Thursday, June 24, 2010

Wall Street Rising: 1980 -

In this chapter, Johnson and Kwak briefly sketch the story of how from 1980 until today, Wall Street burst free of the regulatory restraints of the postwar period and became the economic and political behemoth it is today.

The authors begin their discussion by comparing the wealth of Salomon Brothers, the paradigmatic 1980s investment bank, and today's JPMorgan Chase, headed by "President Obama's favorite banker," CEO Jamie Dimon:

At the time [July 2009], JPMorgan Chase had over $2 trillion in assets...$155 billion in balance sheet equity; and it earned $4.1 billion in operating profits in the second quarter alone. By comparison, the 1985 Salomon Brothers, even after converting to 2009 dollars to account for inflation, only had $122 billion in assets, $5 billion in equity, and $2 billion in operating profits for an entire year...Although Dimon voluntarily took no cash bonus for 2008, his total compensation including stock awards was still $19.7 million, more than three times Gutfreund's (the former head of Salomon) inflation-adjusted earnings of $5.8 million. And this was in a bad year for CEOs; in 2007, Dimon earned $34 million, Blankfein $54 million, John Thain of Merrill Lynch $84 million, and John Mack of Morgan Stanley $41 million. (p. 57-58)

Meanwhile, politicians friendly to the financial sector work hard behind the scenes in Congress to stand in the way of financial reform, and bankers balk at proposals to rein in compensation schemes that encouraged the kind of big-time risk taking that led to the 2008 financial crisis.

How did we ever get to this point? Johnson and Kwak frame their discussion around the transition from "boring banking" to "exciting banking," which has produced banking on a much bigger scale than was the norm decades ago. This shift began in the 1970s, when a general push toward deregulation in finance and the economy generally began during the Carter administration. Deregulatory legislation began to erode the firewall between commercial and investment banking created by the Glass-Steagall Act. Just as importantly (perhaps even more so), the emergence of academic finance and the Efficient Market Hypothesis, which held that financial products are always correctly priced by the market, provided intellectual justification for the shift toward deregulation, even though many other economists pointed out that this assumption stood on very shaky ground.

The push for deregulation kicked into high gear with the election of Ronald Reagan in 1980, whose administration vigorously sought to loosen restrictions on the financial sector and consolidate the ideological dominance of free market economic theories like the Efficient Market Hypothesis. Even so, the Reagan administration's deregulation drive was not entirely successful, at least partially because both houses of Congress had Democratic majorities during his entire tenure. Wall Street's economic and ideological power certainly grew during the decade of the yuppie, but at the time there were still countervailing political forces challenging its desired dominance. They would be swept aside before long.

As Johnson and Kwak argue, Wall Street's rise to political predominance through economic power was facilitated by the creation of what they call "new money machines": high yield debt , securitization, arbitrage trading, and derivatives. These new products fueled the growth of big banks capable of investing in the computing technologies and highly educated mathematicians and scientists that make this kind of banking possible. These developments, in addition to further deregulatory legislation enacted under the Clinton administration that broke down barriers between investment and commercial banking and encouraged a wave of bank mergers, facilitated the formation of a handful of megabanks that comprise today's Wall Street.

Questions for discussion:
1) The authors pay a lot of attention to the importance of ideology in facilitating the shift from the highly regulated postwar financial system to today's deregulated environment. Considering how deeply shaken and seemingly delegitimated the system was in 2008, why do you think that a similiarly powerful ideological countermovement advocating increasing regulation (or even more radical measures like bank nationalization) has failed to come to prominence?

2) The authors briefly touch on the question of homeownership in this chapter while discussing the effects of high inflation in the 1970s: "homeowners...profited while their debts were inflated away - helping to convince a generation of Americans that houses were the best investment they could possibly make." (p. 66) This is true, but I would argue that the appeal of homeownership is a deeper and fundamentally ideological concept - for decades, homeownership has been touted by almost everyone as the key to the American Dream, an indication of one's worthiness to be considered a full, contributing member of society. Indeed, the obsession with promoting home ownership was one of the causes of the current recession. Do you think that what I consider to be the cult of homeownership has delegitimized at all by the recent crisis? New York City has always been a city of renters and continues to have very low homeownership rates in comparison to the country as a whole (30.2% versus 67.1%), so our local perspective may be a bit skewed, but it doesn't seem to me that most people are rethinking the alleged superiority of owning your own home. What do you see and hear?


Larry M. said...

A movement to drastically cut the power and freedom of financial institutions is not likely to happen in light of 2008 because so far, the crisis has not been serious enough to persuade the public to push for greater changes. We would need to see unemployment and bankruptcy levels comparable to the 1930s to get people to push for greater reforms than were included in the just-passed financial reform bill. The financial services lobbyists were able to push back enough to moderate the toughest proposals in the bill. As far as changes in American attitudes about home ownership go, the current tax laws still give a big boost to home financing. We aren't likely to see radical shifts unless that changes. People are not going to view homes as cash machines as they did a few years back for quite some time.

Adam12 said...

People recognize that increased regulation or state control of banking, however well-meaning, is not the answer. The track record of American regulators is not inspiring. See the SEC's mishandling of Bernie Madoff as an example. Wall Street has found ways to circumvent regulations for decades and isn't going to stop now.

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