A REPUBLIC NOT WORTH KEEPING: HOW BONDS BETWEEN PRIVATE FINANCE AND PUBLIC SERVICE SUBVERT THE GENERAL WELFARE A Thesis submitted to the Faculty of The School of Continuing Studies and of The Graduate School of Arts and Sciences in partial fulfillment of the requirements for the degree of Master of Arts in Liberal Studies By Charles McCarthy, B.A. Georgetown University Washington, D.C. October 31, 2012 A REPUBLIC NOT WORTH KEEPING: HOW BONDS BETWEEN PRIVATE FINANCE AND PUBLIC SERVICE SUBVERT THE GENERAL WELFARE Charles McCarthy, B.A. Thomas Kerch, Ph.D. ABSTRACT This paper draws upon the chronology of the nation’s most recent financial crisis, the Great Recession, to expose America’s undemocratic governing reality and postulate that its existence rests upon the preferential bonds forged between private money and public service. Over many years, these connections have assumed a dominant role in the body politic, such that they have superceded the Constitution and subverted the collective will of the American people. This usurpation in authority will become apparent through examinations of modern campaign finance, financial regulatory law and its administration, and the operations of the nation’s central bank, the Federal Reserve. As such major reforms are needed to these institutions, alongside a broader effort to educate the U.S. citizenry about its money supply and how it influences the national economy. ii ACKNOWLEDGMENTS This thesis is dedicated to my family and friends. To my wife, Liz, who exhibited unwavering love, encouragement, resolve, and breadwinning skills. To my mother and father, Adel and Charlie, who provided me with seemingly infinite resources, foremost among them a formidable work ethic, an ethical foundation from which to stand against injustice, and the will to persevere, without which I would not have been able to find myself in pursuit of a graduate-level degree. To Marianne, who gave me the chance to excel at Georgetown, and with whom I forged a truly meaningful friendship. To Sharon and Jim, who afforded me both solace and sanctuary during this academic sojourn. To Kevin, whose intellectual journey forced me to constantly re-evaluate my own and thereby produce better work, and to my compatriots in South Carolina and Washington who, again and again, helped galvanize and reinvigorate my creative spirit. Finally, I would like to thank my mentor, Thomas Kerch, who over the course of more than a year shared invaluable experiences and insights, and allowed me the academic freedom to complete a capstone project that lives up to my personal expectations. iii CONTENTS ABSTRACT ii ACKNOWLEDGMENTS iii INTRODUCTION 1 CHAPTER ONE. GRESHAM’S DYNAMIC, CONTROL FRAUD, 5 & THE GREAT RECESSION CHAPTER TWO. A BRIEF MINSKIAN HISTORY OF MODERN 30 AMERICAN FINANCE CHAPTER THREE. PAY-FOR-POWER CAMPAIGN FINANCE, 41 THE REVOLVING DOOR, & REGULATORY CAPTURE CHAPTER FOUR. A DECADE IN THE MAKING – CIVIL SERVICE 68 FAILURES & THE GREAT RECESSION CHAPTER FIVE. THE FEDERAL RESERVE & THE MONEY POWER 100 CONCLUSIONS 117 BIBLIOGRAPHY 131 iv INTRODUCTION Do you want to live in a democratic society? Or do you want to live in the society we have, which, remember, is not a democratic society, nor [is] it intended to be. –Noam Chomsky The idea that America’s polarized political landscape constitutes the largest barrier to governmental reform and progress may be popular, but it is ultimately misguided. The current ideological terrain is a nothing more than a wasteland of reactionary bravado and bluster, an atmosphere predicated on those foolish and disingenuous allegiances which obscure the ethically unacceptable, morally perverse, and absolutely avaricious relationships between politicians and private interest groups that together subvert the general welfare of the United States. It is a political paradigm that has existed for generations, made manifest by a throng of representatives at the federal level beholden to a legacy, two-party system that is corrupt, perhaps more today than ever before. This paper draws upon the chronology of the nation’s most recent financial crisis, the Great Recession, to expose this governing reality and postulate that its existence rests upon the preferential bonds forged between private money and public service. Over many years, these connections have assumed a dominant role in the body politic, such that they have superceded the Constitution and subverted the collective will of the American people. This usurpation in authority will become apparent through examinations of 1 modern campaign finance, financial regulatory law and its administration, and the operations of the nation’s central bank, the Federal Reserve. For the sake of posterity, a more limited and refined lens will reveal that the unprecedented amount of funds flowing from the sector of the national economy dedicated to finance, insurance, and real estate (FIRE) to federal politicians, especially in the executive and legislative branches, facilitated white-collar crime on an unprecedented scale and provided for its subsequent exclusion from the rule of law. These injustices were primarily perpetrated in the home lending and securities industries. The leaders of commercial banks and other firms offering mortgages to the public committed massive frauds to amass vast personal fortunes over a relatively short period of time. They accomplished this by using modern accounting practices to inflate the value of their corporations through accumulating assets (i.e. mortgages) that they knew would fail over the long run. Investment banks and other brokerages then followed suit, bundling these faulty mortgages with a variety of other mortgages to obfuscate their real value, portraying them as securities that would be safe for institutional investors to buy (i.e. people with a 401k). In effect, corporations were deliberately used as weapons against their prospective customers. The pervasiveness of this strategy was not a periodic anomaly but the inevitable result of a transition in the FIRE economy from capitalistic enterprises based in the risk- averse, hedge finance of industrial production and its peripheral businesses to speculative, ponzi-like trading in assets purported to appreciate in value indefinitely. 2 Once payments stopped on millions of mortgages – the balances of which were never meant to be repaid by design – a deflationary sprial began in which the real estate job market collapsed, making even more homeowners subject to foreclosure; empty properties became the norm due to overcapacity in the housing market; and property values declined substantially for many who were able to remain in their homes. Some of those very same citizens, who were investors in the securities backed by fraudulent mortgages, subsequently saw the value of their portfolios plummet. Such a collapse was only possible because representatives in the federal government, for at least the last 50 years, have presided over deregulatory civil service regimes in which traditional banking and investment firms were permitted to engage in riskier and riskier activities usually reserved for their counterparts in “shadow” finance, eventually to such an extent that their solvency was guaranteed by Uncle Sam. Such an arrangement was the product of record campaign donations by FIRE sector companies – which now surpass hundreds of millions of dollars each election cycle – to members of the House of Representatives, the Senate, and both Democratic and Republican candidates for the presidency in the United States, as well as lucrative employment before and after their terms in office, the latter a sociopolitical phenomenon termed “the revolving door.” In return, America’s elected representatives have ensured the passage of lax laws overseeing the FIRE economy or the repeal of more effective ones; appointed that particular sector’s executives to lead government agencies charged with oversight of many of their former companies and contemporaries (a problematic governance issue that 3 often results in what is called “regulatory capture”); and made it so those responsible for the Great Recession have faced no criminal prosecutions and no meaningful penalties in civil cases. Even though the wake of the crisis has propelled new reformative currents into the injustices and inequities stemming from weak campaign finance laws and regulatory legislation riddled with loopholes, there are questions about the efficacy and certainly the legitimacy of these measures. The single promising development, an audit of the Federal Reserve that revealed tens of trillions in secretive monetary rescues of leading FIRE sector corporations, only served to once more lay bare the major operational feature of the nation’s central bank: The leadership structure of the Federal Reserve – and by proxy control of the U.S. money supply – is determined exclusively by the system’s private- sector, commercial member banks. The Federal Reserve is, therefore, remarkably undemocratic. It represents, by itself, the preferential nature of bonds between private finance and public service, and its actions during the Great Recession undermine the constitutional precept that citizens receive equal protection under the law. But together with the overt corruption that continues to be guaranteed through campaign finance, the revolving door, and regulatory capture, the Federal Reserve and the modern Congress arguably constitute the greatest threats to what is left of American-style democracy and the republican form of government. 4 CHAPTER