WASHINGTON — The lurid 2002 portrait of the U.S. economy as a bunch of Enrons and Tycos, overpaid CEOs running corporations like casinos, electronic speculators, predatory hedge funds, fraudulent stock values, deceptive investment firms and collusive accountants didn't develop overnight. Unfortunately, while some of the excesses may shrink, they are not likely to fade away.
That's because much of the "financialization" that occurred in the 1980s and 1990s has been built into the system, save for the possible purgative of a market crash. The most visible evidence of this--the mushrooming of CEO compensation and the private sector's "imperial corporate presidency"--ironically parallels the dangerous growth and hubris of the governmental "imperial presidency" in the 1960s and early 1970s. Unhappily, reform of business and finance may be harder to achieve this decade than were the public-sector reforms following Watergate. Washington's business and financial lobbies are mobilizing.
Over the past 20 years, the U.S. economy has been reoriented from making, growing, building and transporting things to moving, massaging and manipulating money and securities. So great has this transformation been that by the mid-1990s, the finance, insurance and real estate (FIRE) sector had raced ahead of manufacturing in gross-domestic-product and national-income numbers. By 2001, the FIRE sector had pulled ahead of manufacturing in profits; in the 1960s, manufacturing led by 4 to 1.
This staggering displacement isn't a blip, even though some yardsticks, like CEO compensation and financial profits, may have peaked for now. Examples of previous world economic powers suggest that once a nation's financialization escalates to this extent, it becomes systemic and isn't easily reversed.
During the 1920s, under the spell of a soaring stock market, the United States underwent some kindred changes. Market volume ballooned; mutual funds sprang into being; consumer loans caught on and debt surged. Americans were mesmerized by ticker tapes. However, during the three years after the bubble burst in 1929, stocks fell so low, so many banks failed and so much business and financial dirty laundry came into view that Americans soured on corporations, banks and stocks. President Franklin D. Roosevelt pushed through hundreds of reform laws and regulations, and the harsh economics of the Great Depression put finance through a wringer.
The shenanigans played by Enron, Arthur Andersen and a number of major banks and investment firms, with corporate names being added each week, resemble the financial and corporate dirty laundry exposed from 1930 to 1933. Toward the end of manic booms, frauds and swindles run rampant, inevitably employing techniques that evade the strictures of outdated legislation and regulation. In theory, new legislation and regulation could restore order in 2002-2004. The rebuttal, though, is that the financialization of the United States is deep and pervasive enough to make the speculative beginners' games of the 1920s look like a real-economy study group.
Consider two barometers. Between 1919 and 1929, the volume of stocks traded increased eightfold, and the amount of money in mutual funds climbed from a few million to $8.5 billion. Between 1980 and 2000, by contrast, the volume of stocks traded on the major exchanges increased by roughly 50 times, and mutual-fund assets soared from $135 billion to $7.8 trillion. Many Americans closed savings and checking accounts and put their cash or assets into money market or stock funds.
So bolstered, the Dow Jones industrial average jumped from 775 in summer 1982 to 11,700 in early 2000. The Nasdaq skyrocketed from around 120 in 1982 to just above 5,000 in early 2000. At the same time, the rapid computerization of the financial sector made possible a whole new spectrum of speculative instruments and vehicles for the securitization of loans and income streams. This accounts for part of the financial sector's growth.
Government favoritism accounts for another chunk. Beginning in the early 1980s, the Federal Reserve Board, the U.S. Treasury and allies like the International Monetary Fund embarked on a two-decade march of bailing out failing or shaky portions of the U.S. and international financial sectors. Among those rescued: Latin American bond issuers; the stock market after the 1987 crash; S&L creditors and depositors; the Mexican peso and its U.S. bondholders; Asian currencies; the hedge fund Long-Term Capital Management; and banks menaced by the Y2K scare.
As the financial sector, in short, became too important to fail, the Fed and the Treasury abandoned market economics to embrace socialization of credit risk. No other sector of the U.S. economy, save possibly defense, received such governmental assistance. In the early 1980s, some in Washington had urged a government industrial policy to rescue manufacturing. What we got instead--there was no official announcement--was a "financial policy."