obama Administration has done little to
reshape Wall Street, largely because it has relied on economic policy appointees-- including Timothy Geithner and Clinton Treasury Secretary Larry Summers-- with roots in the Clinton Administration and with strong ties to Wall Street.
Hirsh does an excellent job in pointing out that a growing body of economic theory documents the proposition that markets are imperfect and that regulation is warranted. Columbia's Joseph Stiglitz is the key architect of this view, and Stiglitz and his work are discussed at length in Capital Offense. Hirsh also discusses the marginalization in Washington of other economists and regulators who take a pro-regulation stance, including Brooksley Born (hounded out of the Clinton administration for suggesting federal regulation of the derivatives market), Paul Krugman and, during the Obama years, former Federal Reserve Board Chairman Paul Volcker. Interestingly, Hirsh points out, Stiglitz has been lionized in the EU and Asia due to his prescience on market imperfections, even as he has been ignored by Obama's economics team.
All told, Capital Offense is definitely worth your time. You should know, however, where Capital Offense falls short:
--The workings of derivatives and securitizations are not laid out clearly. Derivatives are contracts that derive their value from the performance of other assets. Options, futures and credit default swaps are examples of derivatives. Securitizations are poolings into bonds of underlying financial instruments, such as mortgage loans, auto loans, or credit card loans; the principal and interest from the underlying loans are used to pay the buyers of the bonds. Derivative contracts can be used to insure buyers of securitizations against adverse market developments. Capital Offense fails to provide these definitions or distinguish between derivatives and securitizations.
--Capital Offense is not a good recounting of the 2007-8 meltdown, which is dealt with briefly and with less sophistication than in other accounts. (Roger Lowenstein's The End of Wall Street does a better job on this subject-- with the exception of Lowenstein's flawed treatment of Fannie Mae and Freddie Mac. Interestingly, Capital Offense gets the Fannie-Freddie story right. Where Lowenstein shines in covering Wall Street, Hirsh shines in covering Washington.)
At the same time, Capital Offense does a superb job of exploring the intellectual underpinnings of U.S. financial regulation from 1980 to present, and laying out the strengths and limitations of this worldview. Thank you to Michael Hirsh for a 4.5 star read that I happily round to 5 stars.