This article is from the January/February 2010 issue of Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org
This article is from the January/February 2010 issue of Dollars & Sense magazine.
at a 30% discount.
Pillaging Villains of the Financial CrisisA review of It Takes a Pillage: Behind the Bailouts, Bonuses and Back-room Deals from Washington to Wall Street by Nomi Prins (John Wiley & Sons, 2009).
It Takes a Pillage focuses on our current economic crisis—who to blame and how to prevent future crises. There are many people to blame.
Near the top of my list, and Prins’, is Hank Paulson, CEO of Goldman Sachs before being made Treasury Secretary by President Bush.
At Goldman and the Treasury, Paulson pushed for deregulating U.S. financial institutions. As late as the summer of 2008, he insisted that bailing out financial institutions was always a bad idea. And, oh yes, Paulson was the one who let Lehman go belly up.
Then he had a change of heart. He pressed Congress for money to bail out large financial institutions. He arranged the deal that let Bank of America buy Merrill Lynch. On the last day of the Bush administration, he gave $20 billion in TARP money to Bank of America. And Paulson rescued AIG shortly after letting Lehman go under.
Prins hints at some sort of conspiracy in Paulson’s actions. Why rescue AIG but not Lehman? Her answer—Goldman was out $20 billion if AIG failed. Saving Goldman was the reason for the AIG bailout.
My interpretation is less conspiratorial. Paulson has always been conservative when thought is required. He has reminded me of his namesake, comedian Pat Paulson. A forerunner of Stephen Colbert, Pat Paulson ran for President in the 1970s. His memorable campaign slogan—“I’ve upped my standards, now up yours”—pretty much sums up Hank Paulson. He blew it when he let Lehman go under and realized that he couldn’t allow another Lehman. All big financial institutions, therefore, had to be saved—but no bailout for homeowners.
Former Federal Reserve Chair Alan Greenspan also makes the blame list. The maestro pushed for deregulating financial markets, believing that markets regulate themselves. He opposed regulation of risky financial derivatives, the cause of our current crisis. And he demeaned US households who were not taking advantage of the savings from variable-rate mortgages. All this, as Prins notes, contributed to the sub-prime market.
Yet another villain is Bill Clinton. He supported and signed the Riegel-Neal Act of 1994, which let banks operate in more than one state. The result was a series of bank mergers that created mega financial institutions too big to let fail. Clinton also signed the Gramm-Leach-Bliley Act in 1999, which allowed banks to sell mortgages and purchase mortgage-backed securities. They could henceforth make, package, and sell risky loans. The winners were bank CEOs, who could show rising corporate profits and get obscene bonuses. The losers were everyone else.
Finally, Prins blames the Federal Reserve for being a secret society with neither accountability nor transparency, and for paying interest on excess bank reserves, which encourages banks to keep excess reserves rather than lending out this money.
I share many of these concerns, but my concerns here are tempered by the problems facing banks. Their assets (mortgages and mortgage-backed securities) are actually worth less than what appears on their books; many are essentially bankrupt. Since our economy cannot function without banks lending money to consumers and business firms, our immediate duty is to keep them from going under. Paying interest to banks and buying their toxic assets have prevented additional mega bank failures, and it has kept us from another Great Depression.
When discussing how to keep history from repeating itself, Prins is completely on firm ground.
First, she suggests we nationalize rating agencies. Letting banks pay agencies to rate their securities is a clear conflict of interest. Without the AAA ratings by these agencies, the junk that got us into so much trouble could not exist. Second, Prins wants to change accounting rules. Banks should not be able to keep risky assets off their books so investors and regulators do not know about them. Third, Prins wants to break up large banks. If they are too big to fail, they should be too big to exist. Fourth, she wants to reregulate banks.
This timely book is a fine introduction to our current economic mess. I wish I could be as positive about the reforms we will likely see coming out of Congress.