CHAPTER
7
The Rise of Ultra-Capitalism
Volatilities gave electronic speculation what it needed to feed on and flourish beyond the wildest expectations. The consequence is a massive, revolutionized, and largely unregulated financial sector armed with the latest high-tech weaponry and pursuing profits on any battlefield, straining the stock and bond markets, plucking loot from any debacle, shooting the economic wounded, and outgunning the “real economy” in its transactions by huge ratios. This leap in the importance of spectronic finance is hard to overestimate.
Kevin Phillips [1]
What did the world’s
presumed economic leader, the
A powerful financial oligarchy is nothing new.
What is new, however, is its
capacity to damage global economic momentum severely.
What is new is the sad picture of countries successfully improving the
lives of their people through economic freedom but then being set back by the
imperfections in global finance. Positive
economic momentum takes years to produce; reversal of this momentum can happen
in weeks, and result in social chaos and frequently violence.
In the early 1990s, the
world seemed to be moving toward a common ideology of economic freedom, powered
by the growth, productivity, and unifying capabilities of the Information Age
Revolution. Communism and socialism
had failed to produce a superior social contract, but in contrast, economic
freedom was improving lives wherever it was competently applied.
Democratic capitalism seemed prepared to eliminate material and cultural
scarcity; a world of peace and plenty seemed to be both an opportunity and an
obligation for society.
Southeast Asian nations¾
By the end of 1997, however, all four of these Asian economies were in
shambles. Currency was devalued as
much as 70%; wages were cut 40%; unemployment, prices, and interest rates were
all rising; government deficits were growing bigger; virtually no new money was
available for business; even lines of credit for operating successful businesses
were cut.
Quickly, the uplifting sense of common purpose was replaced by confusion
and dangerous social tensions. Government
leaders who had been proud of their nations’ successes were now disparaged at
home and abroad. Those leaders who
had espoused the common ideology of free markets now became angry critics of the
immorality of currency speculators and the economic imperialism of the West.
When economic freedom is the norm, an economy can run itself, with little
required of governments except civic order, a stable medium of exchange, and
capital prepared to invest in long-term growth.
Instead, the world’s economy had been damaged by ultra-capitalism,
accompanied by great instabilities in the medium of exchange, and impatient
capital demanding quick returns.
The world’s economic leader, the
To free the world economy to grow and improve all lives, governments, led
by the
·
Control speculation through
taxation and by limiting the amount that can be borrowed.
·
Allow market
disciplines to monitor the process by stopping subsidies, large-risk insurance,
and bailouts.
·
Regulate world banking to
limit damage from “hot” or short-term money rushing in and out of the countries.
·
Develop a new
currency-stabilizing mechanism by harmonizing economic fundamentals in selected
countries.
The
The inherent contradiction in capitalism, according to Marx, is pressure
on profit margins relieved by downward pressure on wages.
According to his theory, in an economic downturn, both pressures are
magnified until the system implodes in a proletarian revolution.
Marx was partly right, but the greater cause of the boom/bust cycle is
government’s unwillingness to control speculation with borrowed money.
Contrary to Marx, the inherent contradiction is not in the economic theory of
capitalism but in government’s failure to manage currency and credit to
benefit the
general welfare. The fault lies with politicians, their errors of judgment, and
their willing response to the lobbying from ultra-capitalists for too easy
credit.
Until the Industrial Revolution in the eighteenth century, society
remained feudal, with static classes and limited freedom.
Capital for commerce was provided by a few wealthy people; labor was
manual, provided mainly by slaves and serfs. With the new technology of the
Industrial Revolution, productivity increased by several thousand times,
although capital held by only a few was still dominant. Adam Smith, and later J.
S. Mill, described how to maximize surplus through involved workers’ sharing
in improved performance; most of industry, however, remained feudal, for return
on capital was adequate, even when workers were more wage-slaves than
participants. Because Mill’s theory of broad wealth distribution through
workers’ accumulation of ownership received little visibility, democratic
capitalism had to be developed by the trial
and error of entrepreneurs willing to experiment with capitalism by improving it
through democratic participation.
In the 20th century, visionary companies combined new technology with
involved workers motivated by performance bonuses and opportunities for
ownership participation. Democratic capitalism thus gained momentum until the
last quarter of the century when ultra-capitalism spread globally and became
dominant. Ultra-capitalism included
mercantilism that treated workers as a cost commodity, and finance capitalism
that speculated with borrowed money causing investment capital to be impatient
and the medium of exchange very volatile. Wall
Street and institutional investors adopted ultra-capitalism and demanded
short-term profits. Many CEOs were seduced to ultra-capitalism by multi-million
dollar salaries and multiples of those millions from enormous stock options.
The Information Age Revolution paralleled the growth of ultra-capitalism
and demonstrated productivity many times greater from cognitive power than did
the Industrial Revolution from manual labor. Information Age industries,
further, demand as a competitive necessity the culture of democratic capitalism
in order to release the cognitive power of their people.
At the beginning of a new millennium, it is unclear whether society will
benefit from the extraordinary opportunities of the Information Age and
democratic capitalism, or whether the malign influences of ultra-capitalism will
destroy the world’s economic momentum. This choice to be made between these
competing forms of capitalism is every citizen’s responsibility: The choice is
for either a twenty-first century of peace and plenty through worldwide economic
common purpose or more folly and violence from a continued concentration of
wealth and power.
The
History of Economic Conflict: Cooperative
Commerce versus Making Money on Money
Throughout history, leaders from government, religion, and elsewhere in
the culture have recognized the threat to society from money that was not
neutral, stable, and patient. The threat to cooperative commerce by those with
the exclusive mission of making money on money goes back to the beginnings:
1000
B.C. and earlier:
Barter was used for commercial exchange but was usually limited to
two-party transactions.
1000-650
B.C.:
Various items were used as a medium of exchange, including cattle,
stones, and women; none was either divisible or easy to handle.
600
B.C.: First coinage was introduced
with various denominations, based on the perceived value of precious metals.
This was to be the basic system for next 2,500 years.
Old Testament:
“Unto a stranger thou mayest lend upon usury, but unto a brother thou
shalt not.”[5]
New
Testament: Jesus warned:
“No man can serve two masters; for either he will hate the one and love
the other, or else he will stand by the one and despise the other.
You cannot serve God and Mammon.”[6]
Rabbinic
Literature:
“The love of gold will not be free from sin, for he who pursues wealth
is led astray by it.”[7]
299-400:
Roman emperors paid for war by debasing currency.
Coin of the realm was recalled, melted, and reissued with lower
precious-metal content.
632:
In the Koran, Islamic law encouraged patient capital through equity investment
but prohibited impatient capital through interest-bearing loans.
789:
When Charlemagne became Holy Roman Emperor, he forbade making money on money in
his Admonitio Generalis.[8]
1200:
Anselm of
1213:
Cardinal Robert Courçon presented his Summa to the Council of Paris,
emphasizing labor as the basic value and condemning the making of money on money
as a corruption of the commercial process. “The
Council ordered each Christian, under pain of excommunication and censure, to
work either spiritually or physically and to earn his bread by the sweat of his
brow.” Courçon
concluded: “All usurers, all rebels, and all plunderers would
disappear, we would be able to give alms and provide for the churches and
everything would return to its original state.”[10]
1300:
Dante Alighieri in his allegorical poem, the Divine
Comedy, described people realizing their potential in a world of peace and
justice based on a commercial order. Under
Dante’s scrutiny of the evils
contaminating
the commercial process, he found a natural law at work and reserved some of the
greatest tortures in hell for the financial predators who transgressed this law.
Dante speaks to Virgil:
“Go back a little further,” I said, “to where
you spoke of usury as an offense
against God’s goodness. How
is that made clear?”
Recalling the Old Testament, Virgil replies:
“Near the beginning of Genesis,
you will see
that in the will of
to labor and to prosper. But
usurers,
by seeking their increase in other ways,
scorn Nature in herself and her followers.”[11]
1694:
King William III of
1695:
John Locke, physician, philosopher, statesman, humanist, and expert on
distribution of wealth and monetary matters returned to
This is evident, that
the multiplying of brokers hinders the Trade of any Country, by making the
Circuit, which the Money goes, larger, and in that Circuit more stops, so that
the Returns must necessarily be slower and scantier, to the prejudice of Trade:
Besides that, they Eat up too great a share of the Gains of Trade, by
that means Starving the Labourer, and impoverishing the Landholder.[13]
1776:
Adam Smith assimilated lessons learned over the centuries of the
development of capitalism. Smith
then anticipated the conflict between the job-growth economy that benefits the
many, and privileges for speculation that benefit the few. He warned of the
dangers from the “prodigals and projectors” who would make money high-cost
and volatile, and would deflect it from job growth.
1789:
Alexander Hamilton, George Washington’s Secretary of the Treasury,
successfully lobbied for payment of war debts at par, and assumption of
$21,500,000 of state debts. An
incidental effect was profits derived from speculation by those who had
anticipated this law and bought up revolutionary soldiers’ scrip for 20 cents
on the dollar. This was the first
use of “insider information” in the new republic.
1790:
Thomas Jefferson,
1792-1845:
1805:
President Jefferson opposed the National Bank and favored State banks as
a means of diffusing the power of financial capitalism.
He exhorted his Secretary of the Treasury, Albert Gallatin:
“It is the greatest duty we owe to the safety of our Constitution to
bring this powerful enemy to a perfect subordination.”[16]
1806:
Capitalists successfully lobbied for a growing body of law, resisting
shorter work days and supporting imprisonment for union activity.[17]
The courts outlawed strikes in
1812:
President James Madison failed in his effort to control finance
capitalism because he was forced to negotiate privileges for the bankers in
exchange for their funding the War of 1812 when the country was nearly bankrupt.
Subsequently, the postwar boom escalated into speculation, much of it on
borrowed money. The Panic of 1818-19, the first speculative cycle in the
1814:
John Taylor, a
1830s:
Andrew Jackson tried hard to democratize capitalism, but he lacked the
tools of economic understanding.
In
1860s-70s:
After the Civil War, dominant finance capitalists persuaded Presidents
Andrew Johnson and U.S. Grant to control currency in a deliberate devaluation to
restore the asset value of the wealthy to pre-war levels.
This technique, copied from the British, caused unemployment, dropping
wages, and rising prices in the economic disaster of 1873.
Later, Ludwig von Mises would blame economic calamities in
1888:
The Farmers’
1896:
The Populist Party was defeated. Their platform, including seeking
democratic capital, became obscured by William Jennings Bryan’s “Cross of
Gold” platform, a political argument between gold and silver interests. The
Populist Movement declined for lack of reform focus.
1873,
1884, 1893, 1907:
Widespread money panics occurred at the height of the crop season when
large amounts of money were needed to bring crops to market.
This seasonal need could not be met except by paying out limited
reserves, causing the whole money supply to contract.[22] When
the surge of demand hit New York banks, their choices were either to draw on
reserves at higher rates or form syndicates to pool resources and meet demand or
borrow gold from Europe to support more lending. Eventually they did none of
this, which resulted in local farmers’ banks not having liquidity to make
loans. This uncertainty caused
people to take their money out of the banks, and that in turn caused bank runs
and bank failures. At root, the
system did not have the flexibility to fund short-term working-capital needs of
the most basic industry, agriculture.
1913:
Financial panics spawned the Federal Reserve.
The Fed was founded to provide the liquidity needed to prevent a
repetition of the bank panics, and to prevent the damaging boom/bust cycles by
representing the public interest. Roger
Lowenstein described this responsibility as follows: “The Federal Reserve
System was created, in 1913, for many reasons, but the underlying one was that
people no longer trusted private bankers to shepherd the financial markets.”
From the beginning, however, Lowenstein added:
“The Fed is supposed to regulate banking but not to shelter banks.”[23]
1928-32:
President Herbert Hoover’s Republican predecessors had done little to
control the leveraged speculation that caused the Crash of 1929. After the
crash, Secretary of the Treasury Andrew Mellon followed the time-honored
ceremony of regaining “fiscal integrity” by hurting people.
Mellon behaved like an avenging angel, shrinking currency 30% in two
years and instituting retroactive tax increases as high as 63%.
These actions converted Wall Street’s overdue stock-market correction
into
The Crash of 1929 is an example of the government’s willingness to
encourage speculation with easy credit. In that crash, brokers’ loans, that
is, stock bought “on margin,” or borrowed money, went from $1.5 billion in
1923 to $6.0 billion in December 1928. Anyone
observing this pattern could have seen the train wreck coming.
New borrowings were collateralized by rising values; the sickness fed on
itself for years. Banks were borrowing from the government at 5% and then
lending at 12%. Corporations were
pumping surplus cash into the stock market rather than into either growth or
dividends. After the crash, the
margin calls demanding that the loans be repaid, fed the downward spiral. As the
values plummeted, the borrowers had to come up with more cash, which forced them
to sell more, which continued the downward spiral.
A few years later, John Maynard Keynes viewed the catastrophic economic
damage done by the stock market crash of 1929, and he put speculation and the
motivations of Wall Street into perspective:
Speculators may do no harm as bubbles on a steady stream of enterprise.
But the position is serious when enterprise becomes the bubble on a
whirlpool of speculation. When the
capital development of a country becomes a by-product of the activities of a
casino, the job is likely to be ill-done. The
measure of success attained by Wall Street, regarded as an institution of which
the proper social purpose is to direct new investment into the most profitable
channels in terms of future yield, cannot be claimed as one of the outstanding
triumphs of laissez-faire capitalism — which is not surprising, if I am right
in thinking that the best brains of Wall Street have been in fact directed
towards a different object.[24]
1930s: After the damage had
been done, the government established the Securities and Exchange Commission
(SEC) to prevent future calamities. Among other moves, the SEC raised margin
requirements to 50%. The speculators now were required to use their own money
for one-half of their bets. By the end of the century, however, the amount of
leverage allowed for speculation was close to 100% in unregulated hedge funds,
the borrowings were in trillions of dollars, and new laws added opportunities
for more leverage.
1932-44:
President Franklin Delano Roosevelt in 1936 bragged that he had
neutralized the privileged financial oligarchy during his first Administration;
he planned to complete his mastery of them in the second. He failed, however,
for the usual reason: The government needed the finance capitalists to fund
preparation for World War II.
FDR reluctantly instituted bank deposit insurance of $5,000 per account
to stop bank panics, but he warned that the practice was an abrogation of market
discipline that could cause economic catastrophes.
By the 1980s, deposit insurance had been raised to $100,000 per account
with no limit on how many bank locations where the speculators might borrow
another federally-insured $100,000. FDR
was right, the Savings-and-Loan catastrophe was the result, and the taxpayers
paid for the government’s mistake
and the speculators’ greed.
1963-1968
: Despite the bipolar tension between the
1971:
Republican President Richard Nixon caused instabilities in the international
monetary system that opened up the world’s electronic monetary casino.
Because of American economic weaknesses in 1971, foreigners were cashing
in dollars for gold so fast that the reserve was disappearing.
Nixon, forced to “close the gold window” and “float” the dollar,
allowed market forces to determine the dollar’s value relative to other
currencies. As a result, for the first time in commercial history, no mechanism
was in place to stabilize currency. According to Joel Kurtzman, “It created
enormous arbitrage possibilities and set the stage for the invention of a myriad
of new financial products.”[25] It
also uncoupled the “money” economy from the “real” economy and put them
badly out of balance:
The new neural network of money made its debut rather abruptly on
After Nixon abandoned the world’s currency-stabilizing mechanism, the
international economy was launched into new and uncharted financial waters. The
premise that market forces would discipline the system proved to be invalid
because market forces had been compromised by deposit insurance, bank subsidies,
and bailouts. Nixon, a Republican,
took action in other areas of the economy that contradicted free market
principles with unsuccessful efforts to control prices and wages. A less visible
effect of Nixon’s actions was the beginning of ultra-capitalism, a perversion
of capitalism in which impatient and volatile money changed industry’s goals
from long-term and patient to short-term and greedy. Ultra-capitalists began to
demand any action, including breaking up companies, that would produce
short-term gains. Kurtzman
explained:
Selling off portions of a company, borrowing money in the capital markets
and then paying it out to stockholders as dividends, even using profits not for
new investment but to purchase a company’s own shares of stock, all became
common practices used by companies to keep their stock prices high.
The era of long-term investing ended sometime in the 1970s.[27]
1974:
The Employees’ Retirement Insurance Security Act (ERISA) was signed into law
by President Gerald Ford to protect pensions.
A worker’s money would be available on retirement because it was
“funded,” that is, cash was taken out of companies, given to trustees to be
invested, later to be paid on retirement.
Before ERISA, companies
assumed that most of the pension money would be funded out of future earnings;
consequently, current cash was used to grow the business.
In effect, ERISA took no-cost growth capital out of companies and
invested it primarily in the stock market. Creative
financial engineering to direct this workers’ money to democratize capitalism,
however, was not done. For example,
basic pensions could have been insured with the pension money directly invested
in companies through a preferred stock paying a 6% annual dividend. A large
dividend, plus long-term appreciation, could have given the wage-earner a secure
double-digit return.
ERISAs enormous flow of cash, excessive liquidity, hit the stock market
at the same time that the benefits of the Information Age revolution were
becoming apparent. Arbitrage on the instabilities in the international monetary
market, new speculative instruments called “derivatives,” and new
unregulated institutions called “hedge funds” were being mixed into the
financial formula. In combination, they began to drive the bull market to record
levels. The world’s economy was becoming more and more dominated by
ultra-capitalism. Senior government officials in the Treasury Department and the
Fed became more involved in protecting finance capitalism rather than pursuing
the original mission of regulating it for the common good. Is this not the
ultimate contradiction in capitalism when the worker’s money is used by
ultra-capitalism to concentrate wealth for the few?
Ultra-capitalism Was Launched during the Last
Quarter of the Century and Came to Dominate both the
The
foregoing sketch of the tortuous path of capitalism and the many bumps in its
road brings us to the final quarter of the 20th century, a time when
many believed that economic freedom was ready to unite the world, but other
successors to the money changers of history were busy bringing ultra-capitalism
into dominance. This was certainly a turning point, for the 21st
century will see either the refinement of capitalism through democratic
principles or the collapse of capitalism through its concentrated excesses that
have already caused instabilities within capitalism itself and world violence.
Ultra-capitalism was
the result of the combination of excessive liquidity (from ERISA), excessive
volatility (from floating the dollar), and then the contradiction in
deregulating banking at the same time that market disciplines were suspended.
Each of the four contributing factors was supported by the lobby power of
Wall Street, though not in an integrated way. Ultra-capitalism was the
unintended consequence of the lack of an integrated policy that could actually
control currency and credit for the general welfare. The lobby power of Wall
Street sucked ultra-capitalism into this vacuum.
During
this time, the struggle between different forms of capitalism was not apparent
because most reformers regarded capitalism as a generic monolithic system;
democratic capitalism was hardly on the radar screen of economists and
interpreters of the culture. Ultra-capitalists
were concerned only with short-term earnings, and they treated workers as a cost
commodity, an expendable object fit for layoffs. Mergers and acquisitions were a
rewarding way for bankers, lawyers, and executives to make large amounts of
money. Benefiting from slippery
accounting rules, mergers themselves became a way to improve short-term
earnings. In this climate, Wall
Street measured CEOs in terms of their actions in large and quick downsizings.
Wall Street, most of the financial press, and even the Business Schools
celebrated ultra-capitalism, calling it the “American Model,” that form of
capitalism with exclusive interest in building stockholder value. The time frame
was always short-term, and the interests of other “stakeholders” were
ignored. In this environment, in fact, the word “stakeholders” itself became
a pejorative expression.
Information Age industries,
although interested in stock price and stock options, depended on the
involvement and contributions of their associates.
Many traditional companies also built on the loyalty of wage earners and
customers. Some of these companies downsized because of global competition, but
they did it through attrition, retraining, generous severance, and with a view
to maintaining the spirit of cooperation and trust. This part of global
capitalism was building momentum on the fundamentals of democratic capitalism:
corporate integrity, employee participation, profit-sharing, ownership, job
security, and associates who were independent thinkers, educated, and involved.
At the same time, the relationship between government and finance
capitalism in the
Back in the early 1970s, before the global economy was hooked up to
supercomputers and changed to the megabyte standard, the financial sector was
subordinate to Congress and the White House, and the total of financial trades
conducted by American firms or on American exchanges over an entire year was a
dollar amount less than the gross national product.
By the 1990s, however, through a twenty-four-hour-a-day cascade of
electronic hedging and speculating, the financial sector had swollen to an
annual volume of trading thirty or forty times greater than the dollar turnover
of the “real economy,” although the latter was where ordinary Americans
still earned their livelihoods.[28]
Deal-makers thrived in this environment.
Smart financial people figured out how to make money with OPM (Other
People’s Money). A company would
become targeted for takeover, and in many cases the company’s assets would be
leveraged to finance the takeover, that is, used as collateral for the borrowed
money. The institutional investors
supported ultra-capitalism without polling their constituency, for deals always
meant a quick win on their investment and a better position on their national
ranking.
Most of the deal-makers had an accountant’s love of cost-cutting. The
complexities of building for the long term were of less interest to deal-makers
who discovered that one-dimensional management was all that was required.
Shortly after a takeover, the word would go out to cut people, and
“downsize” became the familiar expression.
Downsizing is easy to do, and it always improves results in the
short-term, particularly when tax laws allow the downsizers to pull in expenses
from future years, thereby making increasing profits in following years almost a
certainty.
Kevin Phillips also described the history of economic self-contradiction
in which the financial part of capitalism became dominant.
He traced the history, since the sixteenth century, of
This national transformation was no accident.
Economic circumstances had begun souring for Americans in the 1970s, and
in the 1980s the
During similar financialization phases over the centuries in various
countries, taxes were shifted to the middle class, manufacturing declined,
financial services grew, and capital became more concentrated. The satisfaction
of building and selling things morphed into the excitement of making money on
money.
LDCs, the First Victims of Ultra-Capitalism
Throughout
the 1970s and 1980s, the economic failure of the less developed countries (LDCs)
demonstrated the need for an international monetary policy that is long-term,
integrated, and protected from the ad hoc
actions of politicians. This was the presumed mission of the Bank for
International Settlements (BIS), located in
The LDC failures
contained many lessons that, if learned, would have prevented future economic
damage. In the 1970s, South American
countries and
The effect on the world’s economy from rising American inflation caused
by the deficit funding of Johnson’s “Guns and Butter” programs, prompted
the world’s central bankers to gang up on Paul Volcker and insist on action in
the late 1970s as soon as he became chairman of the Fed. Volcker then conducted
a scorched-earth attack to reduce inflation, and in the process drove the cost
of money up to 20%. An unintended
consequence of this high interest rate was the bankrupting of several of the
LDCs because their interest rates “floated” up.
After the economic damage to the LDCs, the
The common denominators in the South American debacles were over-lending
of short-term money and excessive liquidity that encouraged investment in risky
projects or speculation. This short-term hot money then fled the troubled
country when the economy reversed. International banks had no protocols to
measure the total of short-term debt being accumulated by countries, including
the ability to relate this debt to the amount of patient capital invested.
This debt/equity ratio, vital in viewing the level of a company’s
financial risk, was ignored in whole countries. This miss is an important
example of freedom without the requisite discipline. The freedom was of free
capital roaming the world, promoted by the
Walter Wriston, head of Citibank at that time, stated the faulty
rationale for imprudent lending: “Countries
do not go bankrupt.” Despite Wriston’s misplaced optimism, countries did go
broke, and several large
At the same time, many big banks were also hyperventilating over bad real
estate loans they had made. Underlying these speculative, bad-banking actions,
the banks’ basic business, commercial loans, was also declining.
Competition from the finance arms of big corporations was taking this
business away. For example, General
Electric’s aggressive CEO, Jack Welch, had learned how easy it is to make huge
profits in
financial
services.[30] The
Most commercial bankers had not been trained for speculation.
If they had wanted a higher-risk career, they could have become
investment bankers. A well-run
conservative bank, such as Bankers Trust, which had been successful at lending
money for commerce, became a not-very-good currency trader, and ended up being
sued by Proctor & Gamble. The biggest bank, Citicorp, was near bankruptcy
several times from bad loans and speculation under the same leadership, but the
government bailed it out each time. The
combination of deregulation together with the abrogation of market disciplines
pushed the bankers toward ultra-capitalism, that is, towards an economy in which
the desire to make money on money goes up, while the sensitivity to the quality
of the loans goes down.
The government, through
the Federal Reserve, suspended the effects of competition and ignored the
mistakes of bankers by feeding the banks a spread between the cost to borrow at
3% or less, and the return on Treasury Bonds at 6% or more, a spread so large
that bankers only whispered about it. Some
called it “Greenspan spread.” This
weaning process brought banks back to health at the taxpayers’ expense and
further desensitized the bankers to the negative effects of imprudent loans.
This experience was early evidence that the government’s true mission was protecting finance capitalism, not regulating it. Little democratic debate over this shift of the
banking mission was heard, whether in the halls of Congress or elsewhere.
All of a sudden, it seemed, one’s friendly, conservative banker who
formally had carefully fed capital into the job-growth economy, had become an
enthusiastic high-stakes player in the world’s electronic monetary casino.
One
of the more bizarre episodes in the history of ultra-capitalism’s domination
of currency and credit was the silver round-up by rich Texans, Bunker and
Herbert Hunt. The Hunts tried to
corner the silver market, presumably as the ultimate hedge against inflation.
Silver had been selling for $6 an ounce in early 1979; by November, it
was up to $18.77; then it topped at $52.50 in January 1980.
This movement exposed the plan by the Hunts and some Saudi Arabian
associates to corner the market. The
Hunts had been accumulating silver since 1973, and they ended up “controlling
some two-thirds of all silver in the
The same inflation-fighting high interest rates of 1980 helped get the
Hunts in deep trouble. Silver prices plunged to $10.40 an ounce by the
end of March,
1980. The Hunt’s potential default threatened to topple their main broker,
Bache Halsey Stuart Shields, and possibly the giant bank, First National of
Chicago.
This presented Chairman Paul Volcker of the Federal Reserve with a
difficult choice. The speculators, and those who lent them money, should have
been punished quickly and severely by the discipline of free-market forces, but
lacking government control of leveraged speculation, the dollar amounts had
grown so huge that potential failure triggered a concern over the entire
financial system. The government came to the rescue when Volcker worked over the
weekend to help bail out the Hunts, “giving his blessing as godfather to a
thirteen-bank consortium for a new $1.1 billion, ten-year loan to enable the
Hunts to repay their short-term debt.”[32]
The Hunts were hurt
financially, but their $2 billion in losses did not affect their lifestyle.
Some in Congress criticized Volcker for having bailed out the Hunts.
This event further sensitized the banking system to the idea that if a
potential failure is big enough, then it carries a de
facto taxpayer guaranteed bailout. This
unstated policy was far from Adam Smith’s ideal of free banking in which
people who take stupid risks, and banks that make stupid loans, are punished
quickly, severely, locally, and visibly by the natural actions of the free
market. Steven Solomon summarized the Hunt escapade as follows:
It touched a raw nerve
in the bosom of democratic capitalism that politicians were only too glad to
deflect onto central bankers. It was
hard to explain to the democratic body politic why rescuing big financial
institutions, because of their unique ability to spread contagion, served the
public good while the government failed to intervene to save ordinary businesses
employing thousands. In the
Ronald
Reagan Freed That Which Should Be Controlled, and Controlled That Which Should
Be Free
The S&L scandal is a case study for all citizens to learn how the
government fails to control currency and credit for the general welfare but does
control deposit insurance for the benefit of the speculators. President Ronald
Reagan made speeches about how a democratic republic’s success depends on
diffusion of both economic and political power (see chapter 5, introduction),
but then his Administration moved in the opposite direction, concentrating
wealth and power. An early example of this misdirection was the deregulation of
the Savings and Loan industry. Reagan proudly described this deregulation in
1982 as the most important financial legislation in fifty years, not realizing
that he was initiating an economic catastrophe.
A member of the Congressional staff and an industry lobbyist added the
fine print to the law that escalated federal deposit insurance to $100,000, with
no limit on the number of locations at which speculators might borrow. President
Reagan was not in the habit of studying the details.
The Secretary of the Treasury, the former head of Merrill Lynch, was
pleased to anticipate a profitable shift of the peoples’ money from savings
accounts to certificates of deposit that would benefit Wall Street.
Republican President Reagan’s mistakes can be traced back to Democrat
President Johnson’s mistakes in the 1960s when his inflationary policies
resulted in interest rates that later rose to 20%.
These actions were the direct cause of the Savings and Loan debacle, for
the S&Ls were in the impossible position of borrowing high-cost, short-term
money to invest in low-return, long-term mortgages.
Congress tried to fix the problem with deregulation that caused worse
problems. Later, Congress tried to
rectify the damage caused by bad deregulation, going so far in the other
direction that financially sound banks were forced out of business.
Later, these banks successfully sued the government.
Each of these mistakes by politicians was paid for by the taxpayer.[34]
Reagan was determined to
“get the government off peoples’ backs.”
He was convinced that “the government was the problem, not the
solution.” He then proceeded, like
Presidents before and after him, with badly designed programs that failed in
their mission, gave deregulation a bad name, and further confused people about
the proper function of government. The
source of the confusion lay in applying the concept and practices of laissez-faire to the monetary function.
Laissez-faire could be applied
to free banking, but that is not a practical alternative.
The Founders had understood, and experience demonstrates, that control of
currency and credit is a prime government obligation that must be part of the
structure, not part of laissez-faire economic freedom.
While the Reagan Administration was misapplying the theory of laissez-faire to deregulate the banking industry, the government was at the same time protecting the banking industry. In 1984, the government actually bought the Continental Illinois Bank for $5.5 billion. Unable to get the other banks to bail Continental out, the government nationalized it, and within two years wrote off $1.2 billion in bad loans.[35] This event was the formal beginning of the “too big to fa