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Jeff Madrick Pt.3: The Clinton-Bush years and the origins of the derivatives crisis and further deregulation

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in New York. And we’re continuing our discussion with Jeff Madrick. He’s the author of Age of Greed: The Triumph of Finance, the Decline of America, 1970 to Present. So, just in case you haven’t seen part one and part two, Jeff Madrick is a regular contributor to The New York Review of Books and a former economics columnist for The New York Times. He’s a senior fellow at the Schwartz Center for Economic Policy Analysis and a senior fellow at the Roosevelt Institute. Every segment, I’m going to read that faster.


JAY: Okay. Thanks for joining us again. Alright. So let’s just pick up the tale. We’ve got ourselves up to the ’90s. And pick it up from there.

MADRICK: Well, in the 1990s we have the high-technology fantasies, we have the beginning of derivatives, we have one early wave of subprime mortgages, and we don’t have any government regulation. There was a derivatives crisis–I should try to say that word clearly–derivatives crisis in 1994. I don’t think anybody remembers it, really. Big-time derivatives crisis. Orange County, San Diego, where San Diego is in California, lost $1 billion.

JAY: Okay. Really fast again, for a lot of people [who] still haven’t got their heads around what derivatives mean so fast.

MADRICK: Well, if I can’t pronounce it, could they have their heads around it? But basically a derivative is an instrument that allows you to buy a security or a currency or a bond with very little down payment. It’s risky because it fluctuates in price, because you put so little up, but it allows you to make all kinds of fancy investments. You can borrow, you can lend, you can hedge, and you can speculate outright.

JAY: And, as we know, that had a lot to do with the 1929 crash. And there was some legislation that was supposed to restrict at least the banks getting so involved in that, called the Glass-Steagall Act. So get us into that whole–.

MADRICK: Well, the modern derivatives began to develop in the 1970s. We talked a little bit about it in an earlier episode. But they became integral to financing in the 1990s and the 2000s and the mortgage collapse of the 2000s, because you could make all these hedging investments with insurance, basically buy insurance very cheaply based on these derivatives contracts. In any case, the first scandal we had was 1994. Some in Congress–even Republicans–and the Congressional Budget Office wanted–it was the General Accounting Office–wanted to regulate derivatives, not the Clinton administration, not Greenspan, not the chairman of the SEC, Arthur Levitt, went by the board. Happened again in 1999 when Brooksley Born, head of the Commodities Futures Trading Corporation and something of a hero, wanted to regulate at least some of those derivatives. Not Robert Rubin. Not Alan Greenspan.

JAY: We miss a point here. It didn’t really by this stage matter whether it was the Democrats or Republicans in power. They’re going down the same road.

MADRICK: And the Democrats were, by and large, in power. The Democrats were representing Wall Street interests and believed fundamentally in deregulation based on Friedmanite economic principles. Speculation won’t lead to overprice–lots of fluctuations or overprice commodities; it will ultimately stabilize the markets. Speculation is good. Larry Summers made the argument. Alan Greenspan of course made that argument. Meantime, no regulation. Meantime, banks got bigger and bigger with conflicts of interest.

JAY: Was part of the argument that they internalize, Clinton and his group, that we aren’t in the future’s for–America is not going to be the dominant producer of commodities the way it was post-World War II, so the sector we’re going to control is finance; so let’s free up our banks, let them get as big as possible, and we’ll control the global capital flows?

MADRICK: The dominant part of it, the dominant producer of product after World War II, not–commodities are gold, silver, wheat, and so on.

JAY: Yeah, product, yeah.

MADRICK: I think there was some thinking along those lines, but I don’t think there was much thinking about it. I think they by and large bought into this argument that finance is always good because they provide capital where it’s needed. But it wasn’t working. It stopped working. They didn’t think about it very much. And the economy was booming partly because Clinton made some correct choices, partly because there was something of a technology mini-revolution with the Internet and the web and so forth, but also because of speculation in the 1990s, which induced a lot of consumer spending as stock prices and house prices went up. And it couldn’t be sustained, and it came crashing down in end of 2000, big time.

JAY: Well, talk about Glass-Steagall, the fight about it and the significance of it.

MADRICK: Right. Around that time, Glass-Steagall actually has been coming apart since the late 1980s.

JAY: Okay. Really fast again, for people that don’t know, quick, Glass-Steagall was [crosstalk]

MADRICK: Well, the main part of Glass-Steagall separated investment banks who raised money through the stock markets through stocks, and regular banks that took yours and my savings and lent it out to business. It separated those two kinds of institutions because they had conflicts of interest. Gradually, it allowed big banks, like Bankers Trust or First National City, then called Citicorp and Citibank, to do old-fashioned investment banking, raising some equity a little bit at a time. Gradually, it got bigger and bigger. By the late 1990s, Sandy Weill, head of Travelers, the insurance company, which also owned Smith Barney and Salomon Brothers–huge financial conglomerate–wanted to get together with Citigroup, the biggest bank in the world. What a merger this would be, except they had to end Glass-Steagall altogether, because you couldn’t allow–still an insurance company and a bank couldn’t get together under Glass-Steagall–another aspect of Glass-Steagall. Sandy Weill somehow knew that he was going to be able to convince Congress to do that. He goes to Alan Greenspan. Alan Greenspan says, we’ll give you an exemption for two years. If Congress then decides to do away with Glass-Steagall, you’re fine. We’ll give you a two-year window. Isn’t that great? They went in the back door, by the way, ’cause they didn’t want the press to see what they were doing. This is the power that Alan Greenspan accrued to himself. He had become almost legendary by that time.

JAY: So, under Glass-Steagall–I’m sorry. Under Clinton, Glass-Steagall is repealed.

MADRICK: Done away with.

JAY: Done away with.

MADRICK: And the banks are huge. Now these financial institutions are huge. And people would say–and I interviewed Walter Wriston. He’d say it’s okay because they’re diversified: one business may go bad, but another would be good; it will reduce risk, diversification. It did the opposite because they were diversified, and I still think most of the media and many economists haven’t caught up to this fact. Because they were diversified, they took on even more risk, more risky loans, and there were more conflicts of interest within these companies.

JAY: And part of it is they do it as a herd. So they’re all going into the same kind of areas with the same kind of risks. So when it doesn’t work out, it’s the whole sector; it’s not just one bank.

MADRICK: Right. The herd behavior is partly induced by the same thing that’s created herd behavior in financial markets for hundreds and hundreds of years, tulip mania and so forth. The other part of the herd behavior was just the taking advantage of the system, the regulators, and even outright cheating. Jack Grubman tells us WorldCom is a great business as the price of the stock collapses to under $1 ’cause everyone knows it isn’t. Jack Grubman, the analyst at Citigroup, lying and lying and lying. He will claim to this day he didn’t lie, he just got it wrong. Come on. But it happened over and over again.

JAY: So what’s the significance of the Bush-Cheney administration, that period?

MADRICK: They just–basically, they did nothing about it. They–you know, I–it is conceivable, had the Clinton administration or the Gore administration been in power, they would have started clamping down on some of these practices, they would have recognized some of the excesses of the late 1990s. But there’s no guarantee they would have. And under the SEC chairman [under] George Bush, investment banks like Goldman, Morgan Stanley, Bear Stearns, Lehman Brothers were allowed to expand how much they could borrow without any oversight. They said they would oversee them and they never did.

JAY: Because to some extent it’s–during the Bush administration and the subprime mortgage crisis and all the rest, there were–it’s not there were no regulations. There were regulations. But what they were were never used.

MADRICK: Right. There were enough regulations. If they had been implemented properly, this crisis would not have occurred. If government had a sense of their oversight responsibility, it wouldn’t have occurred. Alan Greenspan had the power to stop fraud in the mortgage market. He just didn’t do it. Even when the FBI came to them–I don’t know if they went to Greenspan, but they made public there was an epidemic of fraud in mortgages. Greenspan thought, I’m not–said, I wasn’t going to get involved with that. Quite remarkable.

JAY: It’s such a gravy train, and so many people of the elite that have the capital to get on that train are riding it, that nobody cared if it was systemically so dangerous.

MADRICK: I think that’s basically what happened. We were all on a gravy train, or so we thought. There were very few critics. You can’t find much word of criticism among the columnists of The New York Times in those years, to take one obvious example, and you’d think there would have been. There was some, there was some talk of excess. You know, I mean, I don’t want to paint too broad a brush. I don’t think anybody, in particular Timothy Geithner, head of the New York Federal Reserve, understood what a collateralized debt obligation was, except the few people who were writing it and who were creating them in those days. It was just a remarkable absence of responsibility, which helped, in the meantime, serve to line the pockets of a lot of the people who were being irresponsible.

JAY: I mean, Gore Vidal has this line about USA, United States of Amnesia. The whole 20th century is bubble after bubble after bubble. It’s not like they know this isn’t going to burst. They actually have to know it’s going to burst. They don’t care.

MADRICK: The thing is, you know, after–there was a point when the bankers would get before the FCIC, the Federal Crisis Inquiry Commission, and they’d say, well, bubbles just happen and they burst and we’ve got to deal with them. You know, that’s the brilliance of capitalism: it allows us to unleash our entrepreneurial, speculative instincts and find great new businesses. Except it didn’t really happen. That whole period–and this is key, and your viewers should understand this–over this period, the economy did not perform well. If they were right, the Jamie Dimons and Alan Greenspans of the world, the economy would have performed well. We would have had a crisis, but we would have had so much muscle building up that crisis that we would have created a great economy. We did not. Wages by and large stagnated. Men, the typical man today makes less than the typical man of the same age in 1969, adjusted for inflation. Productivity, the heart of economic growth, output per hour of work, did not grow rapidly but for a few years in the late 1990s. When it started to grow rapidly in the 2000s, it was all at the expense of jobs, not because of great improvements and new ideas, but inefficiencies and basically taking the hide out of the worker, keeping wages down.

JAY: And taking demand out of the economy.

MADRICK: And that’s my [incompr.] I wrote a book called Why Economies Grow. The neglect of the use–the importance of demand on the economy by the economics profession has been extraordinary and one of the causes, I think, of our problems and our misunderstandings about how to run the economy.

JAY: Well, it’s one of the reasons–I think the reason you can make more money in the speculative side, in the parasitical side, than the productive side is ’cause there’s no real–there’s so little demand in the real economy, you might as well just go gamble with other rich people and see if you can bet better than they do [crosstalk] economy.

MADRICK: Well, I think that that is the circle. If you don’t have wages high enough to where people are going to buy new goods and services, you’ve got a problem. I think it’s a problem. There’s an interesting–I don’t know if we should talk about it, but there’s an interest–would be an interesting debate on the progressive side. The old Marxist argument has always been that productive opportunity will always decline, will always diminish, and therefore people will make financial investments and build the financial sector. That’s by and large the Marxist view. My view is a little different, and you and I may agree on that. When you can cheat and there’s corruption and there’s no regulation and no sense, it’s so easy to make profits on the finance side that you neglect the riskier, harder-to-predict investments in the productive side of the economy.

JAY: And maybe no better example of that right now than the carry trade, where the Fed puts money into the banks in order to supposedly give them money to loan into the productive sector of the American economy. But it makes more money for you to take that money and go to Brazil and make three points on money you’re paying zero for.

MADRICK: Yeah, or wherever.

JAY: And the hell with the American economy.

MADRICK: Or wherever. You know, the idea–TARP did staunch the hole in the economy at the time.

JAY: But Q–you’re talking about these QE2s and all of this.

MADRICK: Yeah. But it did not force the banks to start lending again, and that really is the big problem. And it [incompr.] loans. You know, there are movies and all this kind of–books about this. TARP alone did not save the economy from going into depression. It was TARP plus QE2, all that stuff the Fed did, up to trillions of dollars of guarantees, and the Obama stimulus.

JAY: Okay. Well, the next segment of our interview, we’re going to talk about where we are, the Obama years, and what the current risk is to the rest of us. Please join us for the next segment of our interview with Jeff Madrick on The Real News Network.

End of Transcript

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Jeff Madrick is a regular contributor to The New York Review of Books, and a former economics columnist for The New York Times. He is editor of Challenge Magazine, visiting professor of humanities at The Cooper Union, and senior fellow at the Roosevelt Institute and the Schwartz Center for Economic Policy Analysis, The New School. His last book, The Case for Big Government (Princeton), was named one of two 2009 PEN Galbraith Non-Fiction Award Finalists. His new book is titled, Age of Greed, The Triumph of Finance and the Decline of America, 1970-Present and is published by Alfred A. Knopf.