fixing the economy tools for a new economy Proposals for a financial regulatory system Robert Pollin

he collapse of the housing bubble ing families. Banks created opportunities and the speculative market for sub- for families with less-than-stellar credit Tprime mortgages demonstrates, records to obtain mortgages and buy their yet again, the simple point that financial own homes. By bundling thousands of markets need tight regulation. Since Sep- mortgages into securities that were freely tember 2008 a series of massive bailouts traded on global financial markets, banks by the U.S. Treasury and Federal Reserve enabled subprime borrowers to purchase have prevented financial markets from ex- houses that would otherwise have been periencing a1929-style collapse. These ex- off limits. This kind of financial engineer- treme measures, however, have not solved ing, operating on a global scale, could not enzo r the broader problems at hand. As of this o have been possible under the Glass-Stea- l _ s writing, we are experiencing the most se- o gall system.

vere economic downturn since the 1930s. arl The idea behind bundling mortgages American politicians—Democrats into marketable securities is that the local and Republicans alike—began deregu- .com/c bank or S&L that lends you money to buy kr lating the U.S. financial system in the ic a home does not hold onto your loan once l 1970s. Their premise was that regula- you get your money. Rather, it sells your tions devised during the 1930s—specifi- loan to a big financial institution, such as enzo / f r cally the Glass-Steagall system, which o the government-sponsored Fannie Mae l

s defined separate spheres for commercial o or Freddie Mac, which, in turn, bundles arl

and investment banks—would hinder c thousands of individual mortgages into the effective workings of contemporary securities. Fannie or Freddie then sells financial markets. The 2001 Economic specializing in finance—disintegrated in Similar regulations were imposed on these mortgage-backed securities to banks, Report of the President, Bill Clinton’s last, that crisis, requiring a $4 billion bailout Savings & Loans (S&Ls) in 1932, and hedge funds, and other market players. unequivocally dismissed Glass-Steagall: from other Wall Street firms to prevent continued to operate through the 1970s. With thousands of mortgages packaged “Given the massive financial instabil- a market meltdown. In particular, under the old regulatory re- into one security, the dangers of lending ity of the 1930s, narrowing the range of The most severe crash of an over- gime, mortgage loans in the United States to higher-risk borrowers are supposed to banks’ activities was arguably important wrought financial market, the 1929 Wall could be issued only by S&Ls and related decline; within a large portfolio of mort- for that day and age. But those rules are Street crash, produced an economic ca- institutions. The government regulated gages, the losses lenders incur from the not needed today.” lamity, which led in turn to a collapse of the rates S&Ls could charge on mort- small share of delinquent borrowers are The chorus of politicians and econo- the U.S. banking system. Between 1929 gages, and the S&Ls were prohibited from offset by the much larger proportion of mists who for a generation advocated and 1933, nearly 40 percent of the na- holding highly speculative assets in their borrowers in good standing. financial deregulation were right about tion’s banks disappeared. In their wake, portfolios. Market players became convinced one thing: the financial system has be- Roosevelt’s New Deal government put But even during the New Deal years that “securitizing” loans made subprime come infinitely more complex since the in place an extensive system of financial themselves, financial-market titans were mortgage lending a much safer bet. For a 1930s. Something that had been as sim- regulations, many of which persisted already fighting to eliminate or at least time, optimistic expectations became self- ple as a local Savings & Loan making a beyond the conclusion of the Great De- defang the regulations. Since the 1970s, fulfilling. Money rapidly flowed into the home mortgage in their community— market. Housing prices rose, seemingly recall Jimmy Stewart in It’s a Wonderful creating wealth out of thin air for home- Life—is now part of a speculative global owners. Market bulls grew rich while bears market. The old regulations had indeed These proposals need not make the seemed out-of-step. Loan officers earned become outmoded, but it never followed handsome commissions by bringing new that financial markets should operate economy less innovative. The dynamism of customers to their banks. These officers unregulated. had large incentives to approve subprime The historical record makes this clear. a leashed financial market would emerge in mortgages—they did not have to return In the classic text Manias, Panics and their commissions years later when, for Crashes, Charles Kindleberger called fi- the way credit moves into productive areas. example, the loans, now held by a Swiss nancial crises a “hardy perennial” within hedge fund, went sour. the context of unregulated financial sys- The logic here is deeply flawed.M arket tems. He documented that, from 1725 pression. The most important initiative they have almost always gotten their way. players believed that the riskiness of sub- onward, financial crises have occurred was the 1933 Glass-Steagall Act, or, as This led cumulatively to the dismantling prime mortgages would diminish when throughout the Western capitalist econo- it is officially known, the Banking Act. of Glass-Steagall. The final nail in the cof- pooled. In fact, the opposite turned out mies at an average rate of about one every Commercial banks were limited to the fin came in 1999 when President Clinton to be true. The fortunes of most subprime eight and half years. relatively humdrum tasks of accepting signed the Financial Services Moderniza- borrowers rose and fell together with the There is an awful lot about the cur- deposits, managing checking accounts, tion Act. He did so with the strong sup- housing market’s boom and bust. In the rent financial crisis that is familiar. In and making business loans. Commercial port of then-Senator Phil Gramm, later a bust, the problems borrowers faced in 2001 the the U.S. stock market crashed banks would also be monitored by the top advisor to John McCain’s Presidential meeting monthly payments became per- after having been driven during the late newly formed Federal Deposit Insurance campaign; then-Federal Reserve Chair vasive, not limited to isolated cases. This 1990s to unprecedented levels of specula- Corporation (FDIC), which provided Alan Greenspan; and top advisors Rob- is why major financial institutions such tive frenzy by the dot-com boom. A global government-sponsored deposit insur- ert Rubin and Lawrence Summers, both as Citigroup, Merrill Lynch, and Bear financial crisis originated in East Asia in ance for the banks in exchange for close of whom would later counsel the Obama Stearns, which were holding huge pools 1997-98 and spread rapidly. The sure- government scrutiny of their activities. campaign and transition team. of subprime mortgages, experienced un- thing investment then was securities mar- Investment banks, by contrast, could While the current crisis resembles its precedented losses in 2007, setting off the kets in developing countries. The U.S. freely invest their clients’ money on Wall predecessors in many ways, it also has some collapse of U.S. financial markets.T oday’s hedge fund Long Term Capital Man- Street and undertake other high-risk ac- novel characteristics. Its most prominent crisis is thus the direct consequence of the agement—its board of directors guided tivities, but they had to steer clear of the distinction is that it has resulted from ac- generation-long project of deregulating by two Nobel Prize–winning economists commercial banks. tivities that were supposed to benefit work- financial markets.

10 B O S t o n R E V i e W tools for a new economy

e need a new regulatory framework percent, and a tax on a fifty-year bond, 0.5 I propose the reverse: accountable and em- labor, consumer, and community repre- Wthat is capable of both stabilizing percent. The tax would be adjusted on a powered district banks. sentatives. markets and, correspondingly, channel- comparable basis for derivative financial When the Federal Reserve system was Strengthening the Fed’s policy toolkit ing financial resources toward productive instruments, such as options, futures, and formed in 1913, the twelve district banks is a third crucial component of any plan to and socially useful investments and away credit swaps. Brokers would be responsible were supposed to disperse the central increase democratic accountability. Spe- from the speculative casino. What follows for collecting the tax from the sellers at the bank’s authority broadly and respond to cifically, theF ed must be able to promote is a series of proposals to guide the new time of sale. regional needs. This remains a valuable the channeling of credit to productive pur- framework. They offer a decisive break Since the IRS already imposes trade- idea, but it has never been seriously imple- poses over speculation. Without this tool, from the deregulatory agenda of the past reporting requirements, a securities trade mented. Bank presidents are currently ap- extending democracy within the institu- generation, yet they are all feasible within tax would entail little additional admin- pointed by the banks’ boards of directors. tion will be largely symbolic. the existing set of political and regula- istrative apparatus. Nor would it have a These are businesspeople, mostly com- A system of “asset reserve require- tory institutions. Enacting them would significant impact on anyone who bought mercial bankers, who are also appointed, ments,” which would oblige financial in- require insignificant increases in admin- an asset and did not promptly resell it for a not elected. stitutions to maintain cash reserve funds istrative costs and low levels of public quick profit.F or someone who buys stock At the level of national policy-mak- in proportion to the high-risk assets in outlay. All of these proposals have been at $50/share and sells it ten years later at ing, the district banks have influence only their portfolios, would encourage banks, debated seriously within mainstream po- $100/share, the trading tax would be $0.50 because five of the twelve bank presidents hedge funds, and the rest to channel credit litical circles. per share, on a $50 capital gain. sit, on a rotating basis, on the Federal Open to high-priority and less-risky areas. This U.S. markets, of course, operate within Conversely, a 0.5 percent tax would se- Market Committee, the body that votes on idea has an extensive, if largely neglected, a globally integrated setting, a reality that riously reduce profit for short-term specu- all monetary policy initiatives by the Fed. mainstream pedigree. MIT’s Lester Thu- complicates any regulatory scheme. These lators. It is not uncommon for speculators However, under present arrangements, the row, for example, sketched the following proposals are intended to apply to all fi- to buy a stock, hold it for a day or even Chair of the Fed, who is also the Chair of arrangement in a 1972 paper written for nancial institutions under U.S. legal ju- hours, and then resell it for a small gain. the Open Market Committee, exercises a conference at the Federal Reserve Bank risdiction, whether they are called banks, A $1 capital gain for a $99 share bought predominant influence over the fullC om- of Boston: holding companies, hedge funds, or varia- yesterday and sold today $100 today nets a mittee, usually acting in consultation with tions thereof. good return on a one-day investment. The the Treasury Secretary. If national goals called for investing 25 My first proposal is the establishment trading tax would garner 50 cents—half The direct election of district bank percent of national savings in housing of a small tax on all trading of financial the earnings from the trade. presidents by residents of the relevant re- and other preferred sectors, each finan- assets. Financial markets do provide an One could use the tax on its own to cut gions would democratize the banks. And cial institution would have a 100 percent essential service by simplifying the con- financial speculation dramatically. That creating additional seats for them on the reserve requirement on that fraction of its assets. As long as it invested 25 percent of version of investments into money. But would only entail raising the tax rate until Open Market Committee would increase its assets in housing, however, it would not this benefit must be weighed against the the point where traders see little incentive their power. District bank presidents, once have to leave any reserves with the govern- fact that trading has almost nothing to do to trade at all. But the aim is not to shut on the Committee as elected representatives ment. If it had invested 20 percent of its with raising funds for investment. As of off trading altogether; if that were the from their regions, could explicitly address assets in housing, five percent of its assets 2007, players in the market traded roughly case, full nationalization of the financial the concerns of their constituents. would have to be held with the govern- $300 worth of stocks and bonds for every markets would probably be a more effec- A related proposal would build on an ment in required reserves. If it invested dollar that nonfinancial corporations raise tive approach. experiment from the 1930s when district nothing, 25 percent of its assets would be for new investments in plant and equip- Even at a rate too low to dampen banks formed committees of bankers and held as reserves. ment. This ratio is about three times what speculation, the securities-trading tax businesspeople to discuss financial-mar- it was only a decade ago, at the peak of the has another benefit. It would provide a ket issues in a non-market setting. This Other specific versions of asset reserve dot-com bubble. new source of government revenue at a model could now be extended to include requirements were outlined in the 1970s A small tax on all financial-market time when it is badly needed. Working transactions, comparable to a sales tax, with 2007 figures, I estimate that a 0.5 would raise the costs on short-term spec- percent tax on stock trades, and the slid- ulative trading while having negligible ing scale described above for bonds and effect on people who trade infrequently. derivatives, would raise approximately Come Together It would thus discourage speculation and $350 billion, if trading did not decline at Imagine Peace channel funds toward productive invest- all after the tax was imposed. Even if trad- Poems ment. Securities-trading taxes are com- ing declined by 50 percent as a result of mon throughout the world. Roughly forty the tax, the government would still raise Eds. Ann Smith, Larry Smith countries, including Japan, the United $175 billion, roughly equal to both the & Philip Metres Kingdom, Germany, Italy, France, China, entire Iraq war budget for 2008 and the Brazil, India, South Africa, and Chile April 2008 fiscal stimulus initiative.T he For those who still believe in peace. employ or have recently employed such securities trading tax, moreover, could a tax. be designed as a major revenue source to In the aftermath of the 1987 crash, se- fund any new regulatory apparatus for Precedents: Sappho, Whitman, Dickinson, Cavafy, Millay, Patchen, curities-trading taxes or similar measures other government initiatives. Rexroth, Shapiro, Lowell, Creeley, Rukeyser, Ginsberg, Levertov, Lorde, were endorsed by then-House Speaker Jim But a modest tax on securities trading Stafford, Jordan, Amichai, Darwish Contemporaries: Abinader, Ali, Bass, Berry, Bauer, Bly, Bodhrán, Wright, then-Senate Minority Leader Bob is not enough, on its own, to discourage Bradley, Brazaitis, Bright, Bryner, Budbill, Cervine, Charara, Cording, Dole, and even the first President Bush. speculation and channel credit to where Cone, Crooker, Daniels, di Prima, Davis, Dougherty, Ellis, Espada, Variations on the idea have been intro- it is most needed. A second proposal, if Estes, Ferlinghetti, Forché, Frost, Gibson, Gundy, Gilberg, Habra, duced in Congress regularly in subsequent adopted, would increase democratic ac- Hague, Hamill, Harter, Hassler, Haven, Heyen, Hirshfield, Hughes, years, but never passed into law. Two lead- countability within the Federal Reserve Joudah, Jenson, Karmin, Kendig, Komunyakaa, Kovacik, Kryss, Krysl, ing Clinton administration economists, System, which would in turn raise ac- LaFemina, Landis, Leslie, Lifshin, Loden, Lovin, Lucas, McCallum, Nobel Laureate Joseph Stiglitz and Sum- countability throughout the regulatory McGuane, Machan, McQuaid, Meek, Miltner, Montgomery, Norman, mers, argued persuasively for such a tax apparatus as well as in private markets. Nye, Pankey, Pendarvis, Pinsky, Porterfield, Prevost, Ragain, Rosen, in the late 1980s. Summers disavowed the Proposals for democratizing the Fed- Ross, Rashid, Rich, Roffman, Rosen, Rusk, Salinger, Sanders, Seltzer, Schneider, Shabtai, Shannon, Sheffield, Shipley, Shomer, Silano, idea soon after joining the Clinton Trea- eral Reserve have long been advanced Sklar, Smith, Snyder, Spahr, Sydlik, Szymborska, Trommer, Twichell, sury, becoming instead a major supporter in mainstream political circles through Volkmer, Walker, Waters, Weems, Wilson, Zale of the deregulation agenda of the Clinton the efforts of Congressmen Wright Pat- Over 100 poets assemble here to voice Peace. years. What Summers might support now, man, Henry Reuss, and Henry Gonzales, With an Introduction by Philip Metres as the head of National Economic Coun- among others. These three men served, Harmony Series cil under President Obama, is an open respectively, as Chair of the House Bank- Any person who loves another person, question. ing Committee from 1963-75, 1976-82, Wherever in the world, is with us in this room— The technical features of a trading tax and 1989-94. Even though there are battlefields. are simple. For stocks, the seller could be The best approach to democratization - Kenneth Patchen charged, for example, 0.5 percent of the would begin with redistributing power 978-1-933964-22-5 208 pages. $18.00 ($2 shipping) sale price (Jim Wright suggested this rate downward to the twelve district banks of in 1987). For bonds, the tax would be pro- the Federal Reserve System, then opening Bottom Dog Press, PO Box 425 portional to the bond’s duration, at a rate the presidencies of these banks to direct Huron, Ohio 44839 [email protected] of 0.01 percent per year. Thus, the tax on elections. At present, the banks are highly http://smithdocs.net selling a thirty-year bond would be 0.3 undemocratic, and they have no real power. ja n uary / f e bruary 2 0 0 9 11 FIXING THE ECONOMY by former Federal Reserve Governors In principle, marketplace incentives Andrew Brimmer and Sherman Maisel. should push the agencies toward accu- Their proposals were, more or less, in As One Bereft of Reason rate appraisals because supposedly the support of unsuccessful efforts by Senator only valuable product agencies offer is William Proxmire and Representative Re- credibility. One would expect market uss—then chairs of the Senate and House In ambush with web and pin and broken off not-too- competition to reward firms that provide Banking Committees, respectively—to Distant pledge, a flax knife handled like failed office, as hobnails better information. But a large gap exists advance bills establishing procedures for Hammered through the many careful bodies of a breeze between the ideal set of incentives and Federal Reserve–directed credit alloca- the real ones. In practice, rating agencies tion policies. By the hundreds let them come; they come corseted in ice. show strong bias toward favorable rat- In fact, the equivalent of asset reserve I encircle you like sacrifice, a secretary’s desk. ings for a simple reason: they are hired requirements has long been established Between springs, ankles colt-swindled based on sight and by the companies they evaluate. Compa- practice in the United States. S&Ls, af- Artificial things, delight in sound, sound, for melody nies therefore choose agencies that they ter all, originally had their loan portfolios think are likely to provide favorable rat- restricted to fixed-rate home mortgages. Is a most base might of another artificial strain ings; those ratings, in turn, enhance the That could be described as a 100 percent And greets delight like sacrifice, like the seminary companies’ ability to sell their financial asset reserve requirement. Of the swindling class, in bare feet taking leave by hundreds. instruments. Policymakers should first—either Let them come, snow between springs, ankles colt-bearing With the benefit of hindsight, the within a democratized Federal Reserve or agencies’ misjudgments are now widely in a broader dialogue—determine which The slack knives of failed office, corseted in vice. recognized. Economics writer Roger Low- sectors of the economy get preferential Husk to stalk I bind you hobnailed ambush, my corsage enstein recently offered this appraisal in access to credit. In my view, we should Tangled, thin arms webbed and pinned and broken. The New York Times Magazine: encourage domestic investments in which risks are relatively well understood, and, Over the last decade, Moody’s and its two correspondingly, discourage speculative —Ken White principal competitors, Standard & Poor’s investments where risks are relatively and Fitch, . . . [put] what amounted to opaque. Beyond that, we should give gold seals on mortgage securities that preference to job-creation, subsidizing investors swept up with increasing élan. For the rating agencies, this business was the growth of green investments and the ated about 140 separate loan guarantee dized rate would be 6.25 percent—the 10 extremely lucrative. Their profits surged fight against global warming, and afford- and direct lending programs. That year, percent market rate minus 75 percent of . . . . But who was evaluating these secu- able housing. The financing of affordable the government’s $250 billion of new the 5 point difference between the market rities? Who was passing judgment on the housing, for example, would then be sub- guaranteed loans and $42 billion of direct rate and the 5 percent risk-free govern- quality of the mortgages, on the equity sidized directly by public-policy arrange- loans together represented about 14 per- ment bond rate. behind them and on myriad other in- ments, and not, as in the last decade, as a cent of the total borrowing by households Under this arrangement, private lend- vestment considerations? Certainly not byproduct of high-stakes gambling. and businesses in U.S. financial markets. ers would still bear significant risks and the investors. With established goals, this policy Outstanding government loans and loan therefore have strong incentives to evalu- gives significant social control over major guarantees were $1.4 trillion, about six ate loan applications carefully. Market The investors assumed that rating agen- finance and investment activities, while percent of total debt. (These programs forces would be at work, but the policy cies were providing objective and accurate allowing considerable decision-mak- are separate from the operations of would rig market activity toward desirable appraisals. Agency evaluations shape how ing freedom for both intermediaries and “Government-Sponsored Enterprises.” social outcomes. investors price assets, which in turn has a businesses. Intermediaries would still be Fannie Mae and Freddie Mac were the How much would such a program major impact on whether and how invest- responsible for establishing the credit- largest GSEs until they were nationalized cost? That would depend on the default ment projects get financed. worthiness of businesses and the viability in September 2008 to stave off financial rate for the loans. In 2007 the government The outsized importance of securi- of their projects. Businesses would still be collapse. Other GSEs include the Fed- had to cover about $50 billion on an out- tized assets as a share of overall market responsible for the design and implemen- eral Home Loan Banks, the Agricultural standing portfolio of guaranteed loans of activity only compounded perverse incen- tation of their investments. Indeed, busi- Credit Bank and Farm Credit Banks, $1.2 trillion. This is a default rate of 4 per- tives. In financial markets dominated by ness would still have freedom to pursue and the Federal Agricultural Mortgage cent. At this rate, our proposed addition securitization, the primary way banks or nonpreferred projects, and banks could Corporation.) of $300 billion in guaranteed loans would other financial intermediaries earn money still finance them.F inancing costs would Despite their formidable size, these cost roughly $9 billion more per year in is not holding onto loans and collecting just be significantly higher. programs have not been integrated into a loan receivables, increasing the overall fed- interest. Rather, banks earn fees by selling Implementing requirements as a sys- broader policy agenda or tied in any way eral budget by 0.3 percent. But it would individual loans to entities such as Fannie tem of market auctions rather than quotas, to the Federal Reserve’s monetary policy leverage more than $300 in private loans Mae or Freddie Mac that want to bundle as Maisel proposed, would allow more flex- and interest rate management efforts. for every dollar in government spending. the loans into securities. Fannie and Fred- ibility. Institutions would not have to carry They operate rather as financing vehicles This sort of loan-guarantee program could die will themselves earn another round of the specified proportion (say, 25 percent) for distinct programs, from student loans serve as a carrot to the stick of asset-based fees by selling their bundled loans on the in loans to preferred sectors. Intermedi- to rural business development. Their in- reserve requirements for private financial market. Still more fees can be earned by aries that exceed the limit would obtain a fluence on overall financial-market risk or institutions. selling insurance policies on the securi- permit that they could then sell to institu- borrowing costs has not been considered, Fifth, and finally, I propose the for- tized bundle of loans. tions whose loans to preferred sectors are nor has their effectiveness in leveraging mation of a public credit-rating agency to What makes securitized assets more below the minimum. Individual institu- relatively small amounts of public funds to compete with the private agencies such as valuable in the market than the under- tions could therefore choose to maintain move private financial markets in socially Moody’s, Standard & Poor’s, and Fitch. lying bundle of loans is that the risks particular market niches. At the same time, desirable directions. These rating agencies contributed sig- associated with those loans have been re- the system would ensure that some niches An expanded loan-guarantee program nificantly to the housing bubble and sub- configured, repackaged, and presumably carried an extra burden of either higher could be included as a tool to promote sequent crash of 2007-08 by consistently clarified for market participants. Without reserves or purchases of “preferred asset financial stability and social welfare. As- delivering overly optimistic assessments a favorable rating, securitized assets are permits.” sume, for example, that the government of risky financial ventures, especially in simply not marketable. With a favorable A fourth measure that could channel roughly doubled its 2007 level of loan securitized asset markets. rating, opportunities to earn fees emerge credit to priority areas and reduce risk guarantees. The additional $300 billion Rating agencies are supposed to be in at all points in the chain of securitizing, in U.S. financial markets would focus per year could be earmarked for green the business of providing financial mar- insuring, and trading, with market trad- and expand the federal government’s al- investments and affordable housing, and kets with objective and accurate apprais- ers always keeping their fees, no matter ready extensive but unwieldy system of we would set an explicit level of guarantee als of the risks associated with purchasing what happens at some later date to the direct lending and loan guarantees. The at, say, 75 percent. The government then a given financial instrument.I n part, they underlying asset. U.S. government has long been heavily would be the guarantor for $225 billion in understated risk in recent years because A public credit-rating agency would invested in domestic financial markets loans for green investments and affordable they relied on orthodox economic theories counterbalance this perverse incentive as a direct lender and even more signifi- housing. Interest rates on these subsidized in their appraisals. But more important system. Its staff would be compensated cantly as a loan guarantor. The sectors loans would fall with the reduced level for our purposes is that market incentives as high-level civil servants. They would of the economy receiving substantial of risk—i.e. by 75 percent relative to the themselves pushed the agencies toward receive no benefits from providing either support though these loan programs in- difference between a market interest–rate providing excessively favorable appraisals. favorable or unfavorable ratings. Indeed, clude housing, education, agricultural bond and a risk-free government bond. If Giving a favorable risk appraisal was good a compensation system could reflect the and rural development, and small busi- the market interest rate is 10 percent and for the rating agencies’ bottom lines, and accuracy of their risk assessments over ness. As of 2007, the government oper- a government rate 5 percent, the subsi- the agencies responded predictably. time.

12 B O S t o n R E V i e W tools for a new economy s h0t0 p .com/ kr ic l / f l e s tom hen

It is true that providing accurate least the largest and most important in- These are important considerations, public-sector presence in the financial sys- risk appraisals has become increasingly stitutions that represent the “command- but they do not constitute an adequate tem. Indeed, the failures of the national- challenging as securitized markets have ing heights” of Wall Street—should not case for nationalization over a new finan- ized system could be the very thing—per- deepened. The pubic agency’s staff may merely be re-leashed through regulation, cial regulatory system. We would face sig- haps the only thing—that could shift the well conclude at times that an instru- but substantially nationalized, operat- nificant problems under nationalization. target of public outrage over the collapse ment is too complex to allow for an ac- ing with public ownership. After all, the Unlike France or Japan, the United States of the financial system off Wall Street and curate appraisal. But the agency would federal government under George W. does not have a longstanding tradition of onto the U.S. government. be obligated to be open with such an Bush already nationalized Fannie Mae direct public ownership of major finan- At this juncture, it seems preferable to assessment—that is, to assess an instru- and Freddie Mac as part of its fall 2008 cial institutions. Realistically, we would promote financial stability and social wel- ment as “not ratable.” Financial market bailout operations. have every reason to expect a wide range fare by leashing the markets and thereby participants could then decide whether The main arguments for nationaliza- of failures and misjudgments, including reorienting their priorities, not by choking they want to gamble with such an in- tion are straightforward. First, the failings “crony capitalism”—privileged back- them off altogether. strument. of an unregulated financial system are now room dealings with selected non-finan- Private agencies could still operate as blazingly apparent. Re-leashing financial cial firms. they wish, but would have to explain any markets in some form is no longer a matter Even putting aside problems of cor- range of forces in the U.S and global large divergence from the public agency of dispute; only the question of how best ruption, we need to recognize that indi- A economies have combined to create in their assessments. Public rating would to do it remains. One path would eliminate vidual financial enterprises, as with all the most severe economic crisis since the weaken the biases in favor of greater risk private ownership of financial institutions business entities, literally need micro- 1930s. We will debate for years to come and complexity, and move financial-sys- altogether. management. The U.S. government has how these forces came together and how tem operations to a higher level of trans- Second, even while assuming equity at times managed the economy at the they interacted once combined. But one parency. It could even provide the basis positions in several large financial institu- macro level reasonably well. But the chal- factor stands out as the greatest cause of for establishing the asset-based reserve tions at the end of 2008, the government lenges for the government to combine the the crisis. This is the collapse of the U.S. requirements for loans and other assets did not insist on exercising significant au- demands of both micro- and macro-level financial system. The financial-system held by financial institutions. thority over management decisions. Nor management would be formidable. The collapse can be traced, in turn, to the As risk assessment would likely be- did it clearly establish a claim on any profits details of day-to-day management aside, dismantling since the 1970s of the Glass- come more cautious under a public credit- once the crisis subsides. With banks fully the government would have to create an Steagall financial regulatory system. rating agency, the market’s enthusiasm for nationalized, the government would be the incentive system for the managers of the Glass-Steagall was created in the 1930s financial innovation would likely dampen. clear operational manager of the institu- publicly owned banks that would substi- precisely to prevent a recurrence of that Indeed, this would partly be the point of tions as well as the claimant on profits. tute for the profit-maximizing incentives era’s economic disasters. Both Demo- such a measure. But it need not make the Third, without nationalization, we that guide managers of private banks. If cratic and Republican political leaders overall economy less innovative or dy- can be certain that Wall Street will fight the nationalized banks are not committed must now accept responsibility for the namic. With a public credit-rating agency vehemently, as it always has, to minimize to maximizing profits, how should their current calamity. and the other measures proposed here, the regulations that might limit its ability to performance be evaluated? We now begin what will necessarily dynamism of a leashed financial market make profits. Such efforts will include at- Resolving such questions would re- be a long process of building a regulatory would emerge in the way that credit moves tempting to corrupt the regulators and the quire years of experimentation and fine- system capable of mobilizing the econ- into productive areas. elected officials overseeing them. Most tuning. In the meantime, U.S. taxpayers omy’s financial resources for productive such efforts will be entirely legal: assum- would pay for inevitable breakdowns of economic activity instead of casino capi- ing the regulators are generous toward the the nationalized system. The tolerance for talism. With the collapsed model of the t the end of 2008, the financial cri- industry they are regulating, they will find breakdowns would likely be low, and every deregulated financial system now before Asis and recession made respectable a opportunities for lucrative employment misstep or mini-scandal could undermine us, the set of proposals offered here are question that would have been unthink- within the industry once they quit their the legitimacy of the new system. In the a starting place for forming a stable and able only months earlier: whether pri- public-sector jobs and move into private- end, nationalization could undermine the equitable financial structure for the U. S. vately owned financial institutions—at sector positions. larger project of reestablishing a major economy. © ja n uary / f e bruary 2 0 0 9 13