I.
There is a story in the days before the Federal Reserve about the panic of 1907. There was a run on a bank – the Knickerbocker trust. There was a worry that it would spread, as panics often did. Instead of letting the failure of one bank topple over the whole system, JP Morgan got a bunch of other bankers in the library of his personal headquarters at Madison Avenue. He wouldn’t let his peers, the lions of the turn of the century financial world, leave the building until they had pledged their own capital to the banks to stop the panic. Peace was restored.
There is another story in which there was another panic, this time with the stocks dropping and other banks failing, and Morgan’s son tried to do the same thing. The market kept dropping. More banks closed, Roosevelt was elected, and the depression lasted a decade until massive federal spending picked up with the beginning of US involvement in the second world war.
There is a third story, as the financial crisis came to a tipping point in the fall of 2008. Bernanke, Paulson, and Geithner gathered up the leading lights of the turn of the new century in a room. This room was at the headquarters of the New York Federal Reserve, an institution created in the shadow of the panic of 1907 and the fall of the Knickerbocker trust. This time, the leaders were government employees, working for the Federal Reserve or the Department of Treasury. They were being asked not to put up their own capital, but to accept capital from the government. Some bankers were reluctant, as accepting capital was a de facto admission that their banks were insolvent, or at the very least were having liquidity problems. No one wanted to admit that they were having problems or exposed to counterparties with their own issues. But ultimately, everyone did. They even changed the charter of a couple of the institutions so that they could formally accept money from the Federal Reserve because technically up to that point they weren’t even banks. So Goldman Sachs became a bank, that it could fall under the Fed’s preview and take the Fed’s money even though if you asked any at Goldman the crisis hadn’t touched them, they were not to blame, and their hands were clean, thank you very much. Even though it’s been a decade, it might be too soon to be bringing judgement on if this intervention worked or not. Will we be able to tell what’s next?
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II.
Two statues sit outside of the headquarters of the Federal Trade Commission in Washington DC. In the gloriously neoclassical and overly didactic symbolism of the capitol, these statues show a man wresting a horse, both subjects with rippling stone muscles. It is called Man Controlling Trade and shows the mission of the FTC. But it can also be seen as a metaphor for all the regulators in Washington and New York. Capitalism is this wild horse, who can rampage but be put to product use. It is up to the functionaries to make sure that this raging horse is harnessed so that its capabilities are put to good use and it doesn’t rage about the countryside, putting people out of jobs and homes.
You see, Man Controlling Trade is at best an ideal. If our sculptors wanted to represent the actual relationship between the individual business and their regulators, it would not be a man wrestling with the stallion, but instead a person in constant pursuit of the stallion. One thing that capitalism is very good at is innovation. But innovation is not necessarily ultimately for the public good. It is innovative and it isn’t passive. It actively uses the levers under its control to avoid and subvert regulation. Often, there is not the separation between the man chasing the horse and the horse itself. They lose their antagonism and work together.
III.
More stories, more concrete. A woman was chairperson of the Commodity Futures Trading Commission. Her name is Brooksley E. Born. During the Clinton years she saw that derivatives could become a destructive force in the economy. So, she said that these instruments needed to be traded on exchanges. Their terms and their prices needed to be transparent so that the markets could work their magic. Pressure came from above from the banks and through other federal workers who should have been working for the benefit of American Citizens and for the functioning of the economy as a whole. Instead of being pro-market, they protected their specific friends in business. These are names you recognize: Alan Greenspan, and Treasury Secretaries Robert Rubin and Lawrence Summers. They ruined her career. And Brooksley Born was right, as we saw a decade later as these very instruments were key to bringing down the entire financial apparatus.
Alternately. Banks called Savings and Loans fight their regulators, to be allowed to offer higher interest rates on deposits because in part money market funds were offering higher interest rates as the 70s became the 80s. They took these deposits and started offering as many loans as possible. They needed to make the loans to get the money to pay their depositors. This works until there’s a local downturn. The oil market goes south in the 80s, so people can’t pay their loans so the S&L’s can’t pay their depositors. So many of these small banks go bankrupt that the federal insurance institution set up to ensure depositors didn’t lose too much money went bankrupt itself and had to be bailed out. This cost the federal government billions of dollars.
One more. Again, in the Clinton era. Citibank announces that it will buy Travelers group, which sells insurance and other financial products. The problem is that this merger is against the law. The Glass–Steagall Act was put in place after the last time the financial crisis brought all of society down. It explicitly kept separation between banks and investment banks so that banks would not speculate with depositor money. The idea was to keep banking boring and stuck at the 3-6-3 rule, where you borrow at 3%, lend at 6% and are out of the office by three o’clock. What was the reaction to this transaction? Did they disallow it, throw its architects in the stockade? Of course not. A compliant congress passed the Gramm-Leach-Bliley Act to make this combination legal after the fact. Then of course a decade later the economic system crashed again.
IV.
The story of regulation for the last century or so seems to be this cycle, where there is a crash and then rules and regulations are put into place, and then capital fights and evades the rules, setting up the next crash. They capture regulatory agencies and the hodgepodge of these agencies have trouble coordinating – banks and financial institutions are regulated by the Federal Reserve, the FTC, The Department of Justice, the SEC, The Department of Treasury, the old OTS, the OCC among others. Having this sort of spread of agencies means that there is the possibility of searching for the lightest touch, a form or regulatory arbitrage in setting your charter so the least active regulator is your regulator. This is also seen at the state level where so many banks are incorporated in Delaware or South Dakota because they have low taxes and low levels of expected consumer protection.
What this leads to is what I was talking with about statue of the horse in that the regulator, if it is even interested in doing its job and not fully captured, is always working from behind. The political power of these big financial institutions cements themselves so that they become essential. To big to fail is not just a thing that happened, but the outcome of years of decisions concentrating that political and financial power. The next crisis is already brewing, but even if someone is sounding the alarm right now, the regulators will be asleep at the wheel. Because the problem is the cycle of crash then regulate then remove the regulations has been accelerated under the Trump Administration so we might just be hard up against the next crash. What will cause it?
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