Who rigged Wall Street? The question absorbed people for years after the crash of 1929 and the Great Depression that followed. Now it is before us again. The financial crisis that has swept away great wealth and important banking firms was not an accident of nature. The ingredients for disaster were engineered by human architects seeking greater fortunes and authorized by political actors in both parties. The wiring for this calamity was complex, involving obscure changes in how the financial system functions. It will take months, maybe years, to understand it fully.
But in order to reform the system, the country has to find answers. The economy will not be truly healed until the causes are identified and the financial system is reconstructed on sound public principles. The names of key players in both parties must be identified, not for vengeance but because many of them still exercise enormous influence and hope to supervise the repair work, protecting their interests and papering over their past errors. Economic policy-makers like Phil Gramm, Robert Rubin, Lawrence Summers and their protégés arranged Wall Street for inflated profits and ruinous risk-taking and are now hovering around both presidential candidates. We will not get to the hard truth about what went wrong and how to fix it if these people are in charge of investigating themselves.
In the early 1930s, the country had the Pecora hearings and sensational disclosures that stunned Wall Street and public opinion. Formed by the Senate, the commission of inquiry went through three chief counsels before it found one tough enough to stand up to the titans of banking--an assistant district attorney from New York City named Ferdinand Pecora. His investigators pored over the books of famous Wall Street firms, then Pecora personally grilled the self-righteous bankers. Among many revelations, the commission found that J.P. Morgan Jr. and twenty partners of his firm had paid no income taxes in 1931 or '32 and only trivial amounts before that. "If the laws are faulty, it is not my problem," Morgan testified.
The Morgan bankers maintained lists of "preferred clients," who were invited to participate in their speculative stock-market schemes. The list of insiders included public figures like FDR's first Treasury secretary. Hoping to discredit the "circus" atmosphere of the hearings, Morgan's men brought a midget, who sat on his lap. Their PR stunt backfired. The nation was convulsed in derisive laughter. The securities regulations enacted by the New Deal were grounded in what Pecora revealed.
Our crisis might not get a Pecora investigation, not one that digs out the whole truth, for this reason: this time, the dirty details of who rigged what involve many incumbent politicians, Democrats and Republicans alike, and the deals they worked out with their financial patrons on Wall Street. A close accounting would reveal how both parties collaborated for more than two decades in repealing or gutting the prudent safeguards put in place by the New Deal reformers. Congress still has some bulldog investigators, like Representatives Henry Waxman and John Conyers, but their colleagues will have very little appetite for "naming names" or exploring the money connections between Washington and Wall Street.
To dig out the answers, we must rely on the next best thing--a vigilant free press and tough-minded reporting. If that sounds improbable, some elements of major media are already on the case (perhaps seeking redemption for the Fourth Estate's utter failure during the run-up to war in Iraq). For example, Peter Goodman of the New York Times produced a devastating account of how the Federal Reserve and the Clinton administration collaborated to block efforts to regulate the credit derivatives that became a critical factor in inducing the present crisis.
Goodman patiently reconstructed how the Commodity Futures Trading Commission's (CFTC) efforts to impose regulatory oversite on derivatives were stymied by Fed chair Alan Greenspan, Treasury Secretary Robert Rubin and SEC chair Arthur Levitt in 1997. Greenspan, Rubin and Levitt very publicly kneecapped commission chair Brooksley Born and effectively drove her from government. They staged a brutal dressing-down and urged Congress to prevent her from acting. Congress complied with a law blocking CFTC action. Lawrence Summers, Rubin's deputy at Treasury and later secretary himself, personally rebuked Born and accused her of threatening a financial crisis.
The opposite proved to be true. By not applying timely regulation, Washington set up the country for the disaster that followed. Given a free hand and virtually no oversight, major banks and investment houses became the leading salesmen for the dubious derivatives, assuring clients these devices protected them against risk on mortgage securities and other high-flying investments. Instead, the derivative contracts became a multitrillion-dollar time bomb threatening the banks themselves.
The history of purposeful rigging includes at least six other pivotal changes that slyly dismantled the old banking system and created a debt casino with extraordinary gambling and outrageous profits. Reporters, for instance, might look into the initial deregulation of banking--enacted by the Democratic Congress and president in 1980--when interest-rate ceilings were repealed and the sin of usury was decriminalized, authorizing the predatory lending and sky-high rates that are now commonplace. Another bipartisan project worth investigating was ably assisted by the Federal Reserve--the repeal, in 1999, of the New Deal's Glass-Steagall Act by the Gramm-Leach-Bliley Act. The latter measure allowed the merger of closely regulated commercial banks with unregulated investment houses and opened numerous trapdoors and escape hatches for bankers to game the differences between the two.
At the time, leading newspapers led cheers for this stuff, but even the Times editorial page is revising its views. The press lacks subpoena power, but the Times's financial and business section is a bright shining beacon for tough reporting, with a dozen or more deeply informed and aggressive reporters, led by Gretchen Morgenson, who are destroying the old myths of deregulation and Wall Street rectitude. (The Times also has a stable of cheerleaders who keep promoting the official happy talk.)
Greenspan, under grilling from Representative Waxman, offered a weasel-worded admission that he had been mistaken about derivatives. Otherwise, none of these guys have acknowledged error, much less apologized to the American people.
Right now, national politics is in the midst of a deep power struggle over who controls the path of reform and recovery. The old order understands viscerally that its domination is threatened, and financial titans in the shrinking Wall Street club are attempting to pre-empt opposition. The bailout action so far, with hundreds of billions devoted to preserving what's left of the status quo, suggests they are succeeding. But events are not cooperating, and a deepening recession will keep raising the question: what did the public get for all its money? Bush and Paulson will be gone, but the next president will have to answer that question.
John McCain, it seems fair to say, is a hopeless case, given his weak grasp of economic issues. Should he win, McCain would likely stick to the same script, counseled by former Senator Phil Gramm, a leading architect of deregulation, and the many corporate and financial lobbyists who supervise his campaign and agenda. McCain would doubtless face a larger and more aggressive Congressional opposition, but Democrats have been weak and unreliable in resisting the old order's attempts to hang on to power.
As president, Barack Obama will inherit the awkward straddle the Democratic Party has maintained for many years--trying to serve the financial sector and its interests on one side while satisfying (or appeasing) popular constituencies like labor on the other. But Obama will have to manage this balancing act in much tougher circumstances--an economic contraction swiftly turning darker. As a candidate, he has mostly surrounded himself with Clinton-era economic policy-makers and people implicated in "reforms" that led to financial breakdown. This has caused considerable despair in some left-liberal quarters over the possibility that Obama will repeat the abrupt about-face of Clinton's first administration, when he dumped his "putting people first" campaign rhetoric and governed instead as an ally of multinational finance and business.
The despair is premature. It grossly underestimates the high skills and distinctive nerve of this very astute politician. Given his Harvard background and cautious manner of calculating positions, Obama is at home among centrist, establishment figures. As an African-American man and junior senator running for president, Obama needed their respectability and courted them. If he wins, however, he will be governing in very different circumstances and will have to decide if his presidency can subsist on cautious, small-bore reforms or must govern with a far more ambitious conception of what the country needs. The hard debate begins the day after the election. Things are changing rapidly, and none of us know how it will turn out. Obama probably doesn't either.
A photo-op Obama arranged with his economic advisers a few weeks before the election tells the story. Arrayed on either side were policy leaders from the old order. Former Federal Reserve chair Paul Volcker collaborated in the initial deregulation of banking in 1980 and presided over the initial bailouts of banks deemed "too big to fail." Robert Rubin was the architect of Clinton's center-right economic strategy and is now senior counselor at Citigroup, itself endangered and the recipient of $25 billion in public aid. Lawrence Summers, disgraced as president of Harvard, is now managing partner of D.E. Shaw, a $39 billion private equity firm and hedge fund that specializes in esoteric mathematical investing strategies. Laura Tyson was chair of Clinton's Council of Economic Advisors and is now a UC-Berkeley professor who sits on the boards of Morgan Stanley, AT&T and KPMG, the global accounting giant.
None of these people are well equipped to lead fundamental reform of the system they helped create or to speak reliably for the broader interests of society. Volcker, now 81, was a brilliant Fed chair who subdued runaway inflation, but he was no friend of working people. His hard-nosed monetary policy smashed wages, even as he managed the rescue of major banks in the Third World debt crisis, replacing their exposure with public lending from the IMF and World Bank. Rubin is preoccupied with saving his bank from ruin, but Obama's staff is loaded with Rubin acolytes. Nine months ago, Rubin dismissed this crisis as a cyclical hiccup. Summers, on the other hand, seems to be actively running for Treasury secretary or maybe Fed chair. His public pronouncements are taking on a softer edge, and he has dropped his Calvinist devotion to balanced budgets. But now that he works for a celebrated hedge fund and private equity firm, where does Summers stand on regulating these creatures?
Informed gossip says other leading candidates for Treasury secretary are New York Fed president Timothy Geithner, a Rubin protégé; New Jersey Governor Jon Corzine, a former Rubin colleague at Goldman Sachs; and Jamie Dimon, CEO of JPMorgan Chase, the bank with the largest vulnerability on dangerous derivatives. Corzine is the only one with a strong record of social concerns. Another long shot is Sheila Bair, a Republican regulator and chair of the FDIC, whose aggressive corrective actions have angered some big-name bankers.
Finding a financier without severely conflicting personal interests experienced enough to manage the massive bailout will be difficult, no matter who wins the White House. And standing too close to the old order does not seem very promising. Given this country's deformities of power, the president usually needs the establishment's help to prevail or at least avoid open warfare on important matters. Given the extreme circumstances Obama would inherit, he may face a very different calculation. If the old financial order is at the heart of the economic problem, would the president be better off protecting it or trying to disturb its power and cut its institutions down to size? For the first time in many decades, it may be smarter politics to confront the "malefactors of great wealth" (as FDR called them in the 1930s) and force major reforms of their behavior. Does Obama have the guts for such a dramatic confrontation? We don't yet know. But we do know it took a lot of nerve for a young African-American man with a different vision of the country to run for president when the reigning elders told him it was not his turn.
The established order, meanwhile, is setting out some "opportunities" for the next president to demonstrate that he is a high-minded, responsible leader. These are really traps that could doom his presidency. Military leaders are insisting on larger Pentagon budgets after withdrawal from Iraq--pre-empting the social spending that people have been promised. Financial leaders are urging that greater powers be given to the Fed despite the failures of that cloistered institution. This would be a great victory for the Wall Street club, cementing the privileged powers of the corporate state the bailouts seem to have created. The so-called "responsibles" are likewise proposing "reform" that will cut benefits for entitlement programs, especially Social Security, as a way to correct the nation's budget deficit. This would constitute another historic swindle of the people--much larger than the bank bailout.
President Obama would likely gain favor with the public if he rejected all three of these propositions. He would be bolstered further if the people found their voice. This expression can take the form of direct actions, large or small, nonviolent civil disobedience that pushes the new president further than he perhaps intends to go. People can reshape public opinion by showing other citizens they have the power to stop foreclosures in their neighborhood or rally the jobless to demand public employment for all or surround the rescued banks with thousands of their new public "investors," demanding lower credit-card interest rates or relaxed terms for failing mortgages.
The financial crisis continues to spread upheaval in many directions, and we do not yet know how wide or deep the destruction will flow. But strange and sometimes wonderful surprises can happen in unsettled circumstances. In the crisis of the Great Depression, a Mormon Republican banker from Utah showed up in Washington, pushing his heretical understanding of the crisis. Marriner Eccles never graduated from college, but he figured out from his banking experiences the basic economic principles the nation should follow (which later became known as Keynesian economics). Eccles was desperate to share his insights. In February 1933, he managed to testify before the Senate Finance Committee. In one sitting, he laid out an agenda that encompassed nearly all of the important measures the New Deal subsequently enacted. The left-wing advisers around Roosevelt recognized a kindred spirit, and Eccles was asked to join the White House staff. He drafted the 1935 reform legislation that created the modern Federal Reserve. Then FDR appointed him as Fed chair.
Maybe in our chaotic circumstances there will be similar odd convergences. One hopes the next president will be open to them--willing to listen to fresh thinking from outside the circle of established opinion-makers and brave enough to act on new ideas.