The Collapse of Financial Regulation Since 1980 and Its Consequences: A Nice Summary from Lawrence Lessig

The Collapse of Financial Regulation Since 1980 and Its Consequences: A Nice Summary from Lawrence Lessig

Jeff Weintraub: The Collapse of Financial Regulation Since 1980 and Its Consequences

The Boston Review has posted an online interview with Lawrence Lessig about his new book, Republic, Lost: How Money Corrupts Congress—And a Plan to Stop It, which deals with the pervasive plutocratic corruption of our political system over the past several decades. Some of the ideas in the interview strike me as questionable, but most of them are clearly on-target, and it’s worth reading the whole thing. The book sounds worth reading, too.

For the moment, I just want to highlight one very trenchant passage in the interview:

Before 2008, the zeitgeist was deregulation, and Wall Street succeeded in getting deregulation. Frank Partnoy calculated for me that in 1980, 98 percent of financial assets traded in our economy were traded subject to the normal rules of transparency, anti-fraud requirements, basic exchange-based rules of the New Deal. By 2008, 90 percent of the assets traded were traded invisibly because they were not subject to any of these basic requirements of transparency and anti-fraud exchange-based obligations.

This falls in the category of obvious-but-frequently-overlooked-facts that we all need to keep repeating. And the larger context is worth emphasizing, too, even at the cost of further repetition. Every discussion about the economic crash of 2007-2009, which was touched off by a massive financial crisis, should begin with the striking fact that there were no serious financial crises in the United States between the New Deal and the beginning of the Reagan administration. This was no accident. During the 1930s a remarkably intelligent set of regulations was enacted to cover banking and the rest of the financial sector, and it worked.

Over time, new types of financial activities developed that evaded or circumvented this regulatory framework, but the system was not revised and extended to cover them. Instead, starting in the 1980s, that whole framework of financial regulation was increasingly dismantled, in a process that combined free-market-fundamentalist ideological illusions with substantial amounts of irresponsibility, plutocratic muscle, political corruption, and simple greed.

At the same time, in a vicious cycle of mutually reinforcing processes, the financial sector—including a whole “shadow banking system“—metastasized out of control and swallowed up an ever-larger share of the economy. The overflowing funds, increasing political clout, and ideological prestige of the financial system were used, in turn, to promote further deregulation. And it so happens that during the same period, starting in the 1980s, we have once again experienced recurrent financial crises (and massive bailouts), escalating most recently into the great financial crash of 2007-2009 from whose consequences we are still recovering.

(For one very informative picture of how this all worked, I recommend watching Charles Ferguson’s excellent documentary film Inside Job, a guide for the perplexed that, among other things, does an impressive job of explaining esoteric financial arrangements like securitization, credit default swaps, and collateralized debt obligations. If you want to start with something shorter, a brief but illuminating video clip by Elizabeth Warren boils the story down to its essentials here.)

So what happened next? Lessig continues:

But the really astonishing thing is that after 2008, after we suffered the biggest collapse since the Depression, after every independent analyst had said there was a link between the structure of deregulation and the collapse, after the dean of deregulation—Alan Greenspan—confessed he made a mistake in assuming that the self-interest of the banks would lead them to behave virtuously rather than behave in a way that would drive to their maximum profit, after all of that, even then, Wall Street was able to blackmail the Democrats and the Republicans into handing them essentially a “Get Out of Jail Free” card and effect no fundamental change in the architecture of our financial system. That is, frankly, terrifying.

That formulation is a little too generous to the Republicans, since on the whole they should be seen as perpetrators more than victims. (Along with many Democrats, of course—though it’s misleading simply to impute moral equivalence in these matters to the Republican Party and the Democratic Party.) But it’s true that Republican politicians have also been caught in a self-reinforcing system that’s increasingly hard to break out of even if one wants to. And yes, it is terrifying.

Meanwhile, anyone who gets their information about the current Great Recession, and about the political economy of the United States more generally, from sources like the editorial page of the Wall Street Journal, Fox News, and the Republican presidential campaign is presented with an alternate universe in which Wall Street and financial deregulation had nothing to do with precipitating the crash. Instead, the fault lies entirely with quasi-governmental institutions like Fannie Mae and Freddie Mac and with the consequences of the Community Reinvestment Act (which supposedly forced banks to issue subprime mortgages to poor people and minorities). This nonsense was recently summed up, in an astounding statement that seems to vindicate the crudest versions of a Marxist theory of class-bound ideology, by none other than New York City Mayor Michael Bloomberg:

It was not the banks that created the mortgage crisis. It was, plain and simple, Congress, who forced everybody to go and give mortgages to people who were on the cusp [….] But they were the ones who pushed Fannie and Freddie to make a bunch of loans that were imprudent, if you will. They were the ones that pushed the banks to loan to everybody.

Some intelligent, serious, and well-informed people have been taken in by this propaganda, and like most propaganda it does contain some grains of truth, but overall it’s just a fable. (For a patient explanation of some of the reasons why, see here.) However, this nonsense is far from being harmless, since as long as the real sources of the problem are ignored or obscured or distorted out of recognition, it will be hard to generate the political will to do anything constructive about them.

What we really need is a new New Deal, updated for the conditions of the early twenty-first century. I think some of Obama’s supporters hoped he would deliver this, but obviously he hasn’t (and probably never intended to). And prospects for the foreseeable future are not promising. But the first step is to start facing reality.