The New Royalists (and the New Guillotines)
In rough outline, the causes of the French Revolution were pretty simple. The King and his court, plus a bunch of obscenely rich aristocrats, ran the country and owned nearly all the wealth. They ran it badly and didn’t like sharing. They gave little thought to and had no sympathy for common folk. On hearing that peasants had no bread to eat, Marie Antoinette famously quipped, “Let them eat cake!”
They didn’t use their heads (or their hearts), so they lost them.
We in the Western World like to think we have democracy. We like to think we have capitalism. We like to think we know the principles by which both work.
But there is a class of people—very wealthy and powerful people—who have eluded these principles for most of our history. They’re bankers, or more generally, finance men. (I use the masculine gender because the overwhelming majority are men, and have been throughout our history.)
It is an odd thing, really. Today one of these men, Jamie Dimon, has made himself infamous as a one-man lobbying army, opposing effective regulation of the same financial system that three years ago almost destroyed the global economy and continually threatens a repeat performance. He happens to be the CEO of JP Morgan Chase, one of America’s top five banks by assets. He therefore carries the legacy of J. Pierpont Morgan, a private banker who virtually controlled our entire nation’s finance throughout the nineteenth century, and who could control financial panics—or not—at his whim.
Both were big men physically and metaphorically. Morgan had a veneer of culture but made himself look bigger and more imposing with a tall top hat. Dimon looks fitter, in accordance with modern culture. If you saw him in a dark alley without his business suit, you might take him for a Mafia hit man and walk quickly away. Both men no doubt grew up accustomed to obedience because of their size, intensity and cunning.
In the nineteenth century, Morgan operated almost entirely in secret. There were no antirust laws until 1890. There was no income tax (except briefly to pay for the Civil War) until after ratification of our Sixteenth Amendment in 1913. So the money Morgan made and how he made it were known only to the similarly-minded plutocrats with whom he met behind closed doors. He made and broke empires in electricity and steel. He advised and pressured presidents like the potentate of an invisible nation within a nation.
Dimon can’t act precisely like that today. We do have antitrust laws and the income tax. Our legal regulatory regime and our media are vastly more pervasive and intrusive than in the nineteenth century. But Dimon and his ilk have reacted by infiltrating and suborning our government, particularly in Treasury, Congress and the Fed. They still get their way, regardless of the supposed rules of democracy and capitalism. But today they have to do it more publicly.
The paradigmatic private meeting of our era came on October 13, 2008. Dubya’s Treasury Secretary, Hank Paulson, himself a former chairman of Goldman Sachs, called the CEOs of America’s leading banks together in Washington. Fed Chairman Ben Bernanke was present. In addition to Dimon from JP Morgan Chase, there were six others from major banks, representing Bank of America, Citigroup, Merrill Lynch, Morgan Stanley, and Wells Fargo.
Did Paulson call these men together to reprimand them for destroying American finance and (later) the American economy? Did he chide them for building businesses on liars’ loans palmed off to unsuspecting investors in the form of mortgage-backed securities? Did he urge them to take the necessary “haircuts” on their toxic investments? Did he ask them to help him find the best way out of the crisis? No, no, no and no.
Paulson called them together to give them money—our money, yours and mine. He handed out over $120 billion of the people’s money that day. Sure, it wasn’t a gift. In return Paulson got for the Treasury convertible preferred stock paying 9% interest, which Paulson promised never to vote.
Think about that. Now 9% wasn’t a bad interest rate, and it would actually go up with time, to give the banks an incentive to replace the government investment with private capital. But the investment firmly established two principles that, insofar as I know, were unprecedented in American history.
The first principle was “too big to fail.” When banks had failed in the Great Depression, the federal government came up with two answers. The first was depositors’ insurance. It made depositors whole. Not the banks, their investors, or their managers. The depositors.
The government, in the form of the Federal Deposit Insurance Corporation (or equivalent agencies for non-bank financial institutions) took the failed banks into receivership, dismissed management, sold off the parts or assets that other banks or private investors would buy, and liquidated the rest. Bank investors got nothing, or pennies on the dollar, and management largely ceased to function, except as consultants to the receivers.
That was capitalism. The guys who drove the banks into bankruptcy were out. The shareholders who had hired or tolerated them lost most or all of their investment. And innocent depositors and some other creditors were spared. There was no moral hazard, no bank runs, and no financial panic. The economy muddled on, with some duly chastened bankers and shareholders.
Paulson’s excuse for fundamentally changing the paradigm for government intervention was plausible. The banks were too incestuous, he argued. Their toxic assets were too intertwined. They all owned some of the sludge, so if you marked it all to market the whole house of cards would collapse. If you put the failed banks in receivership, no one would buy the toxic assets because no one knew what they were worth.
There was some sense in these arguments at the time. And they got accepted because everyone was in a panic.
But in the clear light of hindsight, we can see their obvious flaws. As it turns out, the federal government (through the Fed) did invest trillions in buying, quarantining and stabilizing toxic assets. It did so through direct capital infusions, like those of October 13, though TARP, through near-zero-interest loans at the Fed window, and by printing new money to do what had to be done.
But on October 13, 2008, Paulson had firmly established a new principle of federal intervention, never before used. (For Obama bashers, let us emphasize briefly that that was during the reign of George W. “Dubya” Bush.) Henceforth government would prop up the banks themselves, their managers and investors, not their depositors and creditors. Saving the banks and their incompetent managers was to be the price for saving the economy.
That principle could only have been laid down by a cabal of bankers, in the manner of J. Pierpoint Morgan in the nineteenth century, before the antitrust laws, the income tax, and federal regulation of banking and securities. Yet Paulson and his fellow thieves pulled it off in broad daylight, in the twenty-first century, under the noses of the public, the Department of Justice, and financial regulators, with active complicity of the Fed. The Wall Street Journal [subscription required] and the New York Times reported on the meeting that same week.
When you think of its consequences, it was probably the single greatest heist in human history, done in plain view.
The second unprecedented aspect of Paulson’s “innovation” was continuity of management. In the old days, when people screwed up, they got fired. When a bank went bankrupt, the court or federal receiver took over, and management was out. The screwups didn’t get a second chance, at least not at the same bank. But in Paulson’s new world, Treasury gave them new money, took stock in exchange, and promised not to vote it. Paulson left the foxes in charge of the hen house with a pledge that they would stay there.
Don’t get me wrong. I don’t think Paulson et al. had the minds of thieves, what lawyers call mens rea. Things just turned out that way. Paulson and his colleagues did what they did because banking was all they knew and all they cared about. Their universe was collapsing, and they wanted to save it. The economy was secondary. The abstract principles of capitalism and free markets, let alone FDR’s response to the Great Depression, if they mattered at all, came in a distant third.
These men just handled things like the new royalists they are, in a back room in their own interest, the same way J. Pierpont Morgan had done over a century before.
Once their little meeting had set the stage, the play went forward as written. By the end of the week, the federal government had committed $2.25 trillion to the philosophy of “too big to fail.” By the time President Obama took the oath of office on January 21, over three months later, additional trillions were committed or in the works. And the President, perhaps unbeknownst to him, had two fifth columnists on his team—Geithner and Summers—both committed, willing and predisposed by background and experience to play out the script.
The rest is history. For three years, the nation’s biggest banks have been exempt from the rules of market discipline, market valuation of assets, and capitalism itself, because they are “too big to fail.”
Not only that. This royalist exemption from the normal rules of free markets has spread to Europe and is instrumental in the ongoing panic there. For example, the latest proposal in the EU is for banks that invested in bad Greek bonds to take a 21% “haircut,” when the bonds’ market value is 60% below face. This approach would leaves the other 40% loss for various governments and the people of Europe to pick up.
It’s not a complete exemption, as here. The banks take one-third the loss they caused and the people two-thirds. But it’s good enough for greedy incompetents.
So there you have it. Democracy and the free press have failed miserably. The process is different, more public, and much more messy. But the outcome is the same as it was in J. Pierpont Morgan’s day. The money men call the shots in private meetings; they protect their interests well; and the rest of us pay the bill. The only difference is that, this time, we have badly damaged the very foundations of capitalism and free markets, at least in finance.
In the French Revolution, the people had a simple, rather mechanical response to royalists: the guillotine. We’re not quite there yet. The French peasants were literally starving. Few are starving today, although many are in poverty, malnourished and sleeping under culverts, in homeless shelters, or in their cars.
So we still have a way to go before we reach the guillotining stage. Anyway, we live in a more “civilized” era, when beheadings and other mass violence are generally just not done.
More to the point, there are guillotine substitutes that might get us back on track without bloodshed.
We can go back to the old ways any time we want. We can stop bailing out banks and liquidate them when they fail. We can continue protecting individual depositors and expand that protection to bigger accounts and to businesses. We can include selected other creditors, to take some of the risk out of a falling house of cards.
We can do all this through existing institutions, like the FDIC, FHLBB, the Fed, and bankruptcy courts. If we’re worried that things might collapse too fast, we can create special receivers with extraordinary powers to unwind failing financial institutions quickly and accurately. In doing so, we would have a signal advantage over liquidators and economic consultants in FDR’s day: computers and the Internet. We use the same technology that created the Flash Crash to restore the principles of capitalism, free markets, and democracy.
It is absolutely clear who is responsible for this brave, perverted world: Hank Paulson, his fellow bankers, George W. Bush, and (to a lesser extent) Ben Bernanke. But it’s far too late to worry about blame. The contagion has spread to Europe, and Japan cannot be far behind. China alone cannot stem the tide and in any event doesn’t care much about democracy.
So if we want to save democracy and capitalism from the latest powerful cabal of unchecked royalists, we have to act fast. There is nothing wrong with our global industries. Our A, B, C companies are the finest in human history.
But if we don’t get the royalist bankers off their and our backs and back under a regime of capitalism and free markets, the entire global economy will sour, perhaps irrevocably. Millions will suffer. Governments will fall. War may break out. Then real guillotines may come into play.
If those horrors come, they will come not because we stuck to the principles of free markets and capitalism. They will come because abandoned them for royalists.