But no one is talking about nationalizing American business, right? There are no decrees transferring businesses from private ownership to government “ownership.” And no panicked flight of capital or despairing businessmen.
And yet, the largest sector of American enterprise, the sector at the heart of capitalism because it is at the heart of investment, the valuation of companies, and the exchange of commodities and money worldwide, is being nationalized—rapidly, massively, and perhaps irreversibly. The financial sector, Wall Street—the worldwide historic icon of capitalism—is far along the road to government control and de facto ownership.
Adding Up the Trends
In a sense, the steps have been obvious, but an article in the Economist
“put it all together” for me. It appeared on May 26, in the famous “Buttonwood” column (named for the tree under which the first, rudimentary ‘stock market’ began in New York City, seen as the precursor of Wall Street). Its title was “ The Nationalisation of Markets: The Rise of the Financial-Political Complex
The article identified trends reported daily, but made the point that the scale of those trends, the extent to which they shape the financial industry, and the dependence of the financial industry on them amounts to the “creeping nationalization” of that industry. The steps by which this is occurring are complex in their interactions and nearly untraceable in their full effects—but sweeping in scope.
Please consider my article not an analysis of this complex process, but an alert: a warning to heed what is befalling the financial sector and to oppose it.
Growth, Dominance, Takeover
The financial industry is the single largest sector in the U.S. economy as measured by the weighting of financial stocks within the flagship S&P 500 Index of the country’s premier companies. For many years, up to 2008, the financial sector kept growing until it reached 21 percent of the S&P 500 index. With the financial panic of 2008 and the crash of 2008-2009, the capital of financial companies plunged and so did their weighting in the index. Briefly, technology became the largest sector; but, by 2010, finance was moving again into first place.
Please consider my article a warning to heed what is befalling the financial sector and to oppose it.
None of this timing is accidental—either in terms of the growing dominance of the financial sector or its accelerating takeover by government. As many industries (such as health care) have discovered, the earliest government involvement often super-charges growth and profits, as government funds pour in and government acts to privilege the industry in the market. Later comes the government control, always with the argument that, since government has a huge stake in the industry, it must regulate it. Soon, the inevitable economic distortions caused by government intervention (such as soaring prices of medical care services as a result of offering them free of charge to millions of people and adding the expense of many layers of government bureaucracy) breed crises—and government steps in as savior.
This pattern has occurred in the financial industry. Starting in the early 1980s, the United States entered a generation-long credit expansion. Since 1981, bank credit as a percent of GDP has increased from 40 percent to 65 percent: that is, credit relative to the size our economy is almost two-thirds larger. Most of this credit growth occurred in the past decade, as banks went on a lending spree fueled by plentiful, almost interest-free money from the Fed. In 2000, after the bursting of the stock market technology bubble (especially the frenzied investment in new “.com” enterprises), the Fed came to the rescue of the market with historically low interest rates. Over the next decade, the Fed watched its policies inflate a vast credit bubble in the real-estate industry; but the credit expansion also affected the balance sheets (savings, borrowing, and debt) of consumers, businesses, and state and local governments. In 2008, that credit bubble burst, precipitating the first full-scale financial panic since 1907, a sickening plunge in the stock markets, and, subsequently, the deepest and most persistent recession since the Great Depression of the 1930s.
Again, the process was immensely complicated—and that is part of the reason that government’s accelerating involvement, and now its virtual nationalization, of the financial industry is so difficult to oppose. For example, in the bitter aftermath of the 2008-2009 panic and stock market crash, as the country slid into recession, many blamed the disaster on the greed, mismanagement, and irresponsibility of bankers, real-estate companies, mortgage brokers, and investment bankers.
Banks went on a lending spree fueled by plentiful, almost interest-free money from the Fed
.But “greed,” the desire for profits, is ever-present in the economy and motivates its growth, the success of companies, and the creation of wealth. And mismanagement, irresponsibility, bad practices, and fly-by-night companies are always present, too. The question is: how did these problems become so widespread, influential, and ultimately almost ubiquitous in the real-estate field (and in the banks, brokers, insurance companies, and others with investments tied to that field)? The answer, in large part, is that the huge credit expansion driven by the Fed—and exacerbated in real estate, in particular, by two government-created agencies with the now-infamous names “Fannie Mae” and “Freddie Mac”—pushed the industry into over-drive, and, at the same time, disabled all the usual restraints such as rising interest rates, increasing risk-aversion, and lack of additional capital for investment.
In summer 2008, as the huge real-estate bubble, and all the financial instruments based on it—many packaging or “securitizing” increasingly shoddy mortgages—began to burst, sheer panic seized the markets. The unfolding of these events is well known, now.
The Treasury and Fed made truly unprecedented investments of taxpayer money in financial firms—a “rescue” for which many (but not all) financial executives pleaded.
This was the pivotal moment when, having intervened for years in ways that distorted the real-estate industry and involved the credit and home values of consumers as well as the investments of banks, brokers, and insurance companies worldwide, the government stepped in to save the financial industry (and, it was claimed, the entire international financial system) by arrogating to itself enormous powers. The nationalizing of the financial sector began in earnest.
In the dark days of the panic in fall 2008, the U.S. Treasury, the Fed, and other government agencies held virtually non-stop meetings with executives of America’s largest banks, investment companies, brokers, and insurance companies at which they decided the fate of firms such as Bear-Sterns, Lehman Brothers, Bank of America, Merrill Lynch, American International Group (AIG), Washington Mutual, and dozens more. At the same time, the Treasury and Fed made truly unprecedented investments of taxpayer money in financial firms—a “rescue” for which many (but not all) financial executives pleaded. Reluctant to act, at first, Congress became panicked—as the markets plunged seemingly endlessly—and approved hundreds of billions of dollars for the financial industry.
Creeping, then Galloping, Nationalization
That was the dramatic phase of the nationalization, the fireworks of the takeover. In a sense, it was presented as being reversible, with companies obligated to pay back the huge government infusions of cash to regain their independence. The more thorough, systematic government assumption of effective control of the financial industry unfolded during the long recession that has followed the panic and crash. I will cite only a few broad examples:
First, in its historic role as “recession” fighter, the Fed periodically had lowered short-term interest rates (the only rates it directly controls) to expand credit, spur bank loans, and relieve debt-stressed companies and consumers. These typically were short-term measures, with the Fed then moving to raise rates as the economy improved. But as the current deep recession has dragged on, the Fed has announced that it would keep short-term interest rates effectively at zero for years—until 2014 was the latest decision. And it has moved to use its powers to influence long-term rates, as well.
Interest rates affect the cost of borrowing and what bank depositors can get for their deposits; they help to determine banks' profits; they are the motor of the huge debt market (government and corporate bonds, for example); they directly affect the valuation of stocks (which compete with bonds as investments); and they have other fundamental functions in the economy. But, today, increasingly, it is not the market but government that drives interest rates.
Second, government, always big in the bond markets, has become increasingly dominant. In order to borrow, government always has sold its short-term and long-term debt—now trillions of dollars. Increasingly, in recent years, that debt has been purchased and is now held by foreign governments, including those of China, Japan, the United Kingdom, the Arab countries, and Brazil, who are holding the debt for political reasons rather than based on an expectation of private profit. Furthermore, during the recession, the Treasury and Fed became purchasers of private debt, spending hundreds of billions of dollars buying “distressed” mortgage-backed securities and other types of debt with which banks, brokers, and insurance companies were stuck. As a result, the American government became the owner of this otherwise unmarketable debt.
The terrified banks used the Fed’s money to buy government debt.
In addition, though, as the Buttonwood column points out, as the Fed flooded the banking system with money, including by means of pure money creation, the banks responded by purchasing government bonds. That’s right; instead of making loans that were supposed to “get the economy moving,” the terrified banks—not knowing who could or could not repay loans in the still chaotic financial system—used the Fed’s money to buy government debt.
Third, the Fed has made the entire U.S. stock market (and, as a side effect, stock markets worldwide) dependent on its policies. In the depths of the stock market crash in mid-2009, the Fed announced aggressive interest-rate cuts and other policies to inject money into the economy. The stock markets rallied powerfully through the last half of 2009 and throughout 2010. As the Fed’s announced “easing” policies came to an end, however, the markets sagged and then began to plunge. Accommodatingly, the Fed announced the next round of cash injections, this time by means of “quantitative easing,” a policy unprecedented for the Fed and far more boldly inflationary that the Fed's long-established policy of creating funds to buy back government debt (“Open Market operations”). The markets again rocketed. For the first time, a Fed chairman, Ben Bernanke, actually stated—in an Op-Ed article in the Washington Post
—that an explicit goal of the Fed was to boost the stock market and so create profits that would be spent and stimulate businesses.
The Fed has made the entire U.S. stock market (and, as a side effect, stock markets worldwide) dependent on its policies.
The response of the economy itself to this huge “stimulus” (the financial field is full of euphemistic terms for government actions) has been unclear—but never very strong and with scant effect on, say, unemployment. But any chart setting side by side the timing of the Fed’s easing and the rise and fall of the stock market indices makes abundantly clear that the markets of the world’s largest, most important financial system now respond like Pavlov’s dogs to the actions of the Fed.
As of this writing, the Fed has sought to yank the markets out of yet another decline in spring, 2012, by a rather weak third round of easing.” This time, the response of the markets has been disappointment, but expectations are that, as the economy continues to weaken, and the November Presidential election nears, the Fed will re-launch full-scale “quantitative easing.”
The Regulators Take Control
Lastly, as government money and activity became dominant in interest rates, debt, and the financial markets—three keys to the economy—the government also created and enacted, on largely party (Democratic) lines, legislation that gave Congress and the executive branch virtually unlimited power to regulate and reorganize the entire U.S. financial system. The Dodd-Frank bill was passed by a Democratic Congress and on July 21, 2010, President Obama signed it into law. The 869-page “Wall Street Reform and Consumer Protection Act,” which the Wall Street Journal reported will require 387 sets of rules to implement, creates an omnibus federal oversight committee charged with identifying ”potential threats to U.S. financial stability” and with “regulatory proposals affecting integrity, efficiency, competitiveness, and stability of the U.S. financial markets.”
What business, market, activity, or organization in the entire financial sector
cannot be regulated, changed, or overridden in pursuit of “financial
stability,” “efficiency,” and “competitiveness”? The answer is nothing
and no one
in the entire industry is outside the purview of Dodd-Frank. Just to list the headline
new agencies, regulatory powers, and responsibilities—for corporate governance, executive compensation, bank policies, credit agencies, hedge funds, financial advisers, and dozens more—requires a long paragraph. But such a list is almost irrelevant to the significance of Dodd-Frank: It arrogates to government unlimited power
over the country’s largest industry. And, commensurate with this power, commentators have pointed out, the new committee has a potentially unlimited budget and staff because it is authorized to call on the funds and personnel of dozens of huge government agencies. (A summary of the legislation
is provided by Harvard Law School.
The clear implication of Dodd-Frank is that if bureaucrats control everything, then no new crisis can develop. Of course: the premise that led to the legislation is that insufficient regulation permitted the 2008 crisis to occur. In a superb critique, called “Too Big Not To Fail,” the Economist noted that the legislation is 848-pages long, but the section on the “Volcker rule,” intended to prevent banks from taking excessive risks with their own (proprietary) trading and their investments in hedge funds, is a mere 11 pages. But five federal agencies responsible for making rules to implement the section “put forward a 298-page proposal which is, in the words of a banker publicly supportive of Dodd-Frank, ‘unintelligible any way you read it’. It includes 383 explicit questions for firms which, if read closely, break down into 1,420 subquestions..”
To implement another section of just a few pages, two agencies issued “ a form to be filled out by hedge funds and some other firms; that form ran to 192 pages. The cost of filling it out, according to an informal survey of hedge-fund managers, will be $100,000-150,000 for each firm the first time it does it. After having done it once, those costs might drop to $40,000 in every later year.
Get the point? If any matter, however small, is left unsupervised and unregulated by bureaucrats, something might go wrong. This was the wisdom of the Democratic majority in Congress in 2010—and, after all, what crisis did Congress ever precipitate, unless you count the national debt, runaway spending, and crushing taxation—to mention only a few.
The Dodd-Frank legislation makes the next crisis not less likely but virtually inevitable.
Like every quantum leap in government power, Dodd-Frank became possible in an atmosphere of crisis—a crisis blamed on private enterprise in a climate of public fear, anger, and confusion. But, as we have discussed, here, the causes of the crisis—not the particular
nature of the mistakes, excesses, and shoddy dealings, but their scope
, engulfing the entire U.S. economy and, indeed, the world—are found in the policies and actions of government over more than three decades. Therefore, the Dodd-Frank legislation makes the next crisis not less likely but virtually inevitable.
After all, what is there in Dodd-Frank to guard against the “financial instability” caused by virtually zero interest rates enforced year after year by the Fed? What will guard against the “financial instability” caused by trillions of dollars in new debt incurred since Mr. Obama became President? And what about the distortions inherent in “quantitative easing”? Or the instability caused by the Fed’s manipulation of the stock market higher and higher without regard for the health of the economy? As Ayn Rand once asked: “Who Will Protect Us from Our Protectors?”
But Is It “Nationalization”?
Does this “great leap forward” in government involvement and control amount to nationalizing—socializing—the financial sector? The answer is technically, by definition, “no”—and, is, in fact, “yes.”
The nationalizing of industry is the pivotal step in the move from capitalism to socialism. The transition to socialism never can be “peaceful” because the forcible expropriation of businesses, the violation of the property rights of thousands of citizens, is the primal act of violence at the birth of socialism. It is irrelevant whether or not the country voted to abandon property rights and expropriate owners; the massive violation remains. The only difference, perhaps, is that there is a special bitterness at knowing your fellow citizens consented at the polls to the seizure of your wealth.
This is the literal implementation of socialism of one type, often called the “communistic” type. But economists, beginning with the great proponent of the Austrian School, Ludwig von Mises, have made a crucial distinction between two variants of socialism. One, as mentioned above, is the “communistic” type; the other is the fascistic type.
Fascism has been the pattern of statism’s advance in the United States.
Use of the term “fascism” to describe a socialistic system once elicited looks of blank incomprehension; today, more people understand the term, though it never appears in the mainstream media. Socialism is the economic-political system under which the “means of production”—factories, mines, businesses, and other property—are owned by the government. But the essence of ownership is the right to use and disposal of property. If I “own” my factory, but the government makes all decisions about production, management, “profits” (if any), pay, and the price for which my output is sold, then my “ownership” is in name only. In fact, the government is the owner. Under fascism in Nazi Germany, factories, mines, and other businesses were not nationalized outright; the owners simply were told what to produce, in what quantities, at what price. This is socialism, and, of course, the full name of the Nazi Party was the National Socialist German Worker’s Party. Benito Mussolini was long a member of the Italian Socialist Party and, in creating the Italian Fascist Party, was adding what he viewed as an element of Italian patriotism to socialism.
Fascism has been the pattern of statism’s advance in the United States, a pattern identified by Ayn Rand in the early 1960’s in her articles “The Fascist New Frontier” and “The New Fascism: Rule By Consensus.” At that time, government command of the economy—at least as compared with today—was just beginning. The process has advanced and accelerated over more than half-a-century until, today, the Economist can speak of the “nationalization” of the largest business sector in the United States. “Nationalization” is rarely mentioned—just proposals to regulate, intervene, expropriate, and otherwise control the economy.
Reporting to Washington
Is the process of nationalization of finance complete? Of course not, but acceleration of the takeover since 2008 is frightening. Signs of a pervasive government assumption of control keep popping up. For example, government criticizes and, in some cases, sets the level of compensation for executives in businesses it “saved” with its largesse. And why not? Those executives are spending taxpayer dollars.
More recently, the media staged a circus in the aftermath of the estimated $5.8-billion trading loss taken by the prestigious Wall Street firm J. P. Morgan. Morgan had to announce the loss on European investments in “derivatives,” originally estimated at $2.0 billion, just a week after its CEO, Jamie Dimon, in a call with reporters, indicated no knowledge of any problem. Dimon humbled himself in making the announcement of the loss, apologizing and taking blame, but that was not enough.
The loss, though significant by any standard, must be considered within the context of Morgan’s huge reserve of capital and profits of about $4.0 billion that it had reported quarter after quarter. But the loss on the derivatives trade became a national issue. Mr. Dimon was summoned before Congress to explain how the loss could have occurred and spent hours responding to probes into and criticism of the firm’s management and policies.
Morgan is, after all, a private firm, and investment firms do take losses—even large losses. And Morgan’s record of trading had been consistently hugely profitable. Yet, Congress, the media, fellow financial executives, and, seemingly, Mr. Dimon himself apparently saw nothing objectionable in his being called to Washington to explain himself and, in fact, fend off questions about why Morgan should not be taken over by government or “broken up.”
A private firm in a private trade with its own capital, a loss that was large but that must be considered against its regularly profitable trading successes: was this a matter for government? Well, consider: In the 2008 financial panic, widely seen as threatening the entire world financial system, a core problem was identified as investment in “derivatives.” Derivatives are financial instruments whose value is tied to the changing value of other securities, commodities, interest rates, or any of a host of other things. By the time of financial panic, these derivatives held by financial firms ran into many trillions of dollars in “notional” value (what it would cost to pay off the holders of all the derivatives under certain circumstances, such as a big move in interest rates).
When the continued existence of a giant insurance firm, AIG, seemed doubtful, Wall Street firms like Morgan Stanley and Goldman Sachs quaked. AIG was the “counter-party” to a staggering total of derivatives that they held; if AIG went under those derivatives were suddenly worthless. Exactly what happened, and what would have happened given various scenarios, has been debated since 2008.
But Brian Pretti, one of today’s outstanding independent economic and financial analysts, whose insights and predictions have consistently trumped those of most other analysts, does not hesitate to write: “Make no mistake about it, Goldman and Morgan Stanley would be distant memories, as would have a number of other leading US financial firms, had it not been for the Government bailout of the AIG derivatives debacle.” That is a chilling statement from so careful and restrained a commentator as Mr. Pretti. It is worth reading all of Mr. Pretti’s brilliant analysis.
And so, since J.P. Morgan’s “bad trade” was in derivatives, and since, today, after the harrowing escape from the financial crisis, the “notional value” of derivatives held by Morgan is $71.5 trillion (yes, seventy-one-and-a-half trillion dollars), far larger than the amount in 2008, is Morgan in fact a private firm making private trades?
But what is driving this huge proliferation of derivatives? The answer is complex, but recall that the Fed exerts a crucial influence on the economy by manipulating interest rates. Today, thanks to the Fed, short-term interest rates are at the lowest level in history—effectively zero. And, for the first time, the Fed seeks to influence long-term rates, as well. With government’s pervasive influence in this area, it should be obvious that interest rates could undergo a jolting change, almost overnight, should government change its policies. Is it any accident, then, that of the more than $225 trillion in “notional value” of derivatives held by the U.S. banking system, well over 95 percent are interest-rate derivatives? These are intended, say the banks, to “offset” most of their “interest-rate risk.” This is the “financial-political complex” at work.
Can the Nationalization Be Stopped?
We know that once government entrenches itself in a sector, reversing that involvement, restoring freedom, is exceedingly difficult. How easy would it be, today, to get government out of the health care field—closing down or making private the Medicare and Medicaid programs? That’s right, it seems impossible.
The same entrenchment is far advanced in the financial industry. What can be done? Rolling back government involvement will be enormously complex, but the essential steps are known and widely discussed by free-market economists.
This is “crony capitalism” and must be exposed as such.
First, the fuel of the America’s financial engine is controlled by government. Government creates money and controls the amount of it in the economy. This represents the power to inflate (expand the money supply and so cause prices to rise) at will and without limit. Government need not tax (and so face angry voters at the polls) or borrow (after all, other countries, as well as businesses, compete to borrow money, and, at some point, lenders begin to worry that even the U.S. Government cannot repay the gigantic debt it has accumulated). Government, though, can create money to buy its own debt, or, as during the financial crisis, to buy billions in private “toxic” assets.
If government were on a gold standard, as were most European governments and America throughout the Nineteenth Century and early Twentieth Century (and the United States partially so till 1971), it would be required to redeem its paper money in gold at a fixed rate. Its creation of money would be strictly limited, and, as in the Nineteenth Century, inflation would be a non-problem. Advocacy of a return to gold standard is growing and increasingly vocal as government under the Obama administration creates and spends money like the proverbial drunken sailor. Returning to the gold standard at a stroke would limit the size and power of government not only in the financial sector but the entire economy. (Although published in 1966, Alan Greenspan’s essay, “Gold and Economic Freedom,” is still the most succinct, philosophical, and persuasive case I know for a return to the gold standard. It is in Ayn Rand’s book of essays, Capitalism: The Unknown Ideal
. The Ludwig von Mises Institute published a book by Ron Paul and Lewis Lehrman, The Case for Gold.
Second, the Federal Reserve system is the locus of government control of money and credit, interest rates, and much of the regulation of the financial system. Its chairman has been called “the second most powerful person in government,” after the President. Chairman Ben Bernanke, appointed by President George W. Bush, fits that description. He is an economic professor who believes that the Fed has unlimited responsibility for ensuring the stability and health of the economy.
In fact, the Fed’s dual mandate is to maintain price stability and help to ensure full employment. It has tended to act mostly at times of recession, lowering interest rates to “stimulate” the economy, and then, when the economy begins to improve, raising rates supposedly to prevent inflation. This is not the place to evaluate the Fed’s success; the point, here, is that, with the financial crisis, market crash, and recession, the Fed has arrogated to itself virtually unlimited power to intervene in the financial system.
Principled advocates of laissez-faire capitalism call for abolishing the Fed, and the case for doing so is powerful. Like advocacy of the gold standard, however, calling for closing down the Fed is not an immediate (or even foreseeable) solution to the accelerating nationalizing of the financial sector. Still, many in Congress, and also commentators in the camp of free enterprise, oppose the growing power of the Fed and call for restraints. This could be an issue in the 2012 Presidential election if Mitt Romney called for limits on the Fed’s role. Rep. Ron Paul, a Texas Republican and candidate for President, introduced legislation as early as 2002 to abolish the Fed and has kept pushing for it. His son, Sen. Rand Paul (R.-KY), is working to introduce legislation to increase government oversight of the Fed. (In 2009, Ron Paul published, End the Fed.)
Finally, remember that the problem is the “political-financial complex.” That is, half the problem is with the financial sector. Wall Street, and the financial sector nationwide, can benefit—to the tune of billions of dollars in profits—from their “partnership” with government. I said earlier that the fortunes of the stock market are now tied to bouts of Fed “easing.” Today, traders, investors, and the financial media focus obsessively on the prospect of the next Fed infusion of cash. To take another example, the Fed pumps money into banks, charging them negligible interest; the banks then invest in government bonds. They then collect interest from these virtually risk-free investments purchased with virtually free loans.
This is “crony capitalism” and must be exposed as such. In their “partnership” with government, financial firms are not earning profits by sound investment in open competition with others. They are benefiting from government largesse, favoritism, and guarantees. There is nothing “free” about this enterprise. (For more on “crony capitalism,” see " Crony Capitalism vs. Making Money
In the end, the battle against nationalization of the financial sector—a lunge toward socialism and guarantee of financial turmoil, including eventually runaway inflation, for years to come—is the battle for laissez faire capitalism itself. The case for free markets must be made on the economic level: for example, with demonstration of the role of the Fed in causing the “boom and bust” cycle. But, above all, it must be made on the philosophical level, including insistence that seizure of control over the financial sector violates property rights as surely as nationalization. To seize effective control over private firms—the process now far advanced—is expropriation of the value of those firms even if they remain private in name. Right now, many firms are profiting from government intervention, but wait until the next, inevitable financial crisis, when the banks and brokers are declared to have failed utterly, endangering the economy, and we are told that the only answer is to nationalize them. Recall that as Congress questioned Mr. Dimon on the J.P. Morgan trading loss, they kept asking why Morgan should not be “broken up.”
If the financial sector, Wall Street, once epicenter of capitalism, channeling investment to businesses nationwide and worldwide—the great marketplace where public companies were valued and bought and sold—goes down before the onslaught of government’s lust for power and control, then capitalism itself goes down.