In a recent interview with Amy Goodman, Chicago lawyer Thomas Geoghegan discusses his Harper’s article, Infinite Debt: How unlimited interest rates destroyed the economy.
The article is well worth reading in its entirety, but here are a couple of significant excerpts:
Some people still think our financial collapse was the result of a technical glitch—a failure, say, to regulate derivatives or hedge funds. All we need is a better chairman of the SEC, like brass-knuckled Joe Kennedy, FDR’s first pick. It’s personnel—it’s Senator Gramm’s fault. Or it’s Robert Rubin’s fault.
In fact, no amount of New Deal regulation or SEC-watching could have stopped what happened. Hedge funds in themselves did not cause Wall Street to collapse. Some New Deal–type regulation was actually introduced in recent years, but it failed to do much: think of the Sarbanes–Oxley Act of 2002, which made CEOs swear an oath that their financial statements were not fraudulent. No, the deregulation that led to our Time of Troubles was of a deeper, darker kind. The problem was not that we “deregulated the New Deal” but that we deregulated a much older, even ancient, set of laws.
First, we removed the possibility of creating real, binding contracts by allowing employers to bust the unions that had been entering into these agreements for millions of people. Second, we allowed those same employers to cancel existing contracts, virtually at will, by transferring liability from one corporate shell to another, or letting a subsidiary go into Chapter 11 and then moving to “cancel” the contract rights, including lifetime health benefits and pensions. As one company after another “reorganized” in Chapter 11 to shed contract rights, working people learned that it was not rational to count on those rights and guarantees, or even to think in these future-oriented ways. No wonder people in our country began to live for the moment and take out loans and start running up debts. And then we dismantled the most ancient of human laws, the law against usury, which had existed in some form in every civilization from the time of the Babylonian Empire to the end of Jimmy Carter’s term, and which had been so taken for granted that no one ever even mentioned it to us in law school. That’s when we found out what happens when an advanced industrial economy tries to function with no cap at all on interest rates.
Here’s what happens: the financial sector bloats up. With no law capping interest, the evil is not only that banks prey on the poor (they have always done so) but that capital gushes out of manufacturing and into banking. When banks get 25 percent to 30 percent on credit cards, and 500 or more percent on payday loans, capital flees from honest pursuits, like auto manufacturing. Sure, GM is awful. Sure, it doesn’t innovate. But the people who could have saved GM and Ford went off to work at AIG, or Merrill Lynch, or even Goldman Sachs. All of this used to be so obvious as not to merit comment. What is history, really, but a turf war between manufacturing, labor, and the banks? In the United States, we shrank manufacturing. We got rid of labor. Now it’s just the banks.
Which is why the middle class is shrinking. Basically, we’re all waiters now; we’re bowing and scraping and working for the banks. Look closely at any American, and it’s even odds that he or she, directly or indirectly, is somehow employed by the “financial services sector,” which covers insurance and real estate and financial instruments of any kind. As brokers, lawyers, loan collectors, loan consolidators, secretaries at big investment firms, chauffeurs of private limousines, or even the high-tech types who exist solely to service banks—all of us, millions of us, are part of it, living off it in some way, as three generations ago we lived off manufacturing.
Yes, we should have more regulators, many more; but as long as capital gushes into the financial sector, the speculators, the gamblers, will continue to outnumber the regulators who can watch them. In 2002 and 2003, financial firms took more than 40 percent of the profits that accrued to U.S. corporations—that’s according to the Bureau of Economic Analysis. Anyway, the point is that 40 percent is more than double the share the financial industry was taking—about 18 percent—when Ronald Reagan left office and interest rates were just beginning to really climb. And the Bureau of Economic Analysis may be understating how much of the economy is now based on finance. Think of the growth of the health-insurance industry, for example. Or think of GM, which, like GE, really makes its money by running a bank on the side. “After a while,” said a friend from Detroit, “the only reason they were making cars was so they could make loans.” Everything followed from this. The bloating of the financial sector helped create the growing U.S. trade deficits, which brought in a flood of cheap money for borrowing—which helped further bloat the financial sector. Look at the timing. The big trade deficits came at about the time the caps on interest rates came off, in the late 1970s. Capital flowed out of manufacturing, with its “low” profits, and into the financial sector, where profits were much higher. We became less competitive in manufacturing because we could not accept the lower rate of profit—not vis-à-vis our competitors in Mexico, but vis-à-vis our competitors in New York City…
It may be hard to grasp how the dismantling of usury laws might lead to the loss of our industrial base. But it’s true: it led to the loss of our best middle-class jobs. Here’s a little primer on how it happened.
First, thanks to the uncapping of interest rates, we shifted capital into the financial sector, with its relatively high returns.
Second, as we shifted capital out of globally competitive manufacturing, we ran bigger trade deficits.
Third, as we ran bigger trade deficits, we required bigger inflows of foreign capital. We had “cheap money” flooding in from China, Saudi Arabia, and even the Fourth World. May God forgive us—we even had capital coming in from Honduras.
Fourth, the banks got even more money, and they didn’t even consider putting it back into manufacturing. They stuffed it into derivatives and other forms of gambling, because that’s the kind of thing that got the “normal” big return; i.e., not 5 percent but 35 percent or even more.
Go back to the top and repeat the sequence.
It was what scientists call an autocatalytic reaction. It just kept going. All of that cheap money would have been a good thing if it had gone into manufacturing. But it didn’t. The capital inflows from the big trade deficits couldn’t go into manufacturing because the returns in banking were just too high. And because this autocatalytic reaction kept going—as long as there was the imbalance between finance and industry—the system could not readjust or stabilize. The bigger the deficit, the bigger the capital inflow; and the bigger the capital inflow, the bigger the financial sector became; and the bigger the financial sector became (relative to manufacturing), the bigger the trade deficit became.
And meanwhile, we lost more and more skill-based jobs. Oh, we had jobs, and even jobs that required college and postgraduate educations. But we stopped being skill-based workers. We became “knowledge workers,” dependent on the financial sector. And knowledge workers, unlike skill-based workers, don’t have the bargaining power to get higher wages out of rising productivity. What can they withhold? They can’t withhold knowledge. And since they have nothing to withhold, it’s much trickier for knowledge-based workers to get a higher wage. And if there are fewer skill-based workers, it becomes harder to raise wages in general. And if it’s harder to raise wages, then more of us go into debt.
