[Corp. Watch] Big Finance needs a 'Do Not Rescusitate' order

[Corporation Watch]

The Market Mystique

  By Paul Krugman

(NY Times, March 27) -- On Monday, Lawrence Summers, the head of the  
National Economic Council, responded to criticisms of the Obama  
administration's plan to subsidize private purchases of toxic assets.

	"I don't know of any economist," Summers declared, "who doesn't  
believe that better-functioning capital markets in which assets can be  
traded are a good idea."

	Leave aside for a moment the question of whether a market in which  
buyers have to be bribed to participate can really be described as  
"better functioning."

	Even so, Summers needs to get out more. Quite a few economists have  
reconsidered their favorable opinion of capital markets and asset  
trading in the light of the current crisis.

	But it has become increasingly clear over the past few days that top  
officials in the Obama administration are still in the grip of the  
market mystique. They still believe in the magic of the financial  
marketplace and in the prowess of the wizards who perform that magic.

	The market mystique didn't always rule financial policy. America  
emerged from the Great Depression with a tightly regulated banking  
system, which made finance a staid, even boring business.

	Banks attracted depositors by providing convenient branch locations  
and maybe a free toaster or two; they used the money this attracted to  
make loans, and that was that.

	And the financial system wasn't just boring. It was also, by today's  
standards, small. Even during the "go-go years" -- the bull market of  
the 1960s -- finance and insurance together accounted for less than 4  
percent of gross domestic product (GDP).

	The relative unimportance of finance was reflected in the list of  
stocks making up the Dow Jones Industrial Average, which until 1982  
contained not a single financial company.

	It all sounds primitive by today's standards. Yet that boring,  
primitive financial system serviced an economy that doubled living  
standards over the course of a generation.

	After 1980, of course, a very different financial system emerged. In  
the deregulation-minded Reagan era, old-fashioned banking was  
increasingly replaced by wheeling and dealing on a grand scale.

	The new system was much bigger than the old regime: On the eve of the  
current crisis, finance and insurance accounted for 8 percent of GDP,  
more than double their share in the 1960s.

	By early last year, the Dow included five financial giants like AIG,  
Citigroup, and Bank of America. And finance became anything but  
boring. It attracted many of our sharpest minds and made a select few  
immensely rich.

	Underlying the glamorous new world of finance was the process of  
securitization. Loans no longer stayed with the lender. Instead, they  
were sold on to others, who sliced, diced and puréed individual debts  
into new assets.

	Sub-prime mortgages, credit card debts, car loans -- all went into  
the financial system's juicer. Out the other end, supposedly, came  
sweet-tasting AAA-rated investments. And financial wizards were  
lavishly rewarded for overseeing the process.

	But the wizards were frauds, whether they knew it or not, and their  
magic turned out to be no more than a collection of cheap stage tricks.

	Above all, the key promise of securitization — that it would make the  
financial system more robust by spreading risk more widely — turned  
out to be a lie.

	Banks used securitization to increase their risk, not reduce it, and  
in the process they made the economy more, not less, vulnerable to  
financial disruption.

	Sooner or later, things were bound to go wrong, and eventually they  
did. Bear Stearns failed; Lehman failed; but most of all,  
securitization failed.

	Which brings us back to the Obama administration's approach to the  
financial crisis. Much discussion of the toxic-asset plan has focused  
on the details and the arithmetic, and rightly so.

	Beyond that, however, what's striking is the vision expressed both in  
the content of the financial plan, and in statements by administration  
officials.

	In essence, the administration seems to believe that once investors  
calm down, securitization -- and the business of finance -- can resume  
where it left off a year or two ago.

	To be fair, officials are calling for more regulation. Indeed, on  
Thursday, Treasury Secretary Tim Geithner laid out plans for enhanced  
regulation that would have been considered radical not long ago.

	But the underlying vision remains that of a financial system more or  
less the same as it was two years ago, albeit somewhat tamed by new  
rules.

	As you can guess, I don't share that vision. I don't think this is  
just a financial panic; I believe that it represents the failure of a  
whole model of banking, of an overgrown financial sector that did more  
harm than good.

	I don't think the Obama administration can bring securitization back  
to life, and I don't believe it should try.