Both sides now
By Daniel M. Ryan
If you ever wanted to spot out a liberal, there's one reliable way. The liberal mind has one distinguishing stamp: when a liberal sees mercantilism, he calls it "capitalism." When the liberal sees Lyndon Johnson-style interventionism, where market forces are channelled to service government demands, she calls it "laissez-faire." Liberals have a real blind spot that renders them unable to tell the difference between a true free-market economy and one that's overseen by the government boss. I don't really mean to compare businesspeople to dogs, but it's as if liberals see a loose-leashed dog and call it wild. The reason why is liberals' odd devotion to command-and-control economic micromanagement by government. They being control freaks, they confuse loosening leashes with unleashing.
Gretchen Morgenson and Joshua Rosner, the co-authors of the new book Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, either share that bias in a mild form or are trying to reach those who do. Their overall narrative is moralistic, and they unsurprisingly think that the regulatory leash was too loose. What makes their book far more interesting than a standard moralization fest is the journalistic and analytical skills of the pair. Rather than flaying Alan Greenspan for rhetoric significantly at variance with the behaviour of the Fed under his watch, rather than thinly displacing resentment over President Bush winning two elections, rather than lazily assuming that libertarianesque rhetoric matches the reality of near-universal interventionism, rather than childishly assuming that the regulatory bureaus are the houses of Hogwarts and Lloyd Blankfein is Lord Voldemort, the two have come up with a book that's unusual and commendable for its depth. Without knowing it, they've penned a real indictment of American mercantilism.
Most people know mercantilism only through popularized snippets of Adam Smith. They see, albeit understandably, the part and assume it's the whole. Mercantilism is more than trade policy that seeks advantage over other nations. Its ideal is government-business partnership, with market forces being used as a more efficient tool to implement government policy and government policy focused on boosting economic growth. Mercantilism can be as crude as government sponsoring privateers to loot rival nations' cargo ships, or as refined as tariff policy designed to encourage infant industries at the expense of foreign competitors (and domestic consumers.) It can be as broad-brushed as England's answer to minimal government, where the Minister was the department, or it can be as encompassing as the army of planners built up by Jean de Colbert. The original mercantilists used accumulating gold (trade surpluses) as a proxy for wealth because they had no national income statistics. Once this point is grasped, the connection between the mercantilism of old and today's can be seen. Yes, gold in the Treasury was seventeenth-century mercantilists' answer to real GDP growth. And yes, the pioneers of government statistical surveys were the French Colbertistes. They were pikers compared to modern governments, but the same mercantilist impulse sways both.
Morgenson and Rosner's main villain, surprising for a book seemingly aimed at liberals, is one of the biggest success stories of current American mercantilism; he's a lifelong Democrat. James Johnson, former CEO of Fannie Mae, is almost an ideal type of political businessperson which thrives in a mercantilist economy. His version of "doing well by doing good" is doing well by occupying the political high ground. When he took over Fannie in 1991, the political high ground was turning towards alleged discrimination in the mortgage market against low-income applicants and minorities. What kicked off the loosening of lending standards that birthed the residential real-estate bubble was a 1992 report from the Boston Fed that claimed minorities were being discriminated against by banks when applying for mortgages. The flaw in the report, the fact that minority default rates were the same as non-minority default rates, was ignored in the firestorm it kicked up. (Had minorities been discriminated against, their default rates would have been significantly lower than non-minorities'. A lower default rate means that more restrictive criteria are in place. The same default rate means that equivalent criteria are in place.) Rebuttal papers, which pointed out the report's crucial misinterpretation of the lack of differential default rates, were as much listened to as 1990 rebuttals pointing out the flaws in the global-warming model. Housing lower-income Americans became the political high ground – and James Johnson was a veritable genius at occupying it.
This is the bargain he carved out: in return for special privileges for Fannie, most notably relaxation of capital-cushion requirements, exemption from disclosure regimens that other public companies had to follow, lighter regulation and implicit guarantees of Fannie-issued debt by the U.S. Treasury (which became very explicit in late 2008), Johnson would direct Fannie to buy up and securitize more mortgages made by lower-income and minority recipients. He would also allocate some Fannie's shareholders' money towards affordable-housing grants. Johnson knew very well where his bread was buttered, and he built up quite the lobbying machine to safeguard Fannie's privileges. Crucial to his lobbying success, mostly used to fend off attempts to privatize or rein Fannie in, was the fact that Johnson let Fannie Mae be a willing mercantilist tool for the lofty goal of affordable houses. Freddie Mac got the same deal, but its CEO was content to sit in the back seat of Johnson's cruiser. James Johnson was the man behind the wheel.
Crucial to the public-private partnership approach, although unmentioned by Morgenson and Rosner, was the fact that the public-housing option had left behind a morass of decrepit, deteriorating urban jungles. Had the government-only approach not failed beforehand, Johnson wouldn't have had his chance. Nor would he have been hailed as a veritable miracle worker by many of his fellow Democrats, including some names that will make conservatives chortle.
Conservatives who were castigated as "wingnuts" two years ago for mentioning the Fannie Mae/ACORN nexus, will find themselves richly vindicated by this book. ACORN receiving lavish grants from Fannie in exchange for talking them up is well documented. So are similar deals made with other purportedly public-interest groups.
Fannie Mae's role as a trailblazer for lowered lending standards is well presented by the authors. They don't quite make it clear that the various bullies and sleazes they castigate were enabled by occupying the high political ground, but they supply enough facts to make the connection evident. They do point out that other banks levering themselves up was in large part a competitive response to Fannie's much higher leverage. Unfortunately, they don't point out often enough that the so-called predatory lenders could justify their actions by saying that they too were bending every which way but tight to house Americans who were normally shunned by mortgage lenders. That's the dark side of mercantilism: lofty goals providing protective shielding for low cunning. The political high ground making sceptics, doubters and realists look like the bad guys - and turning opportunistic bullies into moralizing bullies.
Their narrative sometimes grates, as they have a residual fondness for economic command-and-control that sometimes pops up. They also can't admit when one of their bad guys does the right thing, so this book occasionally has to be put up with.
More seriously, their proposals for reform amount to little more than a yearning to go back to the good old days of suspicious regulators, Glass-Steagall and small banks. They want the regulators to be proactive in stomping out bubbles, which is problematical. Bubble-spotters are typically two to four years early. What would have happened if Alan Greenspan had followed his "irrational exuberance" speech in December 1996 with a clampdown in January of 1997? Where then the Internet?
Unmentioned by all the Greenspan-bashers, and even Greenspan-skeptics, is the fact that Greenspan was four years early. His later, much-ridiculed claim that the Fed can't spot a bubble until it pops was likely prompted by the fact that he looked like a fool all through 1997 and had his nose rubbed in it.
Although there are solid arguments to be made for popping a bubble early, as late-stage bubble projects are typically malinvestments, the sad fact is that it's impossible to tell which is the bathwater and which is the baby. There's also the fact that even genuine Schumpeterian waves of innovation look like bubbles to those who lack the imagination to see their revolutionary potential at the time. It isn't just overly permissive regulators who get stuck in the past. That's why so many bubble-decriers end up looking like the boy who cried wolf and being treated like Cassandras. It's a long, long wait until the bubble finally pops and they finally have their chance to say "I told you so."
Canada dropped its version of Glass-Steagall in 1988, and has a much more concentrated banking sector than even the America of 2007. No Canadian bank failed in '08, just as no major Canadian bank failed during the Great Depression. No less an authority than Joseph Schumpeter said that Canadian banks were resilient because they were (and are) nation-spanning big and thus much more diversified than small banks. Canada is not America, of course, but the resilience of the Canadian financial sector does put a question mark on two of Morgenson and Rosner's three solutions. Suspicious regulators having a track record of stifling genuine innovations puts the question mark on their third.
Frankly, there is no ideal remedy. True laissez-faire would require a lot more diligence, and a lot less trustingness, that is the norm today. Despite the authors' sometimes wistful dreams, bureaucrats do act bureaucratically. A system where the bureaucrats are the top dogs will, and does, stifle innovation. Reckless Endangerment is very good at detailing the problems that arise when politicians are in charge.
But we're still left with Hobson's choice. That said, Reckless Endangerment is a very good read because of its facts. Sadly, as with all the books in its genre, it will not prevent the next crisis; at best, it can provide some raw material for spotting the next one…if it's read imaginatively and its narrative is treated sceptically. The next bubble is never like the last one.
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