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=E2=80=94stabilizing the economy and enabling growth=E2=80=94only if at lea=
st some of the powerful oligarchs who did so much to create the underlying =
problems take a hit. This is the problem of all emerging markets.=20



Becoming a Banana Republic=20



In its depth and suddenness, the U.S. economic and financial crisis is shoc=
kingly reminiscent of moments we have recently seen in emerging markets (an=
d only in emerging markets): South Korea (1997), Malaysia (1998), Russia an=
d Argentina (time and again). In each of those cases, global investors, afr=
aid that the country or its financial sector wouldn=E2=80=99t be able to pa=
y off mountainous debt, suddenly stopped lending. And in each case, that fe=
ar became self-fulfilling, as banks that couldn=E2=80=99t roll over their d=
ebt did, in fact, become unable to pay. This is precisely what drove Lehman=
 Brothers into bankruptcy on September 15, causing all sources of funding t=
o the U.S. financial sector to dry up overnight. Just as in emerging-market=
 crises, the weakness in the banking system has quickly rippled out into th=
e rest of the economy, causing a severe economic contraction and hardship f=
or millions of people.=20



But there=E2=80=99s a deeper and more disturbing similarity: elite business=
 interests=E2=80=94financiers, in the case of the U.S.=E2=80=94played a cen=
tral role in creating the crisis, making ever-larger gambles, with the impl=
icit backing of the government, until the inevitable collapse. More alarmin=
g, they are now using their influence to prevent precisely the sorts of ref=
orms that are needed, and fast, to pull the economy out of its nosedive. Th=
e government seems helpless, or unwilling, to act against them.=20



Top investment bankers and government officials like to lay the blame for t=
he current crisis on the lowering of U.S. interest rates after the dotcom b=
ust or, even better=E2=80=94in a =E2=80=9Cbuck stops somewhere else=E2=80=
=9D sort of way=E2=80=94on the flow of savings out of China. Some on the ri=
ght like to complain about Fannie Mae or Freddie Mac, or even about longer-=
standing efforts to promote broader homeownership. And, of course, it is ax=
iomatic to everyone that the regulators responsible for =E2=80=9Csafety and=
 soundness=E2=80=9D were fast asleep at the wheel.=20



But these various policies=E2=80=94lightweight regulation, cheap money, the=
 unwritten Chinese-American economic alliance, the promotion of homeownersh=
ip=E2=80=94had something in common. Even though some are traditionally asso=
ciated with Democrats and some with Republicans, they all benefited the fin=
ancial sector. Policy changes that might have forestalled the crisis but wo=
uld have limited the financial sector=E2=80=99s profits=E2=80=94such as Bro=
oksley Born=E2=80=99s now-famous attempts to regulate credit-default swaps =
at the Commodity Futures Trading Commission, in 1998=E2=80=94were ignored o=
r swept aside.=20



The financial industry has not always enjoyed such favored treatment. But f=
or the past 25 years or so, finance has boomed, becoming ever more powerful=
. The boom began with the Reagan years, and it only gained strength with th=
e deregulatory policies of the Clinton and George W. Bush administrations. =
Several other factors helped fuel the financial industry=E2=80=99s ascent. =
Paul Volcker=E2=80=99s monetary policy in the 1980s, and the increased vola=
tility in interest rates that accompanied it, made bond trading much more l=
ucrative. The invention of securitization, interest-rate swaps, and credit-=
default swaps greatly increased the volume of transactions that bankers cou=
ld make money on. And an aging and increasingly wealthy population invested=
 more and more money in securities, helped by the invention of the IRA and =
the 401(k) plan. Together, these developments vastly increased the profit o=
pportunities in financial services.=20




Click the chart above for a larger view=20

Not surprisingly, Wall Street ran with these opportunities. From 1973 to 19=
85, the financial sector never earned more than 16 percent of domestic corp=
orate profits. In 1986, that figure reached 19 percent. In the 1990s, it os=
cillated between 21 percent and 30 percent, higher than it had ever been in=
 the postwar period. This decade, it reached 41 percent. Pay rose just as d=
ramatically. From 1948 to 1982, average compensation in the financial secto=
r ranged between 99 percent and 108 percent of the average for all domestic=
 private industries. From 1983, it shot upward, reaching 181 percent in 200=
7.=20



The great wealth that the financial sector created and concentrated gave ba=
nkers enormous political weight=E2=80=94a weight not seen in the U.S. since=
 the era of J.P. Morgan (the man). In that period, the banking panic of 190=
7 could be stopped only by coordination among private-sector bankers: no go=
vernment entity was able to offer an effective response. But that first age=
 of banking oligarchs came to an end with the passage of significant bankin=
g regulation in response to the Great Depression; the reemergence of an Ame=
rican financial oligarchy is quite recent.=20



The Wall Street=E2=80=93Washington Corridor=20



Of course, the U.S. is unique. And just as we have the world=E2=80=99s most=
 advanced economy, military, and technology, we also have its most advanced=
 oligarchy.=20



In a primitive political system, power is transmitted through violence, or =
the threat of violence: military coups, private militias, and so on. In a l=
ess primitive system more typical of emerging markets, power is transmitted=
 via money: bribes, kickbacks, and offshore bank accounts. Although lobbyin=
g and campaign contributions certainly play major roles in the American pol=
itical system, old-fashioned corruption=E2=80=94envelopes stuffed with $100=
 bills=E2=80=94is probably a sideshow today, Jack Abramoff notwithstanding.=
=20



Instead, the American financial industry gained political power by amassing=
 a kind of cultural capital=E2=80=94a belief system. Once, perhaps, what wa=
s good for General Motors was good for the country. Over the past decade, t=
he attitude took hold that what was good for Wall Street was good for the c=
ountry. The banking-and-securities industry has become one of the top contr=
ibutors to political campaigns, but at the peak of its influence, it did no=
t have to buy favors the way, for example, the tobacco companies or militar=
y contractors might have to. Instead, it benefited from the fact that Washi=
ngton insiders already believed that large financial institutions and free-=
flowing capital markets were crucial to America=E2=80=99s position in the w=
orld.=20



One channel of influence was, of course, the flow of individuals between Wa=
ll Street and Washington. Robert Rubin, once the co-chairman of Goldman Sac=
hs, served in Washington as Treasury secretary under Clinton, and later bec=
ame chairman of Citigroup=E2=80=99s executive committee. Henry Paulson, CEO=
 of Goldman Sachs during the long boom, became Treasury secretary under Geo=
rge W.Bush. John Snow, Paulson=E2=80=99s predecessor, left to become chairm=
an of Cerberus Capital Management, a large private-equity firm that also co=
unts Dan Quayle among its executives. Alan Greenspan, after leaving the Fed=
eral Reserve, became a consultant to Pimco, perhaps the biggest player in i=
nternational bond markets.=20



These personal connections were multiplied many times over at the lower lev=
els of the past three presidential administrations, strengthening the ties =
between Washington and Wall Street. It has become something of a tradition =
for Goldman Sachs employees to go into public service after they leave the =
firm. The flow of Goldman alumni=E2=80=94including Jon Corzine, now the gov=
ernor of New Jersey, along with Rubin and Paulson=E2=80=94not only placed p=
eople with Wall Street=E2=80=99s worldview in the halls of power; it also h=
elped create an image of Goldman (inside the Beltway, at least) as an insti=
tution that was itself almost a form of public service.=20



Wall Street is a very seductive place, imbued with an air of power. Its exe=
cutives truly believe that they control the levers that make the world go r=
ound. A civil servant from Washington invited into their conference rooms, =
even if just for a meeting, could be forgiven for falling under their sway.=
 Throughout my time at the IMF, I was struck by the easy access of leading =
financiers to the highest U.S. government officials, and the interweaving o=
f the two career tracks. I vividly remember a meeting in early 2008=E2=80=
=94attended by top policy makers from a handful of rich countries=E2=80=94a=
t which the chair casually proclaimed, to the room=E2=80=99s general approv=
al, that the best preparation for becoming a central-bank governor was to w=
ork first as an investment banker.=20



A whole generation of policy makers has been mesmerized by Wall Street, alw=
ays and utterly convinced that whatever the banks said was true. Alan Green=
span=E2=80=99s pronouncements in favor of unregulated financial markets are=
 well known. Yet Greenspan was hardly alone. This is what Ben Bernanke, the=
 man who succeeded him, said in 2006 : =E2=80=9CThe management of market ri=
sk and credit risk has become increasingly sophisticated. =E2=80=A6 Banking=
 organizations of all sizes have made substantial strides over the past two=
 decades in their ability to measure and manage risks.=E2=80=9D=20



Of course, this was mostly an illusion. Regulators, legislators, and academ=
ics almost all assumed that the managers of these banks knew what they were=
 doing. In retrospect, they didn=E2=80=99t. AIG=E2=80=99s Financial Product=
s division, for instance, made $2.5 billion in pretax profits in 2005, larg=
ely by selling underpriced insurance on complex, poorly understood securiti=
es. Often described as =E2=80=9Cpicking up nickels in front of a steamrolle=
r,=E2=80=9D this strategy is profitable in ordinary years, and catastrophic=
 in bad ones. As of last fall, AIG had outstanding insurance on more than $=
400 billion in securities. To date, the U.S. government, in an effort to re=
scue the company, has committed about $180 billion in investments and loans=
 to cover losses that AIG=E2=80=99s sophisticated risk modeling had said we=
re virtually impossible.=20



Wall Street=E2=80=99s seductive power extended even (or especially) to fina=
nce and economics professors, historically confined to the cramped offices =
of universities and the pursuit of Nobel Prizes. As mathematical finance be=
came more and more essential to practical finance, professors increasingly =
took positions as consultants or partners at financial institutions. Myron =
Scholes and Robert Merton, Nobel laureates both, were perhaps the most famo=
us; they took board seats at the hedge fund Long-Term Capital Management in=
 1994, before the fund famously flamed out at the end of the decade. But ma=
ny others beat similar paths. This migration gave the stamp of academic leg=
itimacy (and the intimidating aura of intellectual rigor) to the burgeoning=
 world of high finance.=20



As more and more of the rich made their money in finance, the cult of finan=
ce seeped into the culture at large. Works like Barbarians at the Gate , Wa=
ll Street , and Bonfire of the Vanities =E2=80=94all intended as cautionary=
 tales=E2=80=94served only to increase Wall Street=E2=80=99s mystique. Mich=
ael Lewis noted in Portfolio last year that when he wrote Liar=E2=80=99s Po=
ker , an insider=E2=80=99s account of the financial industry, in 1989, he h=
ad hoped the book might provoke outrage at Wall Street=E2=80=99s hubris and=
 excess. Instead, he found himself =E2=80=9Cknee-deep in letters from stude=
nts at Ohio State who wanted to know if I had any other secrets to share. =
=E2=80=A6 They=E2=80=99d read my book as a how-to manual.=E2=80=9D Even Wal=
l Street=E2=80=99s criminals, like Michael Milken and Ivan Boesky, became l=
arger than life. In a society that celebrates the idea of making money, it =
was easy to infer that the interests of the financial sector were the same =
as the interests of the country=E2=80=94and that the winners in the financi=
al sector knew better what was good for America than did the career civil s=
ervants in Washington. Faith in free financial markets grew into convention=
al wisdom=E2=80=94trumpeted on the editorial pages of The Wall Street Journ=
al and on the floor of Congress.=20