It all sounds primitive by today’s standards. Yet that boring, primitive financial system serviced an economy that doubled living standards over the course of a generation.
After 1980, of course, a very different financial system emerged. In the deregulation-minded Reagan era, old-fashioned banking was increasingly replaced by wheeling and dealing on a grand scale. The new system was much bigger than the old regime: On the eve of the current crisis, finance and insurance accounted for 8 percent of G.D.P., more than twice their share in the 1960s. By early last year, the Dow contained five financial companies — giants like A.I.G., Citigroup and Bank of America.
And finance became anything but boring. It attracted many of our sharpest minds and made a select few immensely rich.
Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.
But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.
You can't have a stable society if economic ups and downs are too dislocating. It's possible that this is a once in a century event and everything can readjust and go back to the way it was a couple of years ago, but it's doubtful. We have seen over and over again that this reliance on complexity too often turns out to be fraud --- see the Enron energy market, the AIGFP CDS market etc. This recent implosion has shown us just how risky it is to allow such opaque, inscrutable deal making to dominate our financial system. Thre incentives are all skewed th wrong way.
William Greider makes a similar point in his new book Come Home, America: The Rise and Fall (and Redeeming Promise) of Our Country and will be appearing on Moyers tonight. I am looking forward to hearing what he has to say because he's one of those guys who's been railing about Greenspan and the Fed for decades. (If you haven't read Secrets of the Temple: How the Federal Reserve Runs the Country --from 1987! -- you should pick it up. You only thought you were living in a democracy.)
These are people with good track records. They could be wrong now, of course. Nobody is perfect and as we've seen economics is an especially treacherous predictive field. But the underlying concerns they express, regardless of whether or not the stock market turns around or whether the recession last for another year or two years, are things we should take seriously. We don't know where all this is going to end up right now. But whether or not we see a recovery soon or a long, painful economic slump, the system has to be reformed. And sadly, we're not seeing any sign that the ruling class is ready to do that.