I recently interviewed Liar's Poker author Michael Lewis. After talking about his new book, Home Game: An Accidental Guide to Fatherhood, we discussed the financial meltdown and the bailout. This is Part 2 of some excerpts. You can hear the full podcast at terrencemcnally.net.
In Part 1, we talked about how the rules of the game were "totally screwed up" - for individual traders, firms, and ratings agencies. In Part 2, we look at some implications for American society at large.
TM: In 1970 only about 5% of men graduating from Harvard went into finance. By 1990, 15%, and by the class of 2007, 20% of the men and 10% of the women planned to go into investment banking.
ML: And half of the other ones applied, they just didn't get jobs. This is a radical misallocation of human talent. You can say it's faith in the free markets, but it's caused by the huge growth of a culture of financial manipulation.
TM: For years people have been saying that the U.S. was shifting from a manufacturing to a service economy. I suspect people thought of services as fast food, IT, health care, maybe lawyers. I don't think many really saw the huge role played by the financial sector.
ML: That's right. And let me draw an analogy. With the sub-prime mortgage racket generating lots of fees, the people within each big Wall Street firm who create that business acquire enormous power. So when the business gets decreasingly sane, when the loans get shakier and shakier, and the leverage gets bigger and bigger, they're the ones who say we've got to keep doing this. Even though people not directly implicated in the business might have said, "No, it's time to stop."
TM: So there were people within the firms who were sane and conservative ...
ML: There were, and they got driven out.
The plot thickens. Lewis sees the same dynamic at play among our country's leadership.
ML: I want to draw an analogy between what happens inside Merrill Lynch and what happens inside the United States. Here we have our little company, the United States of America. For thirty years the people who have had the most money to throw around were engaged in financial manipulation. Now they have outsized influence over the way the company is run.
TM: The company being the United States, the U.S. government...
ML: We are at a point right now where we should be radically reforming the financial system, and no Wall Street person with an actual interest should have a great deal of influence on that reform. Instead, the Obama administration is sort of half-heartedly reforming things, with little radical change -- and Wall Street people are instrumental in designing the new rules.
I think they think nobody's going to say anything to them about it, but I think it's politically risky. There's a real chance that there's going to be an uprising about this, and they're going to have trouble controlling the process.
TM: Do you mean they'll face trouble when what they pass doesn't work?
ML: Right. It won't work, and the mess they've created is going to have slow-burning economic consequences. We're going to be living in a very soft economy for a long time, and it's going to create disillusionment and anger. I expect there's going to be a crashing down of Wall Street's influence. It's just amazing it hasn't happened yet. And it hasn't happened yet because for thirty years their influence has become part of the air we breathe.
TM: It doesn't look like it's due simply to financial contributions to political candidates -- although there's certainly plenty of that -- but it's more that the best and the brightest...
ML: -- want to go work on Wall Street. That's the out.
If you're in Washington right now and you're engaged in public policy around Wall Street, if you're a regulator at the SEC, or you're at the Federal Reserve or the U.S. Treasury, and you're thinking what do I do next -- after I stop doing my poorly paying public service job -- there is an out. You get paid millions of dollars a year to go work at Goldman Sachs.
I don't think people engaged in trying to fix the problem are necessarily conscious of this, of how corrupt it all is. It's just in the air they breathe.
The existing institutional structure rewards those who are making the decisions, so they don't want to change it. In fact, they can't imagine a different institutional structure. They can't imagine a completely tamed financial sector that actually exists to serve the productive economy.
TM: They never ask, "How do we save the folks?" They never get past, "How do we save the banks?"
ML: The premise of the bailouts wasn't even really "How do we save the banks?" There are lots of banks, not all of them were involved in sub-prime mortgages. If you were going to start giving money to banks, you'd think you'd give it to the ones who didn't do dumb things. But instead the money goes to bankers who did do dumb things, because they're the ones who are about to go out of business.
What's even more interesting, the starting point for dealing with this problem - for both the Bush and Obama administrations -- was to say, one, we can't nationalize these banks, and two, the creditors of these banks can't take any sort of haircut, they can't take any losses.
TM: -- for making these terrible investments.
ML: So it leaves you, as a matter of public policy, with only one solution: to give money to the banks until they "earn their way out of it". Congress wrote a check for 700 billion dollars six or seven months ago. Then they lost the appetite for giving money to the banks, so now the banks are being gifted money, kind of sneakily, in the form of zero interest rate loans from the Federal Reserve. They can reinvest it in government securities, continue to run their high leverage, and keep the spread.
You take a step back and say, "What kind of society is this, where you have socialism for careless bankers and capitalism for everybody else?" Capitalism for everybody but the capitalists. That's not sustainable.
I think people generally don't completely understand what's going on, but it's a political issue.
TM: People say to themselves, "This is too complex for me..."
ML: -- and "They must know what they're doing."
But the fact is, they haven't known what they were doing, so there's no reason to suspect they know what they're doing now.
They're trying, I guess, but with a double standard that in these places alone, profits are privatized, and losses are socialized. That's a disaster. That they have not taken a more punitive approach to Wall Street amazes me, but I think the Obama administration is going to be forced to.
ML: Couple of years out.
It's hard to guess what's happening, but Obama probably looked at the problem and said, "If I do what actually needs to be done right now, it would consume the first two years of my administration. I could get one thing done -- radical reform of the financial industry, but I wouldn't get healthcare, climate change, anything else. So I'm going to put a band-aid on that problem, and do the other things I want to do. Then we'll come back to it.
TM: You're giving him the benefit of the doubt.
ML: Maybe. I think he deserves the benefit of a lot of doubt. He's earned it with me. That's the only thing I can think.
TM: You do see a day of reckoning...?
ML: Yes I do.
TM: And the question is, "Will society get really ugly before that happens?"
ML: Yes, that's the problem.
If you accept that what caused the financial crisis was totally screwed up rules of the road, totally screwed up incentives...then you claim you're reforming things, but you don't change those rules, you're just going to get the same problem all over again. I think that's the issue. Eventually we're going to have to change the rules of the game.