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Salvo 03.03.2021 8 minutes

Why Both Sides Hate Our Rigged Economy

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Populist anger at our insider-driven system will not be abated unless that system is overhauled.

Trump is gone and Bernie Sanders has a diminished profile. It would be a mistake, however, to count out their respective populist bases. The same grievances that prompted fervent support from the right and the left over the last two major election cycles continue to motivate millions of Americans. The Trumpers and the Sandersistas may differ on the nature of the solution, but each sees a similar problem: the country’s economic and financial system has failed much of the population and is rigged to the benefit of a government-business elite. Until these grievances are addressed, the forces that elevated Trump and pulled the Democratic Party to the left will remain formidable.

The problem is real and systemic. The economy and financial markets are indeed “rigged” in favor of an elite. When politicians, corporate executives, pundits, journalists, academics, and activists propose ways to make society more just or efficient or globally competitive, they invariably call for government-corporate cooperation. These arrangements, no matter how well-meaning, inevitably drift into a self-serving collusion among those charged to cooperate. These arrangements may even occasionally advance a greater good. But because this collusive system benefits mostly the colluders, it should be no wonder that the outsiders—left and right—resent it.

The country’s economic and financial history of the past few decades is replete with evidence of this rigging, though an especially stark illustration emerged from the 2008-09 economic and financial crisis. When the crisis hit, Washington made it clear that the problems facing the country were the result of greed and malfeasance at banks and other financial institutions. President Obama described financial behavior as “criminal” and insisted that someone should pay. He told financial executives that he was all that “stood between them and the pitchforks.” But then Washington dedicated trillions to rescue failing financial companies from the mess that everyone agreed those same companies had created. Pitchforks were kept out of the boardrooms. No major financial player faced criminal charges. Big-ticket out-of-court settlement penalties vanished into federal balance sheets.

The only financial institution to face prosecution was Abacus Federal Savings Bank in New York’s Chinatown. Manhattan District Attorney Cyrus Vance, Jr. charged this tiny bank with 184 counts of fraud and the falsification of business records. He had the bank’s principals led before the camaras, handcuffed and chained together, as though these clerks and bank managers were a physical threat to the police surrounding them. The authorities were not blaming the bank for the financial crisis, which would have strained credulity. And as it turned out, the bank was found not guilty. But whatever the reality for Abacus, it was bizarre that in a political climate of reform, the authorities, with literally thousands of lawyers and investigators at their disposal, could find nothing of interest to prosecute other than this tiny institution. 

But the focus on Abacus becomes clear in the larger picture of the crisis and the widespread collusions that caused it. In the run-up to the crisis, Washington enlisted the cooperation of the banking industry to promote home ownership among less affluent Americans, which required banks to lend money to people with sub-par credit ratings and thus a questionable ability to repay the loan—the so-called sub-prime borrowers. Because banks were reluctant to take these risks, Washington applied pressure. Under the 1992 Housing Community Development Act, the two federal agencies designated to support private mortgage lending, the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), announced they would extend support only to lenders who made many subprime loans. By the aughts, those two agencies limited that support to banks that reserved half their mortgage lending for subprime borrowers.

Because these demands put cooperating banks in an unusually risky situation, government regulators helped them spread their risk through questionable financial devices. “Credit default swaps” allowed insurers to sell indemnification insurance to lenders against the risk that a borrower might default. The authorities also allowed these arrangements to stand outside normal insurance regulations and, consequently, outside usual security protocols. Washington also encouraged “securitization,” by which banks created bonds backed by a bundle of individual mortgages. The banks could then sell those bondson the open market and spread the sub-par risks to individuals, foundations, pension funds, and even foreign governments. Washington promoted this effort by also willfully ignoring the credit rating agencies that were giving undeservedly high safety ratings to these bonds, even though they included a large proportion of risky sub-prime debt.

Despite all the maneuvering, this house of cards began to collapse in 2007. Sub-prime borrowers began to fail on their mortgage obligations. In the face of widespread default, the firms that had so actively cooperated with Washington’s guidance faced insolvency, as did the buyers of that questionable debt. Washington sprang into action, to save, it claimed, the financial system, but, as it turned out, also to protect its corporate partners.

The fate of Bear Stearns is instructive. When, in 2008, this New York-based global investment bank first showed signs of having trouble, it was in compliance with all federal and international regulations. It was solvent. What it did face was a temporary shortage of liquidity. It was well within Washington’s power and experience to arrange an emergency loan to protect the firm and those parts of the financial system that depended on Bear’s ability to meet its obligations.That’s what Washington did later for several companies, putting more than $430 billion in tax money at risk through the Troubled Asset Relief Program (TARP).

But the government treated Bear Stearns differently. It surely was no coincidence that this broker-dealer had always been a disruptive and uncooperative agent in financial markets. In 1998, Bear Stearns refused to join a Federal Reserve effort to arrange loans for Long-Term Capital Management, whose top executives, not coincidentally, had exceptionally good Wall Street, Washington, and academic connections. So instead of smoothing over Bear Stearns’ troubled moment, Washington forced the company to sell itself at a bargain price to J.P. Morgan, a firm with deep Washington ties.

It was only after the forced sale of Bear Stearns that Congress passed TARP legislation and released money to assist Citibank, Chase, and other banks with less obstreperous reputations and who could also boast of their cooperation with Washington’s earlier subprime push. Because TARP funds could only go to banks, and because Goldman Sachs—known to wags “as Government Sachs” for its close insider ties—at the time lacked a commercial banking license, the authorities rushed a license through for it. But they made no such effort for Lehman Brothers, a firm that, despite its long pedigree, was well outside the collusive establishment; Lehman went bankrupt. Then the government, in a novel move, effectively nationalized insurance giant AIG. This firm, too, had a less-than-cooperative reputation, but it was the counterparty to Goldman Sachs on credit default swaps. Once the federal government took over, it forced AIG to pay Goldman in excess of $4 billion. These particular default swaps were one of the few assets that paid in full during the 2008-2009 crisis, when virtually every other holder of mortgage-related securities or derivatives took a “haircut” on what they were owed.

In the early nineties, when a similar crisis developed among savings and loan associations (S&Ls), the government behaved very differently. Because most of these institutions were too small to “qualify” for government-business collusion, the authorities had little need to protect some and not others. Washington treated all the S&Ls equally. To oversee orderly bankruptcies, the federal government established and funded the so-called Resolution Trust Cooperation (RTC). The RTC sold off the good assets of troubled S&Ls to meet their obligations to creditors and, for the sake of financial stability, took their questionable assets onto its own books for resolution over time. The government actually made a profit through the RTC. But in 2008 and 2009, favoritism trumped fairness, and the desire to pick winners led to a more chaotic and less consistent approach.

This is just one illustration of our rigged system. And all its practices remain in place. Trump, for all his bravado, failed to change it, if he ever intended to do so. On the left, there is a disintegrating scrap of hope that Biden will attack these structures but given that he’s been a creature of the system for 50 years, it seems unlikely he will pull it down. Populist anger about our chump economy will go unslaked, it seems. Without any real effort by the authorities to address the inequities of this rigged system, this angry, messy aspect of American politics will persist, and worsen, well into the future. Whether such a corrupt and financialized economy can last as long remains to be seen.                  

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