The Backstory of the Financial Collapse

Call it Gall Street. How else to describe an industry that applauds nearly $500 million in bonuses for executives taking an entire economy down with them?

Here's one small bit of payback that angry and frustrated New Yorkers could easily bestow on the grasping financial merchants behind last week's meltdown: Have the City Council—always down for a good street renaming—simply re-tag Wall Street with a new label, one more in line with its recent history: Boulevard of Greed? Gluttony Gulch? Chozzer Terrace?

For those of us prone to take the low road, these are the sort of names that instantly spring to mind, the nastier the better. And why not? How else to describe an industry that applauds nearly $500 million in bonuses for executives recklessly steering straight into the fiscal rocks, taking an entire economy down with them?

A gentler, more uplifting suggestion comes from James Parrott, an insightful economist whose practice centers on gauging the well-being of everyday New Yorkers, rather than scouting the fiscal horizon on behalf of fortune-seekers like so many in his profession. "The new Wall Street signs should read, 'Broadly Shared Prosperity Place,' " Parrott said on Brian Lehrer's show on WNYC last Wednesday morning as stocks and 401(k)'s were still tumbling in free fall. The new street signs would serve "as a constant reminder to the markets," suggested Parrott, that they need to serve the greater good—not just the good of a few.

Fat chance. These are the same people who, once the Clinton administration lifted decades-old safeguards that had long separated conservative commercial banking from Wall Street's rapacious investors, promptly went on a drunken, no-holds-barred, profit-seeking binge, culminating in last week's collapse. The old rules stemmed from the New Deal era, when Roosevelt's aides—haunted by the 1929 stock-market crash and the ensuing Great Depression—insisted that average holders of savings accounts and home mortgages needed protection from the gung-ho risk-takers ruling the investment-banking world.

Fast-forward 60 years, and Bill Clinton's brain trust—including economic czar Robert Rubin, who was fresh from investment giant Goldman Sachs, and Alan Greenspan, the crusty Federal Reserve chief and Reagan-Bush holdover—insisted that the challenge of new-world markets demanded far greater laxity for the U.S. banking industry.

Greenspan had previously been a director of the mighty J.P. Morgan firm, which had been broken up by the 1933 reform known as the Glass-Steagall Act. He began nibbling at the law's margins as soon as he became head of the Fed in 1987. Greenspan quickly used his clout to approve new rules allowing the biggest banks—Morgan, Chase Manhattan, Bankers Trust, and Citicorp—to utilize loopholes in the law allowing them to deal in debt instruments previously out of bounds. A few years later, he opened the loophole even wider. In 1999, he gave the all-important head nod to a merger between the old Travelers insurance company and banking colossus Citicorp—a marriage quickly consummated with the approval of Clinton and Congress.

It was a bipartisan achievement. Senator Phil Gramm—John McCain's top economic adviser until his "mental recession" quip a few weeks ago—led the Republican charge for the regulatory rollback. Chuck Schumer, who quickly became the Senator from Wall Street after his 1998 election, pushed hard from the Democratic side of the aisle. Clinton, after some quibbling over community-reinvestment protections, approved. Making the circle complete, Rubin resigned as Treasury Secretary and became the third member of a ruling troika in the newly formed Citigroup, America's first genuine financial supermarket. The new entity promptly jumped into the subprime-mortgage market, the root of the current morass. Rubin now offers economic advice to Barack Obama.

Things might still have worked out, notes Parrott, who is chief economist for the union-backed Fiscal Policy Institute, had Greenspan or regulators kept an eye on the powerful new forces they'd unleashed. But the Bush administration—delighted with the surging markets—turned a blind eye. Much of the blame falls in Greenspan's lap.

"Greenspan was the cop on the beat," says Parrott. "He chose to just look the other way and join the party." Every would-be watchdog, from the Fed on down, was lulled by the enormous profits being taken from a seemingly ever-rising housing market. "Greenspan went through all kinds of intellectual gymnastics to rationalize the run-up in housing prices, when it was clear it was historically way beyond anything that had ever happened before," Parrott says. "It should have been cause for some responsible adult to say, 'Wait a minute, things are getting out of hand here.' "

Indeed they were. One new financial market in something called credit-default swaps—basically a gamble on someone else's ability to meet their debts—managed to balloon in five short years to a breathtaking $16 trillion. All of it was unregulated.

"The Federal Reserve could have asked the investment banks about some of the creative financing tools they were using, and the instruments they were developing," adds Parrott. "It might have asked whether they were even listed on the firms' balance sheets. And if plain jawboning wasn't sufficient, Greenspan could have gone to the SEC and Congress for action."

Even after Greenspan's departure in 2006, his spirit ruled. As late as July, after the shocking collapse of investment giant Bear Stearns, top Bush administration banking regulators insisted to Congress that no new controls were needed.

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