Who Stole the American Dream?

by Hedrick Smith

  THE INSIDE TRACK OF “THE MONEY MONOPOLY”

  I sincerely believe, with you, that banking establishments are more dangerous than standing armies….

  —THOMAS JEFFERSON,

  letter to a friend, 1816

  In a political system where nearly every adult may vote but where knowledge, wealth, social position, access to officials, and other resources are unequally distributed, who actually governs?

  —ROBERT A. DAHL,

  Who Governs?

  The finance industry has effectively captured our government….

  —SIMON JOHNSON,

  Atlantic headline, “The Quiet Coup”

  NO SLICE OF AMERICAN BUSINESS has amassed more political power or more astronomical profits—and contributed more to the acute economic divide and the hyperconcentration of wealth in America today—than what Woodrow Wilson once called “the money monopoly,” meaning Wall Street.

  Wall Street has enjoyed meteoric growth before—in the Gilded Age and the Roaring Twenties—but the scale of its financial boom in the past two decades is unprecedented in American history.

  Since the late 1980s, Finance has become the heart of the New Economy. It has far outpaced other sectors, exploding from $1.2 trillion of assets in 1978 to $11.8 trillion in 2007. It overtook manufacturing to become the largest sector of the U.S. economy. Its profits soared—from 17 to 18 percent of total U.S. corporate profits in 1980 to 46 percent in 2005. As former Nixon political strategist Kevin Phillips put it, Wall Street “hijacked” the U.S. economy for its own profit, causing a “perilous overconcentration” of economic power.

  In terms of political power, Wall Street has no peer. Over the past two decades, the bankers portrayed by Tom Wolfe in Bonfire of the Vanities as arrogant “Masters of the Universe” have been even more successful than the leaders of other sectors of business, such as oil or the military-industrial complex or the pharmaceutical industry, in influencing Washington to adopt their agenda. They have lobbied successfully to overturn New Deal–era laws and time-tested government regulations. They have won several government bailouts in one financial crisis after another, culminating in the collapse of 2008. They have gained repeated concessions from Washington’s Wall Street–friendly regulators. Most important for them, and costly for the nation, the powers-that-be on Wall Street managed in the 1990s and 2000s to break down the walls separating different types of banking and to fence off their gold-plated derivatives business from regulation.

  What has made “the money monopoly” explosively dangerous is that its power and wealth have been built on debt—debt that dwarfed the debt of the U.S. government. The debt of the financial sector metastasized from $2.9 trillion in 1978 to $36 trillion in 2007, plus another $33 trillion of exposure in derivatives. What Wall Street likes to call its leveraging, its debt, had become well over four times the size of the $15 trillion federal government debt—far more debt than the superbanks could sustain. When Wall Street’s bubble burst, it pushed the nation to the precipice, and only government action saved the rest of us from going over the edge.

  Wall Street Corners the Policy Market

  But in spite of the wide peril it posed, Wall Street has escaped serious oversight. It has gotten its way in Washington to an extraordinary degree. It wields influence not only through lobbying power and lavish campaign donations, but even more through the tight symbiotic relationship it has built with official Washington.

  The chieftains of the financial world have acted on the evident conviction that money spent on lobbying and political campaigns pays big policy dividends. In those terms, too, finance has no rival. In the 2009–10 election cycle, the financial sector poured roughly $318 million into congressional campaigns and spent another $946 million on lobbying—$1.25 billion in all. Most other high-profile sectors—oils, defense, pharmaceuticals—did less.

  Even more striking than the flow of money is the steady flow of Wall Street luminaries and master financiers into the most important policy posts of government. At times, the line between government and banking has become blurred: Alan Greenspan, head of an elite New York financial consulting firm and board member at J. P. Morgan & Co., served as chairman of the Federal Reserve for twenty years; Robert Rubin and Henry Paulson, former top executives of Goldman Sachs, have run the Treasury for both Democrat Bill Clinton and Republican George W. Bush, respectively; so many Goldman alumni were recruited by Paulson to manage the taxpayer bailout for Wall Street banks that they were called “the Guys from Government Sachs”; former New York Fed president Tim Geithner, who for five years worked under a Fed board dominated by Wall Street bank CEOs, was chosen to head Treasury by President Barack Obama; and former Harvard president and economist Larry Summers, who was paid nearly $8 million in fees in 2008 by Wall Street firms and hedge funds, became the head of Obama’s National Economic Council. Under Democrats as well as Republicans, Wall Street cornered the policy market.

  Fourteen Hundred Ex-Government Officials Lobby for Wall Street

  What’s more, the Washington–Wall Street axis works as a two-way street. Wall Street recruits its lobbying army from the ranks of government. During the battle over the 2010 law to regulate Wall Street, the financial services sector hired 1,447 former government officials as lobbyists—former members of Congress, Capitol Hill staffers, or White House and Treasury Department policy makers as well as former high officials from other key agencies.

  Finance had a lobbying team that included 73 former members of Congress, headed by two former House majority leaders, Democrat Dick Gephardt and Republican Dick Armey, and two former Republican Senate majority leaders, Bob Dole and Trent Lott. Less visible but no less influential were 115 former staff aides for the key House and Senate banking committees that were actually writing the financial reform bill. These staffers were inside experts who possessed not only intimate knowledge of the intricacies of the law, but also access to key members of Congress. Their job was to turn every conceivable subparagraph and semicolon to Wall Street’s advantage.

  Under The Atlantic’s headline, “The finance industry has effectively captured our government,” economist Simon Johnson observed. “A whole generation of policy makers has been mesmerized by Wall Street…. The American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country.”

  What Johnson called “the Quiet Coup” was a matter not just of people, but of ideology. In the 1990s, with Greenspan chairing the Federal Reserve and Robert Rubin leading Treasury, Wall Street’s laissez-faire market philosophy became Washington’s conventional wisdom. Its “capture” of Washington was evident in practically every major financial policy battle under Clinton in the late 1990s and under Bush in the zero decade, and even into the battles over financial regulation under Obama.

  Brooksley Born’s Warning on Derivatives

  In 1998, Brooksley Born, a tough-minded, iconoclastic lawyer who headed the Commodity Futures Trading Commission, saw danger ahead and began pushing for government regulation of over-the-counter derivatives—the esoteric investments that renowned investor Warren Buffett called “financial weapons of mass destruction.” Over-the-counter derivatives were not standard products. Each was different from the next one, making them almost impossible for regulators to monitor. When Born dared to challenge the Wall Street power axis by suggesting that these derivatives be standardized and made more transparent, Rubin, Greenspan, and then Treasury deputy secretary Larry Summers tried to muzzle her. They contended that the mere release of her concept paper on derivatives regulation would trigger a market collapse. Born, seeing unregulated derivatives as a greater danger, released her paper anyway. Wall Street bankers were apoplectic, but nothing dire happened.

  In September 1998, Born was vindicated when Long Term Capital Management, a huge hedge fund deeply inves
ted in derivatives, collapsed. Born told Congress that the hedge fund’s disaster “should serve as a wakeup call about the unknown risks that the over-the-counter derivatives market may pose to the U.S. economy….” But instead of hailing Born’s prescience, Greenspan, Rubin, and Summers cut off her regulatory arms. They asserted that the big banks could protect themselves and that regulators should not interfere with the market. They pushed Congress to pass a bill blocking the commission that Born headed from taking any action on derivatives. Born accused them of “muzzling” her agency and abruptly announced her intention to quit the government when her term expired in April 1999. But eight years later, just as she had warned, the derivatives market started to blow up and spread financial mayhem worldwide.

  Repealing Glass-Steagall

  An even more pivotal victory for the Wall Street–Washington axis was repeal of the Glass-Steagall Act (the Banking Act of 1933) by Congress in 1999, at the urging of Rubin and Greenspan. Glass-Steagall had been passed as one of the first reforms of the New Deal to try to prevent a repeat of the 1929 market crash. Its purpose was to separate commercial banking from investment banking. The law walled off the dull but vital business of safe, reliable banks, where consumers could put their savings and their checking accounts, from the risky business of investment banks engaged in mergers and acquisitions, “financial engineering,” marketing derivatives, and playing the market with company assets for their own profit.

  But by the 1980s, Wall Street banks chafed at any limitation on their operations. They wanted total deregulation. Investment bankers like Rubin began a drumbeat for tearing down the Glass-Steagall wall. It was constricting their operations and limiting their profits.

  In Washington, they had powerful allies. As John Reed, former CEO of Citicorp, told me, “Greenspan was sympathetic. Greenspan was always against Glass-Steagall. He had been on the J. P. Morgan board of directors, and Morgan was always against Glass-Steagall. Greenspan and the Fed had been watering down Glass-Steagall for years. The key phrase [in that law] was that commercial banks were not permitted to be ‘principally engaged in’ investment banking. The question was, what constituted ‘principally engaged in’?” Starting in 1987 and then reaching a climax in 1996, Greenspan chose to reinterpret the wording of the law to create a loophole that weakened the Glass-Steagall separation of commercial and investment banking, and then he greatly enlarged it. He and the Federal Reserve Board, lobbied by Wall Street bankers, permitted an escalating expansion by commercial banks into underwriting securities and other investment banking operations by allowing them to do first 5 percent, then 10 percent, and finally 25 percent of their business in those higher-risk areas by the late 1990s.

  The Rise of “Too Big to Fail”

  But that was not enough for Sandy Weill, Wall Street’s most ambitious banker. Weill wanted to create the world’s largest superbank. To do that, he needed to demolish Glass-Steagall. By the late 1990s, Weill had formed a financial giant that combined Travelers Insurance and Salomon Brothers investment house. His next step was to arrange a megamerger with a big commercial bank. He tried first with J. P. Morgan and then, when that failed, with Citicorp.

  Weill knew that his dream merger would violate Glass-Steagall, but after some private soundings with Greenspan, Rubin, and President Clinton, he decided to force the government’s hand. On April 6, 1998, Weill and Citicorp CEO John Reed announced the breathtaking merger of Travelers and Citicorp.

  Greenspan quickly gave his blessing and allowed Weill and Reed some breathing time for the merger to solidify. Rubin, who had been pushing Congress to repeal Glass-Steagall since 1995, lobbied Congress to ratify the merger and open the field to more megabanks. Consumer groups and community bankers protested that this would create uncontrollable financial empires. Former commerce undersecretary Jeffrey Garten, then dean of the Yale School of Management, warned prophetically that bank megamergers would come back to haunt the government. If the superbanks got in trouble, Garten predicted, the taxpayers would have to bail them out because they would be “too big to fail” without causing a wider financial disaster.

  But with Wall Street lobbyists in full cry and with “wise men” from Wall Street like Greenspan and Rubin arguing that superbanks would generate “synergies” that would “enhance the competitiveness” of U.S. banking in the global economy, Congress repealed Glass-Steagall, a law that had worked well for six decades.

  Just as Jeff Garten had forecast, Citigroup and other megabanks created massive havoc when the financial earthquake hit Wall Street in 2008. The damage was all the more colossal because the multitrillion-dollar market in derivatives was unregulated, which meant there was nothing to stop banks from overplaying their risks even when they had inadequate reserves to cover their losses. And there was no Glass-Steagall wall shielding commercial banking and the deposits of ordinary customers from the disastrous collapse of high-rolling investment banks like Bear Stearns and Lehman Brothers. All the big banks were linked to one another, as vulnerable as dominoes. Wall Street maimed itself with self-inflicted wounds, and when Bear Stearns and Lehman Brothers went under and other firms like Merrill Lynch had to be rescued by rivals, the taxpayers were stuck with the bill—not only for the reckless greed on Wall Street, but also for the myopia of the Wall Street gurus who were making policy in Washington.

  The Banks: “Obstruct and Delay”

  The moment had come for reversing two decades of policy. But given the high stakes for the nation’s economy, the federal government had little choice but to step in to rescue Wall Street once again. With former Goldman Sachs CEO Henry Paulson running Treasury, even a limited-government Republican like President George W. Bush scrapped his free market ideology to push Congress into appropriating $700 billion for the country’s largest corporate welfare program—a bailout for the superbanks—while the Federal Reserve handed out $7.8 trillion more in low-interest loans. All that cheap money enabled the surviving banks to grow even larger and to get back to making the same kinds of profits they had made before the collapse.

  The surprise was not that the Washington–Wall Street symbiosis was still at work. The surprise was that once the hemorrhaging slowed and Congress sat down to write a new law to prevent a future collapse, Wall Street was back at lobbying full throttle, resisting almost every regulatory idea. Equally surprising was the fact that at the very moment when Wall Street’s credibility should have been in tatters, it still had enormous political clout—proof that the power shift begun in the 1970s still dominated political Washington despite the dangers to the U.S. economy.

  In 2009, the political climate demanded action. The public, mired in unemployment and home foreclosures, was in an anti-bank uproar, clamoring for change. But the bank and business lobbies defied the public mood. Their brazen strategy paid off, and President Obama, guided by former Wall Street bank regulator Tim Geithner, moved timidly. The banking sector, with its fourteen hundred lobbyists, fought off a potential historical reversal of policy with the tactics of “obstruct and delay.” The banks shrewdly calculated that mass amnesia would save them: The longer it took to craft regulatory reforms, the greater the likelihood that the drive for reform would lose momentum. The public lost track—and lost interest.

  In May 2010, a group of Democratic senators tried to pass a provision shrinking the biggest banks and limiting their size to deal with the “too big to fail” problem, but the banks and their allies in Congress killed that measure. President Obama wanted a freestanding consumer protection agency. The bankers hated the idea. They lobbied successfully to have the new agency tucked inside the Federal Reserve and then, in 2011, got Senate Republicans to block any consideration of Elizabeth Warren, the vigorous consumer advocate who was Obama’s choice to head it, forcing her to quit the administration and abandon her chance to head the new agency that she had proposed and helped to organize.

  When reformers wanted to revive Glass-Steagall protections, bank advocates argued that it was too late, and they won.
When it was proposed that the banks pony up a bank tax to help pay for future bank failures, the banks got the bank tax killed. When Senator Blanche Lincoln of Arkansas proposed barring banks from marketing derivatives, she came under withering fire from business interests as well as the banks. The Obama administration, in retreat, pushed to make the derivatives trade more open and regulated, but the banks fought successfully to exempt certain derivatives, such as the credit default swaps that played a big role in the mortgage blowup. Former Fed chairman Paul Volcker advocated barring all regulated banks from proprietary trading on their own account (what came to be called “the Volcker Rule”), to keep superbanks from speculating recklessly and putting the whole system at risk again. Volcker won backing from former Citicorp CEO John Reed, who apologized for what he now called the mistaken Citi-Travelers megamerger. Congress passed a vague version of the Volcker Rule but left its definition to regulators who were besieged by bank lobbyists.

  In mid-2011, a full year after the financial regulatory law was passed, Treasury Secretary Tim Geithner accused Wall Street banks of stalling the whole process in order to water down the new rules. “There’s an attempt to kill this through delay,” asserted Michael Greenberger, a former member of the Commodity Futures Trading Commission staff, and the delay “could be cataclysmic.” That did not trouble Wall Street. The big banks wanted to stave off regulation, even regulation to improve the safety of the financial system.

  Volcker: The Reforms Fall Short

  The Danger: Another Future Collapse

  It is true that passing any major regulatory legislation over the near unanimous opposition of Republicans was a major achievement for the Obama administration. Creating the Consumer Financial Protection Bureau was a milestone. Passing the Volcker Rule against proprietary trading was a gain, though it was watered down with one loophole that allowed banks to speculate with up to 3 percent of their assets and another loophole that delayed implementing the Volcker Rule for seven years, long enough for banks to fight to expand the loophole and perhaps to elect a bank-friendly president in 2012 or 2016 who would wipe the Volcker Rule entirely off the books. Ultimately, the concessions made to win the final crucial Senate votes largely emasculated the reform.