Yves here. Having lived through some of these developments, I concur with Krippner’s observation that financial deregulation was well underway prior to the Reagan era and the most important driver was interest rate volatility, which wreaked havoc with interest rate caps and other policies that made sense only if inflation stayed within a limited and not all that high range. But similar deregulatory forces were underway in the securities industry side as well. The New York Stock Exchange dropped its requirement that NYSE firms be partnerships in 1980. Partners in general partnerships are exposed to unlimited liability, which produced a generally conservative, long-term perspective towards managing their firms. Another sea-change was the deregulation of fixed commissions on stock trades in 1975, which greatly thinned the ranks of brokerage firms and accelerated the rise of integrated securities firms (ones that participated in stock and bond underwriting, trading, and sales).
By Matt Stoller, who writes for Salon and has contributed to Politico, Alternet, Salon, The Nation and Reuters. You can reach him at stoller (at) gmail.com or follow him on Twitter at @matthewstoller. Originally published at Observations on Credit and Surveillance
I just got done reading the wonderful book Capitalizing on Crisis: The Political Origins of the Rise of Finance, by University of Michigan historical sociologist Greta Krippner. I say wonderful for a reason – Krippner brings enormous and very necessary depth to the financialization of America, a subject which has been treated with far too much superficiality since the financial crisis of 2007-2009.
To understand why this is such an important book, it’s useful to start with how our understanding of deregulation informs today’s political debates on finance. The financial crisis was such a momentous event, and the various blame games going around among politically interested parties, left a vacuum for a historical narrative. There are several popular theories about why the crisis happened. Most start with this undefined thing called financial deregulation. There’s a right-wing argument about the Community Reinvestment Act and how the crisis began with Fannie and Freddie, but there’s no empirical basis for that thesis, so I won’t touch it in this review.
So let’s start with deregulation. Krippner in her account really defines her terms and brings us through the narrative step-by-step. Her attentive account shows how financial deregulation – the removal of laws key to the New Deal system of political economy – started in the late 1960s. Much of the architecture of the political economy of financialization, the decision-making that would or could take place when credit markets were ascendant – was in place by 1980. She shows howthis architecture was designed by state actors, with a meticulous grounding in original sources.
According to Krippner, deregulation wasn’t a nefarious set of choices by Reagan and his Republican banking cronies, it was a response by a policymakers (a Democratic Congress and Democratic President) to the failures of the liberal state. After it was put in place, Reagan of course was a key player in setting its direction. Along with Paul Volcker and Alan Greenspan, Reagan took financialization in unexpected directions, but the basic contours were clear before Reagan came to power.
In my conversations with policymakers who were working at the time, such as Jane D’Arista, and in my readings of 1960s and 1970s Congressional hearings, the timing seems accurate. For example, long before usury caps were removed in 1980, Nixon pushed for their removal and Congressmen like Wright Patman complained about how credit cards were making usury caps obsolete. The Supreme Court’s 1978 Marquette decision, which helped deliver the death knell to the old regulatory model, was a move by the judicial branch, not regulators or politicians. And the plaintiff, Marquette bank, sued as far back as the early 1970s. Change to the New Deal political economy was in the air, due to inflation. Perhaps a President less conservative than Carter would have wrought a different kind of change, and Carter did face a Kennedy primary in 1980. But Krippner’s book is the first account of changes in our political economy that actually explains the roots of financialization in terms of the inflationary periods of the 1960s and 1970s.
This is in slight, though not entire, contrast, to several other strains of thought. The argument popularized by Inside Job filmmaker Charles Ferguson and Roosevelt Institute fellow Jeff Madrick in his book Age of Greed is that financialization occurred because of a nefarious set of players who sought to reorganize society on a social darwinian model. This is the Gordon Gecko narrative, that greed is good. Another argument, broached by Tom Ferguson and Sidney Blumenthal in the 1980s, and then popularized in the 2000s, is that the conservative movement was the result of a group of far-sighted and well-funded businessmen who saw in the 1970s rise of Ralph Nader politics an implacable set of enemies who needed to be defeated in the realm of ideas. But this isn’t entirely fair – one thing I learned from Krippner’s book is that Ralph Nader, among other consumer advocates, supported financial deregulation, specifically the end of Regulation Q, which capped interest on savings accounts.
A simple way to state Krippner’s thesis is follows. In the 1970s, politicians got tired of fighting over who would get what, and just turned those decisions over to the depoliticized market. This is known as ‘financialization’. Then political leaders didn’t have to say “no” anymore to any constituency group, they could just say “blame the market”. It’s very much akin to the rationalization for inequality one hears from elites these days, that it’s globalization and technology, as if those are just natural trends with no human agency or decision-making involved.
To state her thesis in a less glib manner, it is as follows. The state, in the 1960s, was confronted with three interrelated problems – social, fiscal, and legitimacy crises – and that financialization provided an inadvertent mechanism to deal with them. After World War II, the United States was the only industrial base standing, so its corporations had pricing power and could pass on labor costs to the rest of the world. Social problems could be solved with the standard American lubricant of growth and then dividing the spoils among the groups grasping for them. But as American competitiveness declined in the 1950s and 1960s, and due to the “guns and butter” strategy of LBJ’s financing of the Vietnam War, this growth model began failing. The result was that inflation kicked up, and inflation provided the means by which the state could effectively deny resources to constituency groups without explicitly doing so. In other words, dealing with fewer resources created severe pressure on the New Deal liberal architecture of decision-making, which first revealed itself as inflation.
Krippner is careful with definitions, and she’s interested in financialization – or as she puts it, “the growing importance of financial profits in the economy.” She first establishes that this is a real trend. Financialization is not just the rise of the mega-banks, or private equity firms, but the increasing importance of financial profits to non-financial firms. Ford and GM in 2006 made more money on auto lending than making cars, which is an example of financialization. It’s a clear trend, and one she establishes persuasively. Not only did American financial corporations take in 40% of all aggregate profits in 2006, but finance is a critical profit source for many other firms like GE.
Her story accords with what many of us now know. Firms like Google and Apple aren’t just technology firms, they are also financial, and use sophisticated money management techniques to manage large cash hoards. I once asked the President of Darden Restaurants whether his firm used derivatives, and he told me, of course. It turns out his background was in investment banking, not restaurants. As Barry Lynn once told me, American companies used to be managed by engineers, today they are managed by bankers. That is the story of modern corporate America, but it wasn’t the story before the 1980s.
Krippner goes on to describe why the old financial system fell apart. The New Deal system of finance had a series of speed bumps and firewalls across it, so that credit for certain activities had to come from certain institutions. The most well-known of these firewalls was the split between investment and commercial banks, or Glass-Steagall. But there was a far more comprehensive structure involved, which set in place interest rate caps on savings accounts (Regulation Q), deposit insurance, centralized monetary policy in the Federal Reserve Board of Governors, and implemented a slew of disclosures in the securities market. The net effect of this was a heavily partitioned and regulated financial sector. If you wanted a mortgage, you got it from a savings and loan, or thrift. Businesses borrowed from commercial banks, companies underwrote securities and bonds through investment banks. Finance companies delivered consumer credit, retailers offered installment loans, and so forth. There was some blurring of lines, but not much.
Regulation Q, or the cap on interest on savings accounts, was, as Krippner put it, “at the heart” of the system. By prohibiting banks from bidding for deposits, Regulation Q prevented the creation of a credit market, where supply and demand determined the interest rate. What Krippner doesn’t mention, but should have, is that this was due to how the banking system collapsed in the run-up to the 1929 crash. Banks at the time were parking their excess funds in high-yielding accounts of New York banks that were in turn making call loans to stock market speculators. This daisy-chaining of the banking system allowed the stock market crash to cascade throughout the entire system, leading to runs on banks as depositors feared their money had been lost. It was the 1929 version of systemic risk, and paralleled what happened in 2008 with mortgage-backed securities and money market funds. Regulation Q was designed to prevent this from ever happening again.
What Regulation Q also did, according to Krippner, is that it provided a ‘balance wheel’ for the economy. When the economy did well and interest rates went above Regulation Q caps, people withdrew deposits from savings accounts and put them in Treasury and corporate bonds. As deposits fled thrifts and banks, credit to the consumer economy was shut off. This could work in reverse as well, savings returned when interest rates dropped.
Inflation, however, destroyed this system. Inflation caused credit crunches routinely. Savers were getting wrecked as their savings yielded less than inflation, prompting anger. Consumer borrowers were also angry when they couldn’t get credit at any price, simply because they were trying to borrow off-cycle. Similarly, state and local finances were hamstrung because they couldn’t borrow at particularly high rates, so capital to those entities dried up even when riots and violence were routine.
There were serious problems on the supply side as well. With inflationary-induced instability in the credit markets, banks and financial institutions innovated to get around Reg Q to fund lending. They used the Eurodollar market, commercial paper, and certificates of deposit. The government tried to stabilize the mortgage market by creating Freddie Mac and mortgage securitization in 1968, the first in a series of attempt to help the less-nimble thrifts that had long-term mortgages on their books. But with high inflation, financial institutions kept finding new ways of bidding for credit, and policymakers were continually forced to decide on whether to bring those new instruments into the regulated financial sector or allow the creation of a national free credit market. There were abortive attempts at a variable mortgage, an early precursor to the adjustable rate mortgage (ARM), but these brought fierce consumer opposition.
As this struggle continued throughout the 1970s, consumers began taking up a larger and larger role in the struggle for deregulation. The Consumer Federation of America, Public Citizen, and the AARP argued that with inflation over 10% a year, the public was losing money on deposits, and would gladly accept higher borrowing costs in return for higher savings rates. So in 1980, Jimmy Carter was persuaded to simply gradually eliminate Regulation Q in the The Depository Institutions Deregulation and Monetary Control Act. This was also the bill that formally ended usury caps.
The debates and fights in the 1970s were the most interesting part of the book to me, since no one has really covered them comprehensively. Krippner effectively tells a (slightly) more well-understood story of finance in the 1980s. Reagan cut deficits and raised defense spending, which Paul Volcker feared as inflationary. So Volcker slammed on the monetary brakes, pushing interest rates to nearly 20% to crimp inflation. With no regulatory firewalls or speed bumps, it was all up to monetary policy. Policymakers feared that high government deficits would lead to massive inflation, because Reagan was even more than his predecessors not making choices about social priorities. But high interest rates, plus the recent deregulation of the Japanese financial system, led to a massive inflow of capital into the United States from Japan. This meant that Americans could buy credit in any amount they wanted, even though it would be quite expensive. There would be no more credit crunches, just high interest rates.
Of course, the international capital flows and high interest rates had other consequences. The dollar spiked as the Japanese bought dollars, leading to the destruction of American manufacturing. And companies could make more by putting dollars into financial instruments than investing in their businesses. American finance profited, and non-finance companies like Sears tried to become finance giants. Credit was big business again.
Aside from these trenchant observations about the Reagan economy, Krippner also analyzes decision-making at the post-1970s Federal Reserve. She notes that Paul Volcker disingenuously adopted ‘monetarism’ as a method of shielding the Fed from political blowback from its induced harsh recession of the early 1980s. This kind of avoidance of explicit responsibility continued during the Greenspan era, as Greenspan sought to position the Fed as ‘following’ the markets rather than leading them. One gem in a footnote is a Krippner interview with Janet Yellen, in which Yellen says she heard Robert Rubin in the 1990s arguing the Fed was irrelevant.
The era of financialization was not letting the market decide, it was, as Krippner argues, a specific form of ‘neoliberal statecraft’. It was governing without consent of the governed, by depolitizing decisions to a state-constructed market. And for a time, it did defray the social, fiscal, and legitimacy crises that politicians in the 1960s and 1970s couldn’t solve. But that time, as our episode of bubbles and crashes and frauds suggest, is over. We will have to create an architecture of decision-making once again, to solve the problems earlier politicians wouldn’t and couldn’t. The fight over resources, as Occupy Wall Street reminded us for a time, is perennial.
Sociologists at their best are detail-oriented scholars of technocracy, people who can play in the sandbox that economists set up but explicitly choose to recognize modern economics as the giant power-ignorant witch-doctor con that it is. Krippner is polite about this, but she’s also clear that politics and not efficiency was the motivating factor behind the rise of finance in America (and the global) political architecture since the 1970s. But for all her superb work, which includes reading every single public meeting of the Federal Open Market Committee and it seems like every single hearing in Congress in the 1960s and 1970s, I found myself unconvinced on two fronts.
One, as Jeff Madrick noted in The Age of Greed, the era of financial deregulation started with National City’s development of the CD in the 1950s, and the Eurodollar market at roughly the same time. The regulators allowed these ‘innovations’, but they didn’t have to let these first cracks in the dam to remain un-repaired. Similarly, one could note the same thing about the explosion of bank cards in the 1960s, which the bank regulators ardently defended throughout the era. It’s obvious they wanted a national credit market, and they wanted their banks to control it.
And two, Krippner argues that the shift to finance as dominant was an inadvertent response by policymakers to a difficult set of circumstances. Surely, pushing inflation into the financial architecture of the 1960s and 1970s caused massive problems, and created the preconditions for inevitable reform. But she doesn’t prove that financialization was inadvertent.
People like Citibank’s Walter Wriston were empire builders and had been working at financialization for decades, and organizers in the industry like Andrew Kahr (who invited credit card data mining) were intent on tearing down financial regulations for ideological reasons. Perhaps some of the politicians that made these decisions didn’t know what they were doing, but that doesn’t mean that all residual memory of the 1920s and 1930s was gone. It wasn’t. And it certainly didn’t mean that the traditional American suspicion of the banking industry just ended in the 1970s. Finally, it’s not like people didn’t know that Alan Greenspan was involved in overlooking accounting fraud during the Savings and Loan scandal, before he was appointed Fed Chair. He was a well-known social climber and charlatan in DC. To believe that financialization was inadvertent is to take the same leap of faith required when asked to believe the financial crisis was due to a lot of greedy lenders and borrowers all getting greedy at the same time instead of recognizing manipulation in the capital markets.
Nonetheless, this book is a spectacular achievement, empirically grounded and remarkable in its depth and historical scope. Capitalizing on Crisis, is a discussion of the rise of finance in America since the 1970s, and is one of the first satisfying accounts I’ve read of why it happened. I enjoyed it immensely and learned a great deal. Congrats to Professor Krippner.