A Laissez Faire-y Tale

Libertarianismand deregulation successfully trashed the US economy. Americans lost theirsavings, their homes, and their jobs in record numbers unprecedented since theGreat Depression. Former Federal Reserve Chairman Alan Greenspan’s libertarianphilosophy that markets know best is responsible for the U.S. financial crisisthat erupted at the end of George W. Bush’s presidency. Greenspan’s acolytes – TreasurySecretaries Robert Rubin, Larry Summers, and Timothy Geithner – also bearresponsibility for the existing international economic debacle. And it allbegan with Ayn Rand.

Rand immigratedto the United States from Russia in 1926, the year Alan Greenspan was born. Thecelebrated fiction author of the novels TheFountainhead (1943) and AtlasShrugged (1957), Rand championed libertarianism. She famously told MikeWallace in a 1959 CBStelevision interview that she believed in “the separation of state andeconomics.” She opposed all regulations of markets. Greenspan became her pupiland she was present when he was sworn in as President Gerald Ford’s chiefeconomic advisor. That she came from an oppressive government regime likelyexplains her extremist laissez-faireattitude – something that Republicans love.

By the timeRand became a Hollywood screenwriter, President Franklin Roosevelt signed theBanking Act of 1933 (Glass–SteagallAct). This New Deal legislation established the Federal Deposit InsuranceCorporation (FDIC) and introduced banking reforms to control speculation. Followingan era of corruption, financial manipulation and "insider trading"resulted in more than 5,000 bank failures following the 1929 Wall Street crash. The Glass–Steagall Act also allowed theFederal Reserve to regulate interest rates in savings accounts.

Deregulation fevertook hold in 1980 with the enactment of the Depository InstitutionsDeregulation and Monetary Control Act (DIDMCA) that gave the Federal Reservegreater control over non-member banks. Among other things DIDMCA allowed banksto merge, forced all banks to abide by the Fed's rules, and removed the powersof the Fed under the Glass–Steagall Act to set the interest rates of savingsaccounts. Ronald Reagan became president that year, famously saying thatgovernment was not the solution to the country’s problems, “government is theproblem.”

The AlternativeMortgage Transactions Parity Act of 1982 (AMTPA) removed regulations that barredbanks from making anything but the conventional fixed-rate loans. That gavebirth to the kind of mortgages that put borrowers in default situations; Adjustable-Ratemortgages (ARM), Balloon-payment mortgages, and Interest-only mortgages crushedborrowers. The option-ARM allowed borrowers to underpay by as much as they wantduring the first few years of the loan so that the unpaid monthly interest gottacked onto the size of the loan.

A $300,000mortgage could become a $350,000 loan. Homeowners could find themselves out ofequity, upside down, and into default.

As for AlanGreenspan, he continued to build upon his libertarian Wall Street-friendlyinfluence in Washington. On August 11, 1987, the Senate confirmed Greenspan as PresidentReagan’s nominee for chairman of the Federal Reserve. Paradoxically, the AynRand influenced, anti-regulation, free-market economist Greenspan became theultimate regulator as the head of the central bank. Two months later, on October19, the Dow Industrials' plunged 508-points and the New York Stock Exchange crashed.

But as adisciple of Ayn Rand, Greenspanpresumed that “the self-interests of organizations, specificallybanks and others, were such as that they were best capable of protecting theirown shareholders and their equity in the firms,” as he testified beforeCongress. He sought and attracted fellow believers in free-marketeering whogrew in their influence and power during the Clinton administration. Greenspan’sinner circle included Wall Street financier Robert Rubin, Harvard economistLarry Summers, and the Treasury Department’s Timothy Geithner. Each of thembecame Secretary of the Treasury.

The so-calledgo-go ‘90s seemed to confirm Greenspan’s hands-off approach to regulation. Butas a result the financial world suffered a fiscal heart attackin 1998.  

Long TermCapital Management (LTCM) started to meltdown. The secretive computer modeldriven firm made huge leveraged bets on various forms of arbitrage, inparticular securities called over the counter derivatives. Derivatives made upan unregulated $27 trillion dollar international market. Unfortunately, LTCM’s proprietarycomputer models failed when a financial crisis in Russia fractured their virtualfinancial world and crashed those models. It took a private bailout, overseenby the Federal Reserve, to prevent systemic financial catastrophe.

Congresssummoned Fed chairman Greenspan. He again assured them that markets know best.He told them that he knew of no regulations that could prevent people “frommaking dumb mistakes.” So despite the systemic meltdown, Congress took noregulatory action. The following year Congress sent President Clinton the FinancialServices Modernization Act of 1999 (Gramm–Leach–BlileyAct) which he signed. The Gramm–Leach–Bliley Act allowed commercial banks,investment banks, securities firms, and insurance companies to consolidate.

From 1999 to2008 the grateful financial industry spent $2.7 billion on lobbying, whileindividuals and committees affiliated with it made more than $1 billion incampaign contributions. During this time, the banking industry hid its use of off-balance-sheetderivatives and its excessive use of leverage. That created a shadowbanking system  in which the banksrelied heavily on short-term debt. The lobby got what it wanted and Greenspan gotthe praise. However, Greenspan's apparentsuccesses in managing the economy from 1987 to 2006 are a façade. Thatmanagement created the largest credit bubble in world history.

PresidentGeorge W. Bush awarded the Presidential Medal of Freedom to Alan Greenspanafter his 18 years at the Federal Reserve In 2005. Hailed as a financialwizard, Greenspan retired in 2006. Dr. Ben Bernanke, a Princeton University EconomicsProfessor, succeeded him. Goldman Sachs Chairman and CEO Henry M. Paulsonbecame Treasury Secretary. Greenspan’s protégé Timothy Geithner served as theCEO of the Federal Reserve Bank of New York. The U.S. housing bubble continuedto swell.  

In 2008 asystemic failure like the LTCM meltdown a decade earlier hit the Wall Street.The investment house Bear Stearns began to meltdown. It imperiled the interconnectedglobal financial market, largely because of derivatives that had been created withtoxic mortgage backed securities. Federal intervention in the form of a loan toJ.P. Morgan Chase as an intermediary allowed Bear to be bailed out, but it didnot solve the underlying problems such as secrecy, avarice, and fraud.

Next, the epidemicmortgage crisis forced the Treasury to nationalize Fannie Mae and Freddie Mac,putting each of the mortgage giants into conservatorship. Secretary Paulsonsaid that "that conservatorship was the only form in which I would committaxpayer money to the GSEs [Government Sponsored Entities]."  The Treasury committed to invest up to $200billion to keep the GSEs solvent.

Wall Street’sLehman Brothers faced bankruptcy next. Secretary Paulson decided to teach WallStreet a lesson. He told Lehman management that the government would not stepin. Lehman needed a buyer but found none. Forced into bankruptcy, thegovernment allowed Lehman to fail. With that, the systemic risk plunged Irelandinto trouble. The Bank of England had to start bailing out banks. Iceland wentbankrupt. China faced 0% growth. At home U.S. banks stopped lending. The worldfinancial system began to meltdown.

Then one ofthe world's biggest insurers, American International Group (AIG), fell victimto the mortgage backed security crisis. This time, however, the governmentdecided AIG truly was too big to failand seized control. The $85 billion deal demonstrated the government’s extremeconcerns about the danger of what such a collapse could pose to the financialsystem.

SecretaryPaulson and Fed Chairman Bernanke called congressional leaders to NancyPelosi’s office and bluntly requested $700 billion dollars to save the USeconomy. At first rejected by the House, the Emergency Economic StabilizationAct of 2008 was signed into law by U.S. President George W. Bush on October 3.It created the Troubled Asset Relief Program (TARP) which allowed the UnitedStates government to purchase assets and equity from financial institutions.  

To solve thelending crisis, Secretary Paulson summoned 9 of the largest banks’ CEOs to theTreasury. He forced them to accept capital injections that made the UnitedStates a stockholder. To prevent the failure of Wall Street’s Merrill Lynch,Paulson arranged its buyout by Charlotte based Bank of America. Under TARP somebanksgot bailed out. Other banks were seized by the FDIC and placed intoconservatorship until they could be purchased.

In retrospect,many analysts and economists now blame weak Fed policies for the 2006–2008 housingcrash, the Wall Street financial crisis, and resultingrecession. Failing to take action to stem the bubble in housing prices,inadequate oversight of financial firms, and keeping interest rates low for anextended period are major contributors.

AlanGreenspan now says, "I made a mistake in presuming that the self-interestsof organizations, specifically banks and others, were such as that they werebest capable of protecting their own shareholders and their equity in the firms."He testified to congress that he “found a flaw.” Greenspan said the crisis hadshaken his very understanding of how markets work. He also agreed that despitehis former opposition to it, financial derivativesshould be regulated.

The Ayn Rand-inspiredlaissez faire libertarianism that Greenspan and his fellow US financialregulators practiced not only failed on a colossal level but led to phenomenalgovernment interventionism. Deregulation and the absence of regulating allowedfor massive investment fraud hidden in an opaque and secretive internationalmonetary system. It also concentrated Wall Street firms and U.S. banking, whichwill continue to pour money into opposing past and future regulations. Rand’sphilosophy emanated from a world coming into the 20th century. It failedthe world coming into the 21st.  

 Originallypublished as ALaissez Faire-y Tale on Blogcritics.