A few days ago I posted some thoughts on a talk Joseph Stiglitz gave to AOL Daily Finance last month on the need to reshape the law to toss the folks behind the financial crisis in jail. At the time I mentioned in passing that Stiglitz was reaching for a draconian structural solution -- recasting the laws -- but that he had relatively little to say about reforming regulation. Why was that? It's not that Stiglitz is not familiar with financial regulation at a fairly sophisticated level. But it is as if he has lost faith not only in the regulatory apparatus that currently exists, but also in the entire notion of the administrative state that began to appear in the U.S. early in the 20th century as a counterbalance to enormous corporate interests. He seemed to want to replace regulation with hard and fast legal remedies, which in turn were based on the norms of the community -- that is, on politics.
Stiglitz isn't alone. Much of the discussion since the collapse of Lehman Brothers has swirled around dramatic structural remedies. Not long after Lehman Brothers collapsed, The Wall Street Journal's Dennis Berman suggested shuttering all the big banks and then creating new banks, without the debilitating burden of bad loans. More realistically, there have been proposals to break up the big banks, turn them into utility banks, or to re-impose Glass-Steagall. But behind many of these ideas is a set of assumptions about what exactly happened that is deeply political. In their book "13 Bankers," MIT's Simon Johnson and his blogging partner at the Baseline Scenario James Kwak make two related arguments about size and power. As banks consolidated and grew larger, they assumed greater political power, shaping the laws and regulations to their own greedy ends -- a theme they share with Stiglitz -- and "capturing" regulators in the process. In their view, a takeover of the government took place; an oligarchy of crony capitalists arose not unlike the tight links between ruling families and financial institutions in the emerging markets. Matt Taibbi in Rolling Stone provided his own gloss on this by placing Goldman, Sachs & Co. not only at the conspiratorial center of this bubble, but of bubbles going back to the Great Depression. Government Sachs became a popular meme.
Johnson and Kwak first offered up this critique in the Atlantic magazine in March 2009, but they were simply articulating a widespread argument that has a long history. At its heart is the notion of a self-conscious effort by private or special interests to control the government. In Karl Marx these "interests" were embodied in class; for populists of the late 19th century, they were gold bugs and "Wall Street interests"; during the New Deal, they were "malefactors of great wealth" and, like today, "bankers" (recall how mysteriously powerful David Rockefeller's Chase Manhattan Bank, J.P. Morgan & Co. and that old warhorse the Trilateral Commission once seemed). Now I'm not going to argue that this kind of analysis is right or wrong, except to say that historically speaking, it's hard not to remember a period in American history when powerful interests -- railroad barons, captains of industry, bankers, plantation owners, WASPs -- did not possess disproportionate influence over American politics; go back and read your Henry Adams or ponder the reign of the Wise Men. It's also hard to argue that major banks did not gain more clout as they grew larger, that a degree of regulatory capture did not occur (though that notion is more complex than a simple sellout), that senior bankers didn't make immense sums and that the interests of finance become identified with the interests of the country. All that I'll say is that we've seen that before as we've seen the tendency to overreach, or to lose their vitality or strategic importance. New interests replace old.
For Johnson, Kwak, Stiglitz, Taibbi and many others, this "takeover" is more dire, more self-perpetuating and more dangerous than just the usual interest group jockeying in Washington. They can explain nearly everything that happened -- meltdown, recession, bailouts, even income inequality and high pay -- through this notion of a "takeover." In Johnson and Kwak, not only have "bankers" taken control, yanking the strings of power, but they've been feverishly at work since the founding. In fact, at the heart of "13 Bankers" is a potted history of American finance and political history that features a caricature of the struggle between Alexander Hamilton and Thomas Jefferson. This history doesn't work; but as polemic it has a seductive simplicity. Johnson and Kwak portray themselves as Jeffersonians, distrustful of markets and big banks, advocates for small, prudent, decentralized, democratic finance. The fact that Hamilton was interested in markets and regulation, and Jefferson ideologically favored agrarian farmers and disdained the constraints of regulation, doesn't seem to matter.
If you believe in the takeover theory, then what is to be done? Reform becomes a mere fig leaf, an attempt once more to fool voters into believing the problem is being solved. Wall Street may be publicly chastened, but it remains as dominant and as self-interested as ever; the banks still call the shots, whether it's on bailouts, foreclosures or Federal Reserve monetary policies like quantitative easing. You have not excised the cancer, which is the size and power of the banks. Indeed, there's a kind of mental contagion at work here, a cabal of like-minded souls. This is roughly how the Obama financial reform efforts were characterized by many members of the takeover school. Again, no one in their right mind would argue that Dodd-Frank is a perfect, even necessarily a very good bill. The legislation is a grab bag of compromises and expediencies. There's no overriding vision, no underlying coherence. Regulators are given new orders and told to write new rules. The regulatory bureaucracy has only expanded. Some of the most important parts -- resolution authority and the consumer agency -- are untested. And, as Johnson has pointed out again and again, the legislation ignores too-big-to-fail. It depends upon the vigilance of regulators to monitor risk and act appropriately.
And that will not do. Regulators are human, fallible, fallen creatures. They will fall to the blandishments -- monetary, intellectual or otherwise -- of capital. Even if they tighten up for a few years, they will eventually succumb. What the takeover school really calls for is a permanent remedy, a structural reform that insures, as the president in one of his unhappier statements says, "that this will never happen again." Stiglitz seems to demand a kind of shifting body of law that insures that those who "exploit" will be charged with criminal fraud and go to jail; how they will be chosen for punishment, and how the law will be written, is vague. He seems to argue, in fact, that large swaths of the American political system should somehow be constrained from participating in politics at all. Johnson and Kwak call to break up the banks, to impose hard caps on size, thus eliminating the implicit subsidies provided by the government to TBTF banks. They decry bank lobbying and innovation. "The solution," they write in "13 Bankers," "must be economically simple, so it can be effectively enforced; the more complex the scheme, the more susceptible it is to regulatory arbitrage, such as reshuffling where assets are parked within a financial institution's holding company structure. And the solution must change the balance of power, so it will last."
"So it will last." That becomes the bottom line. Johnson and Kwak are looking for a permanent solution, an end to dangerous bank failures: an escape from history. The financial crisis only seemed to be an economic breakdown. In fact, it was a deeply rooted failure of democracy. The power of the big banks must be shattered above all other considerations, including growth. What this approach suggests is a loss of faith in democracy generally. After all, like shareholders at Citigroup or Lehman Brothers, voters accepted the consolidation of banking and the rise of an over-mighty Wall Street; indeed at times they cheered it on, despite the ambiguity toward Mammon that always lurks. True, voters now have a very negative view of finance. But voters regularly change their minds. Voters, like regulators, are imperfect and prone to capture. Mechanisms, structural changes, must be made to insure that this will never happen again -- that voters will not fall in love with the liquidity, power and sheer sex appeal of Wall Street. Just as a gold standard was once viewed as a mechanism to insure that central bankers do not tumble for the allure of inflation, so we need an extra-human mechanism to banish banks from the temple.
There are many aspects of the takeover critique that are valid: TBTF is a huge problem, financial reform is a work in progress, and the sheer amount of money in politics is frightening. But democracy is always a mess, just as banks have always been vulnerable to failure. Corruption in politics is like trust in finance: always a work in progress. But rigid mechanical, or structural, solutions nearly always collapse under the ever-increasing variousness and uncertainty of humanity, as Europe has recently discovered. The world changes; technology advances; nations rise and fall. It's unpopular to say it these days, but Glass-Steagall itself was an anachronism that needed to be hauled off to the scrapyard. Did the repeal of Glass-Steagall have to lead to more deregulation? No. Could regulation have prevented big problems? Certainly. Was Glass-Steagall useful in its day? Absolutely. But the failure to repeal Glass-Steagall would have left us with two options: first, to live with legislation that had already been hollowed out by Fed exceptions; or two, to try to deal with a commercial bank sector that was increasingly uncompetitive, not only with Wall Street but with foreign banks. At the end of the day, the takeover critique and its various themes represent a recoil from democratic policies and from the inevitability of change. We can't be trusted. We have to be saved from ourselves. Trust us.
Robert Teitelman is editor in chief of The Deal.