Barack Obama’s political future may hinge on a man who lost his life in the most notorious duel in American history. As the sky was just beginning to lighten, a barge ferried two men across the Hudson River to a rocky outcrop near Weehawkin, New Jersey. In the boat were Alexander Hamilton, Nathaniel Pendleton and Dr. David Hosack. Hamilton was on his way to a duel with death. Aaron Burr had challenged Hamilton after the 1804 New York Governor’s election in which Hamilton had vilified Burr in a campaign whose nastiness was notable even for those days of no-holds-barred elections.

Dueling was illegal in New York which is why the two journeyed to the Weehawkin Heights, which was a well-known local dueling ground where Hamilton’s son had died three years earlierl. The two seconds published an account of what happened when Burr and Alexander Hamilton met:

Colonel Burr arrived first on the ground, as had been previously agreed. When General Hamilton arrived, the parties exchanged salutations, and the seconds proceeded to make their arrangements. They measured the distance, ten full paces, and cast lots for the choice of position, as also to determine by whom the word should be given, both of which fell to the second of General Hamilton. They then proceeded to load the pistols in each other’s presence, after which the parties took their stations. The gentleman who was to give the word then explained to the parties the roles which were to govern them in firing.

He then asked if they were prepared; being answered in the affirmative, he gave the word present, as had been agreed on, and both parties presented and fired in succession. The intervening time is not expressed, as the seconds do not precisely agree on that point. The fire of Colonel Burr took effect, and General Hamilton almost instantly fell. Colonel Burr advanced toward General Hamilton with a manner and gesture that appeared to General Hamilton’s friend to be expressive of regret; but, without speaking, turned about and withdrew, being urged from the field by his friend, as has been subsequently stated, with a view to prevent his being recognized by the surgeon and bargemen who were then approaching.

The duel at dawn had mortally wounded both men. Hamilton would die of his wound; Burr’s political career was ruined. Two centuries after that duel another former Treasury Secretary would found the Hamilton Project, an adjunct of the Brookings Institution. Yet many believe the founder of the Hamilton Project may suffer a fate as tragic as Hamilton or Burr’s.

A previous essay discussed Rubin’s early years, particularly his penchant for taking risks, something both he and Hamilton share.  Like Hamilton, Rubin also has a powerful political patron–Hamilton’s was George Washington; Rubin’s is Bill Clinton. Where the course that lead Hamilton to Weehawkin began during Washington’s term, Rubin’s tragedy began during Clinton’s Presidency. It involved the repeal of the one of the cornerstones of the New Deal, the Glass-Steagall banking act.

Rubin and Glass-Steagall

Unfortunately many have blamed the repeal of Glass-Steagall solely on the Democrats, when in fact it was not a Democratic Party idea. In the mid-1980s a Federal Reserve Board stocked with Republican Reagan-Bush appointees began reinterpreting Glass-Steagall in a series of actions that slowly expanded the ability of banks to engage in other financial operations.

The actual bill that repealed Glass-Steagall has the name of John McCain’s principal financial advisor Phil Gramm: the 1999 Gramm-Leach-Bliley Act. Here is what Gramm said at the signing ceremony for Glass-Steagall:

We are here today to repeal Glass-Steagall because we have learned that government is not the answer. We have learned that freedom and competition are the answers. We have learned that we promote economic growth and we promote stability by having competition and freedom.

I am proud to be here because this is an important bill; it is a deregulatory bill. I believe that that is the wave of the future, and I am awfully proud to have been a part of making it a reality.

So how did Bill Clinton and Robert Rubin get involved in what had been largely a Republican attempt to gut Glass-Steagall? Curiously, Rubin’s Treasury biography says nothing about the Glass-Steagall repeal.

Actually, Rubin’s support for repealing Glass-Steagall is entirely consistent with his actions at Goldman Sachs, especially his advocacy of expanding ways banks could operate. In a sense, as related in the previous essay in this series. Rubin’s tenure at Goldman set the stage for the repeal of Glass-Steagall.

With Rubin’s ascendancy to Treasury Secretary during the go-go economy of the 1990s, the feeling grew among some economists and the financial community that Glass-Steagall hampered America’s financial competitiveness. Among the many voices favoring this was Alan Greenspan along with his former Goldman Sachs colleague Robert Rubin, then Bill Clinton’s Treasury Secretary. In a 1995 speech and testimony to Congress Rubin signaled the Clinton Administration was ready to repeal Glass-Steagall:

“The banking industry is fundamentally different from what it was two decades ago, let alone in 1933.” He said the industry has been transformed into a global business of facilitating capital formation through diverse new products, services and markets. “U.S. banks generally engage in a broader range of securities activities abroad than is permitted domestically,” said the Treasury secretary. “Even domestically, the separation of investment banking and commercial banking envisioned by Glass-Steagall has eroded significantly.”

A year later Sanford Weill set in motion the forces that would finally end Glass-Steagall. Weill proposed the most audacious financial merger of in American history: he would merge one of the largest insurance companies (Travelers), one of the largest investment banks (Salomon Smith Barney), and the largest commercial banks (Citibank) in America. Weill convinced Federal Reserve head Greenspan, Rubin and Clinton to sign off on a merger that was illegal at the time, with the expectation that Congress would repeal Glass-Steagall.

The story of that repeal has been told several times in this blog, most recently this past spring, so I will not detail it yet again except to note that although it was Robert Rubin who urged the repeal of Glass-Steagall, the official signing did not happen on his watch, but instead during the tenure of his successor and protege Lawrence Summers.

The year 1999 was an interesting one for Robert Rubin if you do nothing but look at the chronology. On May 6, 1999, the Senate passed Gramm-Leach-Bliley. Rubin’s last day at Treasury was July 1, 1999. On July 30, the House passed a different version of the bill. At this point the House and Senate conference committee began trying to work out their differences.  This is the impasse that sparked the famous middle-of-the-night telephone call on October 21 between Citigroup head Sanford Weill and President Bill Clinton, in which Weill urged Clinton to throw his weight behind the resolution advocated by Gramm.  A September 17 New York Times article announced that Rubin was planning on returning to Wall Street, but he had not yet decided where or in what capacity.  A little over a month later–and five days after that phone call–on October 26, 1999 Rubin joined Citigroup. On November 4, the final version of GLB passed both Senate (90-8) and the House (362-57).

This chronology leads you to the famous question asked during the Watergate hearings, “What did he know and when did he know it?” It would have been interesting to be a fly riding around on Robert Rubin’s shoulders between September 17 and October 26. What role, if any, did he play in breaking the deadlock? What conversations did he, Weill, Summers and Clinton have, if any? In that crucial month there is plenty for a good Washington investigative reporter, especially one with access to inside sources, to track down.

Citigroup

Rubin very cleverly negotiated a deal with Citigroup that gave him the title of director and chairman of the executive committee. Rubin explained his reasons for the title:

By the time I finished at Treasury, I decided I never wanted operating responsibility again.

A banking official put it more bluntly:

When you have responsibility with no accountability, that is a very dangerous thing on Wall Street.

Exactly how much impact Robert Rubin had on Citigroup has now become one of the chief topics of gossip on Wall Street, in the press, and inside the Beltway, His friends have been actively running cover for him, claiming he played no role in the present debacle, but as reporters pry more into how Citi fell into this mess, they have begun to draw the noose tighter around Robert Rubin.

They also brought up some of his other missteps at Citi such as In November 2001 when in the midst of the Enron debacle Rubin phoned Peter Fisher, undersecretary of the treasury for domestic finance, tried to convince him to delay a downgrading of Enron’s debt.

The Noose Tightens

Last spring’s Times profile contained a few hints.

“He is like the Wizard of Oz behind Citigroup, he is the guy pulling on all the strings,” said one Citigroup banker who was not authorized to speak publicly about the situation. “He certainly was the guy deferred to on key strategic decisions and certain key business decisions vis-à-vis risk.”

Yet for each of these negative words about Rubin, the Times would quote one of his allies to balance it.  They also quoted Rubin’s defense:

“People know I was concerned about the markets,” he says. “Clearly, there were things wrong. But I don’t know of anyone who foresaw a perfect storm, and that’s what we’ve had here.”

“I don’t feel responsible, in light of the facts as I knew them in my role,” he adds.

But did he make mistakes?

“I’ve thought a lot about that,” he responds. “I honestly don’t know. In hindsight, there are a lot of things we’d do differently. But in the context of the facts as I knew them and my role, I’m inclined to think probably not.”

But last week the tone changed and the quotes became more pointed in a Times’ piece on Citi’s downfall.

“Chuck Prince going down to the corporate investment bank in late 2002 was the start of that process,” a former Citigroup executive said of the bank’s big C.D.O. push. “Chuck was totally new to the job. He didn’t know a C.D.O. from a grocery list, so he looked for someone for advice and support. That person was Rubin. And Rubin had always been an advocate of being more aggressive in the capital markets arena. He would say, ‘You have to take more risk if you want to earn more.’ ”

According to current and former colleagues, he believed that Citigroup was falling behind rivals like Morgan Stanley and Goldman, and he pushed to bulk up the bank’s high-growth fixed-income trading, including the C.D.O. business.

Meanwhile the rest of the press has also been busy, especially Rupert Murdoch’s New York papers. The Wall Street Journal and the Post called for the resignation of the entire Citi board, including Rubin. A Journal editorial asked:

When taxpayers are being asked to provide the equivalent of $1,000 each in guarantees on Citi’s dubious investments, how can these men possibly deserve to remain on the board?

It did not help that word was quickly spreading through the media and the blogosphere that Rubin had called on his former Goldman colleague, Treasury Secretary Henry Paulson to give Citi the bailout money or that Barack Obama’s new Treasury Secretary Timothy F. Geithner remained silent about the affair.

Teflon Robert

Part of the reason Rubin has not faced his day of reckoning stems from his extraordinary ties to Democratic Party politicians along with his network of colleagues and proteges. This circle of influence ranges from former President Bill Clinton to present Treasury Secretary Henry Paulson. When Nancy Pelosi arranged a seminar for new representatives after the 1996n election, she scheduled three speakers on foreign policy and one for economic policy. You can guess the identity of that speaker.

Robert Kuttner has dubbed his imposing network “Rubinistas,” writing about an influence on American economic policy that is approaching two decades. In an article he asks:

What kind of magic does this man Rubin have? He was one of the key Democratic architects of the extreme financial deregulation that brought the economy to this pass. At Citi, he was one of the grand strategists of the speculation in securitized loans and off-balance-sheet gimmicks that has brought Citi to the edge of bankruptcy. Yet he continues to fall upwards. Surely Barack Obama must have noticed that Rubin is a false prophet. So why is his entire senior economic group a Team of Rubinistas?

It’s a fair question. One answer lies in the Hamilton Project.

The Hamilton Project

It is significant that the Project was unveiled at a policy briefing featuring Rubin and Obama and moderated by Peter Orszag, now Obama’s choice for director of the Office of Management and Budget. Others involved in the Hamilton Project include Obama advisor Austan Goolsbee and Lawrence Summers, incoming director of the National Economic Council. Because of this connection between Obama, his appointees and the Project, it is important Americans understand what the project stands for.

Directly tying itself to Hamilton, the Project states:

Consistent with the guiding principles of the Project, Hamilton stood for sound fiscal policy, believed that broad-based opportunity for advancement would drive American economic growth, and recognized that “prudent aids and encouragements on the part of government” are necessary to enhance and guide market forces.

Here is what the vision document states:

The Project’s strategy–strikingly different from the theories driving current economic policy–calls for fiscal discipline and increased public investment in key growth-enhancing areas.

This sounds suspiciously like a have-your-cake-and-eat-it statement in its call for “fiscal discipline” and “increased public investment.” During the Clinton years Rubin earned a reputation as a deficit hawk who was not afraid to cut back on social programs to balance the budget.  He also is known as an advocate of the open-markets approach favored by the Democratic Leadership Council and the GOP. A Reagan-like statement in the vision document notes:

Government has a limited but essential role in creating conditions for growth in which all Americans can share.

In explaining this paragraph the statement goes on to describe how this might be achieved:

Reform regulation so that it effectively guides private firms without unnecessarily hampering them; and take measures to make all proposals budget-neutral.

The entire vision document reads to me like a cut and paste job that tries to meld current Republican and Democratic Party ideas, with a Clinton-like triangulation.: For example, we will enhance education but make it budget neutral. Clearly to rescue American education will require an increase in education spending, but if we are to do that without deficit spending where do we cut? For a think tank of economic experts, the Hamilton Project is curiously silent about spelling out these cuts.

Is This The Final Act?

The Obama Administration will not have that luxury. The showdown in the administration and the Party is likely to loom between those who favor a level playing field and those who favor the measures advanced by the Hamilton Project. It is reminiscent of the battle between Hamilton and Jefferson in Washington’s Presidency. Navigating between these two factions will be as difficult for Obama as it was for Washington, yet so far Barack Obama has shown an uncanny ability to do so.

Yet, The fear on every American’s mind is whether the tragedy of Robert Rubin and the Democratic Party will become America’s tragedy just as Hamilton’s was.

Tagged with: Al Smith • alan greenspan • Barack Obama • Bill Clinton • Citi • Citigroup • Democratic Party • economic crisis • economic speculation • financial crisis • Franklin Roosevelt • free markets • gangsters • Goldman Sachs • Great Depression • Henry Paulson • Jakob Raskob • Lawrence Summers • level playing field • market fundamentalism • New Deal • Robert Kuttner • Robert Rubin • Rubinomics • spats • treasury secretary • Wall Street

He always has struck me as a man who belonged in spats. Probably the best place to see spats these days is in Hollywood movies from the 1930s or Planter Peanut jars, but once they were essential wardrobe item of anyone who was rich and successful.That is why the famous Mr. Peanut symbol, which was designed by the winner of a 1916 contest, sports three wardrobe items–a top hat, a monocle and spats.

As the pictures above show, spats went over the top of their shoes and covered the laces. They actually were originally a working class thing as they protected farmers and others who worked outdoors from getting things in their shoes. Military units favored them for the same reason and some still wear them, although now just for decoration.

During the Gilded Age the tycoons and would-be tycoons favored them. In the 1920s, they were worn by dapper, wheeler-dealers (think Gatsby) and gangsters (Edward G. Robinson sports them in Little Caesar). According to a 2007 Los Angeles Times piece, they were making a comeback just before the crash hit.

During the last few seasons, we’ve seen the return of 1960s patent-leather go-go boots, 1930s-era brogues, the classic 1950s ballet flat and the 1970s platform.

But spats?

That’s right, they’re not just for Mr. Peanut anymore.

The article goes on to quote a member of the Hives, which has made spats a part of their wardrobe:

“The fascination is part ’20s mobster, part Scrooge McDuck and part 1903 French infantry,” says frontman Pelle Almqvist.

From these data you might construct a spats theory of economics to go along with the one on skirt lengths: when spats are in style, the country goes into economic hyperdrive as the speculators and high-rollers enjoy the feast of what Vernon Parrington called the Great Barbecue. But as the penchant for gangsters to wear spats symbolizes, they also signal an out-of-control economy that can turn shady. So when spats are in fashion, economic speculation is running out-of-control and America is headed for a fall. With spats came the 1893 and 1930s depressions–and the current mess.

In this economy no one symbolizes the spats theory better than Robert Rubin, which is why I always imagine him wearing spats. The rise and fall of Robert Rubin represents an American tragedy that tells the story of our times, for Rubin was at the center of what we now recognize was an unmanageable, undisciplined economy.

Setting the Stage

As in any tragedy, Rubin had a huge role in creating the conditions that eventually produced his fall. For awhile many economists and business writers saw Rubin as a brilliant mind, a sage who understood the intricate workings of the market like a high stakes poker player who has figured out a system to beat the odds. It takes a very special mind to pull that off, one with a prodigious memory, one that comes with the equivalent of a built-in microchip that can instantly perform complex calculations of the odds and one that has a certain convincing charisma that enables someone to bring others under her or his spell.

In a revealing profile published last spring, Raymond J. McGuire, Citigroup’s co-head of global investment banking, told the New York Times:

It’s a little like visiting Yoda, You go and get a dose of wisdom.

In the same profile Roger Altman, a veteran of Wall Street who has known Mr. Rubin for nearly 30 years and served with him in the early years of the Clinton administration, described Rubin:

What’s unique about Bob is a combination of rare intellect and rare temperament. That’s what sets him apart. He’s self-effacing, always calm, with a low-ego style.

Low-ego style or not, at Citigroup Rubin displays prominently behind his desk a framed 1999 Time cover featuring him alongside his then Treasury deputy, Lawrence H. Summers, and then Federal Reserve chair Alan Greenspan. Time termed them the “Committee to Save the World.”

Significantly Rubin did not come from academia with a briefcase full of publications and ambitions for a Nobel Prize, but instead he came up through the ranks of the financial industry itself. To Wall Street he is one of them and to those who prize Wall Street over the Ivory Tower he was someone not just with big ideas, but hands-on experience, someone who has actually played the game and not just written about it.

The Early Days

From the very beginning when Rubin started out in arbitrage trading at Goldman Sachs in 1966–speculating on the stocks of companies subject to takeover attempts–the tragic flaw was apparent, but then, as in so many tragedies, what was actually a flaw was taken as a strength. According to the Times:

Mr. Rubin encouraged Goldman to move into more treacherous markets like proprietary trading and commodities trading.

Over the next two decades Rubin rose through the ranks, enriching his resume with experience in a variety of financial roles including heading Goldman’s stock and bond trading departments and reviving its commodities subsidiary. Eventually he rose to the position of the firm’s co-chair in 1990.

All this might seem a typical Wall Street rise story except for one thing, Robert Rubin became involved in politics, Democratic Party politics.  According to the Wall Street Journal, Goldman Sachs’ corporate culture encouraged executives to become involved in community activities, particularly politics, so a list of Goldman employees who are Washington insiders reads like a Who’s Who of those who have influenced economic policy in the last twi decades including Stephen Friedman (head of George W. Bush’s National Economic Council) and Henry Paulson (the current Treasury secretary), along with Rubin and Summers. Which means over the last two decades a the Treasury Department has largely been an extension of Goldman Sachs.

Lee Price, research director at the liberal Economic Policy Institute, notes:

Compared to other Wall Street firms, Goldman has a reputation for recruiting employees with a wonkish enthusiasm for government policy.

Today few remember it was Rubin who advised Walter Mondale to take the risk that cost him any chance of winning the long-shot 1984 election, making his call for a tax increase a major focus of his acceptance speech at the Democratic National Convention.

Mondale’s speech is one of the forgotten, yet flawed gems in American history. There are lines in it that would not be out of place today:

Mr. Reagan believes that the genius of America is in the boardrooms and exclusive country clubs. I believe that the greatness can be found in the men and women who built our nation; do its work; and defend our freedom.

What happened was, he gave each of his rich friends enough tax relief to buy a Rolls Royce - and then he asked your family to pay for the hub caps.

Lincoln once said that ours is to be a government of the people, by the people, and for the people. What we have today is a government of the rich, by the rich, and for the rich.

He was on a roll in that speech when he came to a section introducing what he termed the New Realism–a rhetorical shift in what up until then had been a great speech. It was here that he followed Mr. Rubin’s advice:

Let’s tell the truth. It must be done, it must be done. Mr. Reagan will raise taxes, and so will I. He won’t tell you. I just did.

There’s another difference. When he raises taxes, it won’t be done fairly. He will sock it to average-income families again, and leave his rich friends alone. And I won’t stand for it. And neither will you and neither will the American people.

Rubin’s argument for the tax increase had more to do with his long-standing preference for a balanced budget than for any desire to restore the social programs that were cut during Ronald Reagan’s first term. In this Mondale’s speech has a certain schizophrenia which came to foretell the future of the Democratic Party over the next two decades–would it follow the New Deal value of the level playing field or would it follow the Wall Street value of open markets.

Treasury Secretary

Rubin continued to cultivate Democratic politicians, particularly those of the rising Democratic Leadership Council and the so-called New Democrats with their rising star, William Jefferson Clinton.  Long-time Rubin critic Robert Kuttner draws the big picture:

We have had two Democratic presidents, Carter and Clinton, who both turned away from earlier Twentieth Century Democrats who, since Roosevelt, were more explicit supporters of a more regulated form of capitalism.

We also had the rise, beginning in the mid-1980s, of the Democratic Leadership Council, as a center-right lobby within the Democratic Party. Under Clinton, the ties with Wall Street became even more explicit. Also, the countervailing power of the labor movement has been becoming weaker for close to 30 years. All of this was supercharged by the increasing cost of campaigning and Wall Street’s growing role as money-raiser.

The process is also ideological. Market fundamentalism has become the conventional wisdom, the dominant ideology of all of the Republican party and half of the Democratic party, and much of the press.

In essence for three decades the Democratic Party has been torn between the old New Deal ideas championed mainly by organized labor that government exists to keep the playing field level and the free-market philosophies of Rubin and others. Rubin’s appointment to Treasury Secretary by Bill Clinton signaled that in his administration, the free-market wing would dominate.

As the Mondale speech illustrates, Rubin has another very rare and valuable quality, when he is part of a mess, somehow he emerges without any of it on him. In fact people continue to see him as a genius. The Treasury Department web site contains a laudatory biography of Rubin that captures how much of the country thought of him during the 1990s and up until recently:

When President William Jefferson Clinton swore in Robert E. Rubin (b. 1938) as the 70th Secretary of the Treasury, he was already one of the most knowledgeable and best prepared leaders of finance to assume the office.

Mr. Rubin’s tenure at Treasury was extraordinarily varied.

Upon Mr. Rubin’s retirement, President Clinton called him the “greatest secretary of the Treasury since Alexander Hamilton.”

The official picture accompanying this shows a gray-haired man in a dark suit with his hands casually in his pockets. It is cut off at the knees and it is hard to believe that below the picture, Rubin is not wearing spats  In the years that followed what had been Rubin’s good fortune would fall as rapidly as the value of Citigroup stock. That story follows in the next installment.

Tagged with: 1893 depression • Al Smith • alan greenspan • Barack Obama • Bill Clinton • Citi • Citigroup • Democratic Leadership Council • Democratic Party • economic crisis • economic speculation • financial crisis • Franklin Roosevelt • free markets • gangsters • Goldman Sachs • great barbecue • Great Depression • Henry Paulson • Jakob Raskob • Lawrence Summers • level playing field • little caesar • market fundamentalism • New Deal • Robert Kuttner • Robert Rubin • Rubinomics • spats • treasury secretary • Wall Street

When Abraham Lincoln wrote his Thanksgiving Day Proclamation, he wasn’t thinking about Pilgrims and turkeys; he was thinking about places like the Sunken Road. He established the first official Thanksgiving Day in 1863, a little over a year after what is still the bloodiest day in American history. There were an estimated 23,000 casualties near Sharpsburg, Maryland where the center of battle focused on the Sunken Road, which also became known as Bloody Lane because there were almost 6,000 casualties there in a single morning.

It was called the Sunken Road because it was almost as deep as it was wide, which made it a natural trench for the Confederate soldiers defending it. Three assaults failed to break their line. In a single hour over 1700 men had fallen either dead or wounded. The fourth assault came not long after the sun was straight overhead when troops from the 61st and 64th New York captured a high point on the road turning it into a death trap. The Confederate troops began retreating from the road when they misunderstood an order, leaving it to the Union.

When the battle ended the road lay filled with bodies as the blood of North and South flowed down the trench in scarlet rivulets. Photographer Mathew Brady would later exhibit photographs of the dead in his New York gallery, causing a sensation because it was the first time those on the home front had seen what the New York Times would term “the terrible reality and earnestness of war.”

Abraham Lincoln’s personal visit to the battlefield is preserved in a photograph of him standing with some of his commanders, one of whom leans casually by himself off to one side wearing a broad-brimmed hat and gripping his sword. It is George Armstrong Custer. That photograph reminds us that no other American President endured what Lincoln experienced as he sat in his White House office and heard the sounds of the firing squads executing deserters drifting across the Potomac, visited places like the Sunken Road and Gettysburg and read letter after letter from anxious families.

That in the middle of the carnage, Lincoln could find the spiritual strength to pen the third greatest document in American history, the Emancipation Proclamation, and to conceive of that first Thanksgiving testifies to the iron soul of a man who would not break when lesser ones did. So the real first Thanksgiving did not occur at Plymouth, but across America in cities, villages and isolated farms whose families had waited and endured the grim news coming from places like the Sunken Road.

As he often did during that terrible period, Lincoln put words on paper that were spinning in their heads, captured their conflicting feelings and, most of all, read the needs lying in the those guarded places where not even the images of Brady’s photographs could penetrate.

Lincoln knew the nation deserved a day to pause and reflect, to inhale the fresh air of freedom amidst the dark smoke of war. There are so many other things he could have said, so many different words he could have used, so many feelings he could have vented, but he chose to ignore them. Somehow in the midst of visions of places like the Sunken Road he found something positive and enduring, just as he would at Gettysburg.

While his Thanksgiving Proclamation has neither the philosophical profundity nor the rhetorical precision of what he said at Gettysburg it has something else: a faith in what he termed “one heart and voice by the whole American people.” Abraham Lincoln had the ability to foresee a day when all Americans gathered with friends and family to enjoy each others’ company and give simple thanks for their blessings. In Lincoln’s words, Thanksgiving becomes the most American of holidays–even more than the Fourth of July and all the rest–a national day of unity when all the disparate strands of this diverse nation knit together not to celebrate, but to simply be thankful.

That is why we need to remember the Sunken Road on Thanksgiving, as perhaps Lincoln remembered it, for in the midst of such unspeakable slaughter, the President did not call for revenge or hatred, but instead turned us towards what he termed the “better angels of our nature” and called for us to pause, look around and think about our good fortune. His message that first Thanksgiving to the American people speaks more powerfully to this nation than turkeys and Pilgrims.

Proclamation Establishing Thanksgiving Day

October 3, 1863

The year that is drawing towards its close, has been filled with the blessings of fruitful fields and healthful skies. To these bounties, which are so constantly enjoyed that we are prone to forget the source from which they come, others have been added, which are of so extraordinary a nature, that they cannot fail to penetrate and soften even the heart which is habitually insensible to the ever watchful providence of Almighty God. In the midst of a civil war of unequalled magnitude and severity, which has sometimes seemed to foreign States to invite and to provoke their aggression, peace has been preserved with all nations, order has been maintained, the laws have been respected and obeyed, and harmony has prevailed everywhere except in the theatre of military conflict; while that theatre has been greatly contracted by the advancing armies and navies of the Union. Needful diversions of wealth and of strength from the fields of peaceful industry to the national defence, have not arrested the plough, the shuttle, or the ship; the axe had enlarged the borders of our settlements, and the mines, as well of iron and coal as of the precious metals, have yielded even more abundantly than heretofore. Population has steadily increased, notwithstanding the waste that has been made in the camp, the siege and the battle-field; and the country, rejoicing in the consciousness of augmented strength and vigor, is permitted to expect continuance of years, with large increase of freedom.

No human counsel hath devised nor hath any mortal hand worked out these great things. They are the gracious gifts of the Most High God, who, while dealing with us in anger for our sins, hath nevertheless remembered mercy.

It has seemed to me fit and proper that they should be solemnly, reverently and gratefully acknowledged as with one heart and voice by the whole American people. I do therefore invite my fellow citizens in every part of the United States, and also those who are at sea and those who are sojourning in foreign lands, to set apart and observe the last Thursday of November next, as a day of Thanksgiving and Praise to our beneficent Father who dwelleth in the Heavens. And I recommend to them that while offering up the ascriptions justly due to Him for such singular deliverances and blessings, they do also, with humble penitence for our national perverseness and disobedience, commend to his tender care all those who have become widows, orphans, mourners or sufferers in the lamentable civil strife in which we are unavoidably engaged, and fervently implore the interposition of the Almighty Hand to heal the wounds of the nation and to restore it as soon as may be consistent with the Divine purposes to the full enjoyment of peace, harmony, tranquillity and Union.

In testimony whereof, I have hereunto set my hand, and caused the seal of the United States to be affixed.

Done at the city of Washington, this third day of October, in the year of our Lord one thousand eight hundred and sixty-three, and of the independence of the United States the eighty-eighth.

A. Lincoln

The impact of the financial crisis rippled through my community this weekend yet again. One of the area’s oldest automotive dealerships closed six of its showrooms, laying off an estimated 400 people. The action so upset General Motors it has sued.

Everyone around here is now wondering when the next manifestations of the crisis will hit. A talking head on local TV said he expects there will be more dealers shutting their doors. All I could think of is what do you do if you sold cars for a living all your life or where does a highly-skilled GM mechanic find a place to practice his trade? Finally, I wondered what dumping the vehicles from six dealerships would do for other nervous auto dealers.

The Systemic Impact

Those layoffs represent yet another manifestation of this economic crisis which is rippling through local communities. My wife who is a nursing professor says area hospitals are already feeling the impact as patients put off elective procedures and the uninsured clog emergency rooms. My local school district is close to statutory operating debt, which in my state is the equivalent of bankruptcy.

All these impacts ate turning all of us into systems thinkers as we begin to see how everything really is interrelated. If we were system dynamics modelers we could probably plot how these ripples are taking out one business after another as people struggle to keep from drowning in this tidal wave.

Take the hospitals. All of them are owned by HMOs whose local clinics also are seeing fewer patients. If an HMO is taking a loss what does it do? What other corporations do: close and consolidate, which means patients will have to travel further for health care. But you don’t have to be a systems thinker to see that will have the unintended consequence of further lowering patient visits because rather than travel longer distances, patients just won’t travel. And there will be more questions: what does a doctor do who has been laid off?

The Impact of Consolidation

When economist and Nobel Prize winner Joseph Stiglitz testified before Congress, he told them this crisis represented the end of top-down economics likening it to how the fall of the Berlin Wall symbolized the end of communism. But there is another even more troubling systemic lesson communities across the country are learning: when an economy where everything from health care to auto sales to restaurants has become owned by big conglomerates with offices in faraway places it causes some pretty big ripples.

The chains are already starting to go down. Circuit City filed for bankruptcy. If consumers cut back their spending this Christmas, as they are predicted to do, more bankruptcies will follow. Sears, for example, is in trouble.

In a less-concentrated economy you would have had lots of independent retailers, some of whom might fail, but their fates would be more tied to local factors than the decisions of some multinational corporation. Those six dealerships closed as much because General Motors was in trouble as because of acts by the dealerships. It is said one reason Circuit City went down is due to decisions by top-level management to locate stores in lower-rent, but less traveled malls.

The Financial Plague

Yet nowhere is the systemic impact of the crisis more visible and more devastating than in the place where it started–the financial industry. As FDIC head Sheila Bair testified, what we have is a liquidity crisis–lending has frozen because institutions do not have confidence in each other.

Curiously this is identical to a reaction seen in a type of system dynamics model two of my friends have worked on for two decades. It is called the infection model, which they first used to explore the impact of large disease outbreaks like the Black Death. What they found explained much about the impact of these outbreaks on society. One common theme that runs through their investigation is quite similar to the lending crisis–when a disease such as fear of lending spreads, people try to isolate themselves from the “infection.”

The Infection Crisis

Infection outbreaks are classic compounding growth scenarios. I infect two people, they infect two more and just like that the crisis has doubled. This “doubling” continues as more and more people infect others. If the right conditions are present you can have the equivalent of the Black Death or the 1918 flu epidemic.

The variables are the seriousness of the disease, the percent of the population with natural immunity, the quickness with which authorities act with the right interventions such as vaccinations and how concentrated is the population. Both the Black Death and the 1918 epidemic were a function of increased mobility, so it spread more quickly from town to town.

The Need for Systemic Cures

If how quickly an infection spreads is a function of concentration whether of people or institutions then we have the makings of an economic plague for we have already seen how economic concentration has contributed to this crisis in the closing of those six auto dealerships. So what can we do?

In the simple infection model Jeff Potash and John Heinbokel developed, there are three keys: time (how long it takes the infection to travel and for someone to come down with it), space (how easy is it for people with infections to come in contact with each other) and intervention (how many people can you cure and how quickly).  Curiously these are functioning in the “infection” our economic system has sustained.

Systemic Cure One: Cut Concentration

Economic concentration is one of the roots of the crisis. If we extend the infection model, economic concentration is to the economic infection as population concentration is to a disease infection.  Perhaps the biggest admission of this systemic failure is the idea of “too big to fail.” Too big to fail is the definition of a dinosaur–and we know what happened to them.

The huge financial firms that dominate today’s markets are the equivalent of today’s dinosaurs. They make the liquidity crisis even more disastrous because there are fewer of them, so mistrust spreads quickly and has large consequences. It’s one thing if a locally owned bank tightens up its credit, but when all the banks in the Bank of America system or Wells Fargo tighten their credit it reverberates throughout the country.

Economic concentration is the equivalent of the changes in mobility that made both the Black Death and the 1918 epidemic so catastrophic.  In 1918, for example, one vector that helped to spread the disease was soldiers returning from the war to their home towns. One returning soldier could quickly infect an entire community.  At that time the dominant means of travel between communities was still the railroad, which meant one flu carrier on a train could infect other travelers who brought it to all the stops on the route. With economic concentration the tightening of liquidity quickly engulfs the entire country.

So step one is to cut concentration, especially concentration that is in violation of the law as are Bank of America, JPMorgan Chase and Wells Fargo who currently are operating illegally by ignoring a provision that requires that no financial institution control more than 10% of the market. Not only has the Bush Administration refused to take action against the big three, it has rewarded them by giving them bailout funds which they can use to increase their market share.

Step two in cutting concentration is to bring back the Glass-Steagall Act that was gutted in 1999, leading to the present mess. Joseph Stiglitz described the current financial world in his Congressional testimony:

We need to begin by observing that there are important distinctions between financial institutions that are central to the functioning of the economy system, whose failure would jeopardize the functioning of the economy and who are entrusted with the care of ordinary citizens’ money, and those that provide investment services to the very wealthy. The former includes commercial banks and pension funds. These institutions must be heavily regulated in order to protect our economic system and the individuals whose money they are supposed to be taking care of. Consenting adults should be allowed to do what they like, so long as they do not hurt others. There needs to be a strong ring-fencing of these core financial institutions—they cannot lend money to or purchase products from less highly regulated parts of our financial system.

Those institutions Stiglitz identifies as “central to the functioning of the economy system, whose failure would jeopardize the functioning of the economy and who are entrusted with the care of ordinary citizens’ money” should once more be subject to the provisions that were stripped from Glass-Steagall. In essence we need to reestablish the regulation the Supreme Court favored in it decision Investment Company Institute v. Camp. In that complex case the Court issued one of the most ringing and unequivocal defenses of Glass-Steagall:

Congress was concerned that commercial banks in general and member banks of the Federal Reserve System in particular had both aggravated and been damaged by stock market decline partly because of their direct and indirect involvement in the trading and ownership of speculative securities.

The legislative history of the Glass-Steagall Act shows that Congress also had in mind and repeatedly focused on the more subtle hazards that arise when a commercial bank goes beyond the business of acting as fiduciary or managing agent and enters the investment banking business either directly or by establishing an affiliate to hold and sell particular investments.

By severing the interrelationships in the current system that too readily mix investment banking and what we might term “traditional banking” we cut one of the main vectors of the transmission. It is the financial version of quarantining the infection.

Systemic Cure Two: Interventions

Just as the cure for disease outbreaks is interventions that slow or stop the spread of the disease, so is the cure for our financial infection. If liquidity is at the root of the problem, then the government needs to put in place steps that will reduce the fear of making loans whether to individuals, businesses or other banks.

The liquidity crisis is rippling through the economy so people cannot get loans to buy cars, college students cannot get loans for their education, and homeowners cannot get loans to buy homes.  Automobile dealers close down because they buy cars on credit, stores take out loans to buy inventory (the reason Circuit City is in trouble is that manufacturers refused to make financial arrangements for getting their products to the retailer), and factories across the country cannot get loans to buy new equipment or replace aging machinery. As for things like venture capital which has been a huge driver of innovation, that has become yet another casualty, since many of those firms rely on stock investments and loans.

The FDIC is already implementing steps to ease this crisis with its Temporary Liquidity Guarantee Program. FDIC head Sheila Bair described these:

The program has two key features. The first feature is a guarantee for new, senior unsecured debt issued by banks or thrifts and bank holding companies and most thrift holding companies, which will help institutions fund their operations.

The second feature of the new program provides insurance coverage for all deposits in non-interest bearing transaction accounts at institutions unless they choose to opt out. These accounts are mainly payment processing accounts such as payroll accounts used by businesses.

As the program’s title indicates these measures are only temporary. The systemic problem is that we do not know how temporary they should be. In the disease model, you can reasonably predict at what point your interventions will cause the outbreak to subside, but Bair gave no indications in her testimony that the FDIC has any modeling in place that will help them get a grip on the financial infection.

The interventions all seem to have picked an arbitrary time limit which is a bit like picking how many people to vaccinate in a disease outbreak by drawing a number out of a hat. The second feature, for example, expires at the end of this year, which judging by how things are going will not be long enough.

A vaccination permanently prevents an outbreak of a particular disease from recurring in individuals who receive it. The current liquidity crisis is in dire need of a vaccination, which means Congress should consider making the FDIC interventions permanent. In her testimony, Bair explained:

It is important to note that the TLGP does not rely on taxpayer funding or the Deposit Insurance Fund. Instead, both aspects of the program will be paid for by direct user fees. Coverage for both parts of the program is automatic for the first 30 days, without charge. After that, the FDIC will begin assessing premiums or user fees for the coverage unless an institution opts out of one or both elements of the program.

This is how we make the FDIC plan permanent much as we did with the backing of bank deposits in the 1930s. In return for guaranteeing unsecured debt, institutions would have to agree to contribute the the permanent Loan Guarantee Program in return for additional oversight by the FDIC. The program would be voluntary, but institutions that did not enroll would be ineligible for future bailouts, nor could they join after getting into trouble.

The second intervention is one recommended by Joseph Stiglitz in his Congressional testimony and several recent articles and interviews: a Financial Products Safety Commission, which would be the loan equivalent of the FDIC. Stiglitz described how it would work:

This would assess the risks of particular products and determine their suitability for particular users. Many of these products were allegedly designed for managing particular risks, but the people buying those products did not face the risks for which they were designed. They thus increased the overall risks which they faced. There should be a presumption that financial markets work fairly well, and as a result there are no free lunches to be had. Financial innovations that are defended as reducing transactions costs, but instead lead to increased fees for financial institutions, should be suspect. The Financial Products Safety Commission would also look at the pricing of these products. Many new financial products (derivatives) were sold as lowering transactions costs and providing new risk arbitrage opportunities, but pricing was based on information provided by existing assets, and they succeeded in generating huge fees.

While reinstating Glass-Steagall would prevent future crisis by traditional banks, Stiglitz’s idea would take care of more speculative institutions. Think of it as a kind of public health agency charged with monitoring the financial health of our system just as public health agencies monitor the health of our communities.

The Total Package

Essentially the second, systemic part of the recovery package I call Dollars for Democracy includes four key components to prevent the spread of the liquidity crisis:

1) Reinforce current laws against concentration,

2) Bring back Glass-Steagall,

3) Create a loan equivalent to the FDIC, and,

4) Create Stiglitz’s Financial Products Safety Commission

It is important to recognize the systemic, interrelated nature of these four interventions, without one, the other three fail.  For example, if we bring back Glass-Steagall but do not also ease the liquidity crisis, then it will be like quarantining people in an epidemic and then letting them starve to death. Without the long-term watchdog of the Safety Commission it will be easier for another crisis to emerge.

The Final Result

It is also important to recognize that these must be combined with the solution already suggested for the first part of the three-legged stool that makes up Dollars for Democracy: bottom-up relief that was described in the previous essay in this series. The next essay focuses on the final part of Dollars for Democracy: the level playing field.

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