Prometheus 6

Sir John Templeton observed that the four most dangerous words in the English language are "this time it's different."...

...We have just had a full field test of free-market ideology, and once again it failed.

Fiscal foolishness
Government and the markets have forgotten the lessons of the '20s, and we're all paying.
By Robert Kuttner
November 12, 2007 

The deepening calamity now spreading from financial markets to the broader economy results from the failed fantasy that markets can regulate themselves.

We supposedly learned this lesson once, after the crash of 1929. In the aftermath, we built a dynamic system of managed capitalism so that a financial collapse would never again create a Great Depression.

But beginning in the 1970s, free-market economists and financial elites convinced Congress and presidents of both parties that a deregulated economy would be a more dynamic one; that something new about technology or trade or ideology meant that markets were at last truly self-governing.

New, exotic forms of financial engineering proliferated. These were praised as improving efficiency.

We have just had a full field test of free-market ideology, and once again it failed.

Revisit the financial abuses of the laissez-faire 1920s and you will find different details but the same essentials: deceptive claims about stocks, bonds and balance sheets; conflicts of interest on the part of insiders; excess leverage to finance speculative bets; financial engineering that extracts wealth and does nothing for the real economy. In the '20s, National City Bank turned dubious loans into bonds; in this decade, its successor, Citigroup, did the same in the sub-prime mess.

The regulatory system constructed by the New Deal was intended to limit these temptations. Government mandated extensive disclosures and bank supervision, and it prohibited a broad range of conflicts of interest. Commercial banking was separated from the underwriting and sale of securities.

That regulatory system anchored 30 years of broadly distributed prosperity after World War II, an era when the financial economy played its appropriate role as servant rather than master of the real economy.

But as Congress dismantled one regulation after another, the abuses of the '20s seeped back into deregulated financial markets, enriching insiders, setting up the broader economy for a crash.