Bank Robbery
Bad Money
Reckless Finance, Failed Politics and the Global Crisis of American Capitalism
by Kevin Phillips
Kevin Phillips has one intriguing thesis in "Bad Money." Unfortunately, Phillips doesn't take it far enough, and the bulk of the book is mostly a breathless introductory survey of everything that has gone wrong, is going wrong or conceivably could go wrong in present-day America.
First, the interesting part: "financial, monetary and asset-preservation mercantilism." Phillips argues that since the mid-'80s or so, after then-Chairman Paul Volcker tamed runaway inflation, both Republicans and Democrats, but mostly Clinton-type Democrats in the '90s, willfully chose financial services to be the nation's premier state-supported industry.
Phillips overreaches, but he does present some compelling evidence of the government's favoritism here, including a compilation of all the bailouts the Fed offered to flailing banks and creditors over the past two decades. Phillips finished writing before the Fed rescued Bear Stearns' creditors last month, but even before that, he notes that "no further commentary is necessary."
Phillips is reasonably persuasive that because big financial institutions' creditors and investors could count on federal help whenever they ran into trouble, their influence in Washington grew and grew, while their financial products grew more and more complex. Today, financial services accounts for 20 percent of the nation's GDP, having grown by a third since the '80s, while manufacturing accounts for 12 percent, having shrunk by two-fifths. Much of this evolution is natural, but government favoritism certainly helped.
This data raises another salient point: 35 years ago, banks were vital because they greased the wheels of the rest of the economy. Today, the financial industry is the real economy, rather than a necessary precondition for it. The theoretical reasoning behind a banking bailout—that it protects innocent victims and thus the real economy from banking's bad decisions—falls apart.
Today, bailing out a big bank's creditors encourages yet more bad decisions and ill-considered risk-taking in a sector ever more important to American competitiveness, and it doesn't protect as many innocent victims as it did before deposit insurance existed. And the special-interest demand for a bailout is greater because banking's lobbying power has grown. So Bear Stearns' creditors got their bailout just as Chrysler's did a generation ago.
But Phillips is muddled when it comes to the ideology behind the government's financial-industry favoritism. He conflates it with a trust in free markets and largely blames Milton Friedman for encouraging such trust. It's highly unlikely Friedman would approved of the bailout of Bear Stearns's creditors last month. It's just as unlikely that, say, Ronald Reagan, one of Friedman's followers, would have wanted to see big banking become this generation's government-coddled project. In this case, Phillips doesn't realize that he and real free-marketeers actually agree.
The real problem is not that free markets don't work. Markets ended the mortgage boom, and the international currency markets, through their devaluation of the dollar, are showing their unhappiness with America's monetary, fiscal and economic policies.
Policymakers can't decide when markets stop and social policy starts, and not just when it comes to banking. When a person can't care for himself because of physical or mental disability, it's obvious that the government should offer him a safety net. When a gainfully employed, middle-class family stands to lose its overpriced, overlarge home and be forced to rent for a few years, the government shouldn't step in to help.
Until policymakers make clear how much government protection people can expect, they will keep testing the boundaries.
It's also hard to understand why, if the government chose so wrongly betting on financial services, it would choose correctly now in righting the economy, as Phillips seems to think it needs to do. Absent government intervention, if the current financial contraction is bad enough and long enough, the markets will do what Phillips wants naturally: push financial services down as a percentage of GDP.
Nobody is saying that this painful readjustment will be easy or straightforward, but Phillips doesn't have a better solution.
This piece originally appeared in New York Post
This piece originally appeared in New York Post