With highway accidents, the greatest carnage always
attracts the most onlookers. So, too, with the 2007-08 financial crisis and its
aftermath. Each review of those events paints an increasingly ugly picture of
crass cronyism. Two administrations, one Republican and the other Democratic,
claim only the most noble, disinterested motives for their actions, but
everything done has conspired to protect established financial power and
advantage it against competition. Collusion and cronyism dominated the buildup
to the crisis and informed Washington’s otherwise seemingly ad hoc response.
Now, Dodd-Frank has enshrined the inequitable practices in law.
Whatever
the sins of bankers and investors, Washington orchestrated the mess from the
beginning. For years, the federal government insisted that banks direct their
mortgage lending increasingly toward the dubious credits referred to as
sub-prime. Under the 1992 Housing Community Development Act the two government
agencies that support the mortgage market -- the Federal National Mortgage
Association (FNMA), known as Fannie Mae, and the Federal Home Loan Mortgage Corporation
(FHLMC), known as Freddie Mac -- denied lenders support unless they made more
and more loans to sub-prime borrowers. By the early years of this century,
these agencies would only participate if half the loans involved were of this
dubious character.
Because
this insistence put lenders in a precarious financial situation, it required
collusion from others in Washington. Regulators turned a blind eye to the risk
such lending imposed on bank balance sheets. They looked the other way when
banks used exotic derivatives to pass that risk off to others. When regulators
did worry, they encouraged banks to package the bad loans into securities and
sell them on capital markets. Other authorities facilitated the process by
allowing credit-rating agencies to give these questionable securities
attractive rankings.
When,
despite these arrangements, this house of cards began to come down in 2007,
Washington sprang into action. It said it wanted to protect the financial
system. No doubt it did. It also had two other objectives: to conceal its role
in creating the problems and to protect the established firms that had
previously cooperated. Instead of sanctioning the firms and individuals who the
government said were at fault, the authorities put billions of taxpayer dollars
at risk to rescue them. Hurried legislation under Republican President George
W. Bush and his Treasury Secretary Henry Paulson raised $700 billion of
government funds for what the administration called the Troubled Asset Relief
Program (TARP). It bought from these lenders the “distressed assets” that
Washington had previously insisted they acquire, at least those that these
institutions had not yet unloaded onto unsuspecting investors. Under President
Barack Obama, the Federal Reserve took over the rescue effort, extending such
transfers literally into the trillions of dollars.
Even
as the government rescued the bankers, it blamed them for all that had gone
wrong. President Obama showed superior finger pointing skills. He and the rest
of Washington justified rescues to those that they held blameworthy by claiming
a primary need to save the financial system. It is hard to argue with such
priorities. Still, it is strange that, for all the animus the government
showed, no prosecutions have occurred even now long after the crisis had passed
and financial markets have recovered. Most of the managements of established
financial firms remain in place to this day, as do their boards of directors,
where turnover has been less than 10 percent from before the crisis.
If
this behavior does not at least hint at cronyism, there is more. It surely is
telling that Washington in its crisis management chose to ignore a previously
successful model. Back in the 1980s, the nation found its financial stability
threatened from reckless mortgage lending by a class of financial institutions
then called saving and loan associations (S&Ls). To deal with that crisis,
Washington created the Resolution Trust Corporation (RTC), which, in a kind of
controlled bankruptcy, took over failing S&Ls, removed their managements
and boards, immediately sold off their viable assets, and kept the questionable
ones with a eye to working them out over time. Every failing firm was treated
the same way. Markets stabilized as this systematic approach quickly relieved
panic.
Instead
of opting for such an orderly approach, Washington in 2008 proceeded in a much
less coherent manner. It treated each troubled firm in a different way. When,
for instance, the investment bank Bear Stearns showed signs of trouble, the Fed
arranged its forced sale to J. P. Morgan. Later, as the crisis gained momentum,
government gave lavish loans to Citibank and a few others. Official Washington
allowed another investment bank, Lehman Brothers, to go bankrupt but actually
took a majority ownership stake in the insurer, AIG. If its goal was to save
financial markets from a destructive panic, this was precisely the wrong way to
proceed. A coherent, transparent approach, like a reconstituted RTC, would have
gone a lot further to convince investors and other financial players that the
authorities were in control. The ad hoc approach followed during this more
recent crisis surely contributed to panic by raising in all a strong suspicion
that official Washington had no clear idea of how to deal with the pressures of
the moment.
It
is only fair to ask why Washington in 2007-08 never even considered a
reconstituted RTC. Several have in fact asked raised this point, including
William Seidman, who had served on the old RTC. None in authority have even
tried to answer. Could it be that the RTC’s evenhanded, if tough approach
failed to serve an agenda that Washington preferred to hide? After all, an RTC
approach would have penalized formerly cooperative managements and boards.
Those few senior executives who lost their positions received lucrative
severance packages, something an RTC arrangement would have forbidden. What is
more, an RTC-like approach would have treated all troubled firms equally. This
time the Fed and others in authority preferred to treat firms according to a
clear crony-like hierarchy.
Take
the experience of Bear Stearns. When it became apparent in March 2008 that the
firm was having trouble finding the liquidity to meet its obligations, no one
in authority considered a rescue. The Fed explicitly rejected using its
term-lending facility to help. Instead, it forced Bear Stearns to sell itself
to JP Morgan at a bargain price of $10.00 a share, well off the stock’s high of
$133.20 a share hit during the previous year. What is even stranger is that the
authorities, while denying Bear Stearns a dime, advanced Morgan the bulk of the
purchase price in the form of a loan that the Fed said it would forgive should
Bear’s assets go bad.
Fed
Chairman Ben Bernanke never fully explained why he and the authorities seemed
determined to destroy Bear Stearns while fashioning a sweetheart deal for
Morgan. His most direct response revolved around technicalities, itself a
strange thing to emphasize in an environment full of unprecedented official action.
Of course, he could not say that Morgan was a member of a cooperative
establishment while Bear was not, had in 1998 refused to join a Fed-organized
bailout of the well-connected hedge fund, Long-Term Capital Management or that
Bear, as The New York Times noted at the time, was notoriously considered “an
outsider that defied its more mainstream rivals.” Maybe the authorities have
less questionable motives. If so, no one from the Fed has stated them.
AIG
was also always considered an outsider. When it got in trouble later that year
for guaranteeing some of the dubious mortgage-backed securities, the
government, while extending loans to Citibank and others, insisted on an 80
percent ownership stake in AIG. Then, under management led by the New York Federal
Reserve Bank, the firm paid full value on assets owed to those paragons of the
financial establishment, Goldman Sachs, Deutsche Bank, and Societe Generale,
even though these firms announced that they expected a loss. Though the
Government Accountability Office pointed to “inconsistencies and
contradictions” in the New York Fed’s explanation for its decision, the
investigation, as with so much else from that time, ended there with questions
left open.
All
this dubious behavior occurred under the Bush administration, but, as if to
announce the bipartisan nature of Washington’s crony system, the Obama
administration passed Dodd-Frank. This huge and far-ranging piece of financial
reform legislation advantages established firms at the expense of others. By imposing
a raft of compliance and reporting requirements on all financial firms, it
disproportionately burdens smaller companies. While explicitly imposing
disadvantages on smaller firms, Dodd-Frank offers larger players an additional
and particularly valuable competitive edge by designating them “too big to
fail.” To be sure, the law requires those so designated to jump regulatory
hurdles not required of others, but it compensates them with an implicit
government guarantee against failure. It is no surprise that more than one
fifth of the nation’s community banks have shuttered since Dodd-Frank became
law.
There
is no smoking gun. There seldom is when government and industry collude to
their mutual benefit. Still, a pattern of cronyism emerges, one sufficient to
raise questions among voters and businesses about where government priorities
lie.
Mr. Ezrati is a writer living in New York. His latest book
is Thirty Tomorrows and describes how the world can cope with the challenges of globalization and
aging demographics. See more of his writing at https://thirtytomorrows.com.
http://www.americanthinker.com/articles/2017/05/crony_capitalism_american_style_.html
