America Is Becoming a Banana Republic

This week's must-read commentary on the continuing financial crisis was penned by Simon Johnson and appears in The Atlantic - The Quiet Coup. It should be familiar material for anyone who's read any of Kevin Phillips' recent books or earlier work by Paul Kennedy.

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

This is all, apparently, a natural progression throughout history.

Unfortunately, not enough people in Washington and on Wall Street read enough history.

Some argue that the real Reagan Revolution was the reckless expansion of credit, a development that gave us 20 years of faux prosperity while enriching Wall Street and Mr. Johnson is clearly in that camp.

Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.

But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside.

The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.
Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent.

Somehow, this makes all of the attempts to restore the proper functioning of credit markets a bit less reassuring - it goes on at great length and is well worth reading in its entirety.

Comments

[Jason Rines...:]

I have Google now. Pay me $2 M a year at 40% net aggregate commission. Middle men always think they are invaluable until they themselves are gobbled up the by the Fascist governments they created.


On Mar 31 11:07 AM dybydx wrote:

> This comparison is flawe. Back then,the average staff at a bank may
> have been the teller. Today, bank operations are increasingly complex
> and specialized knowledge and certification is required. This increase
> in criteria shot up much faster than that of the average smokestack
> American factory worker. Naturally, it would make sense that they
> earn 180% of Joe the Plumber or anyone at GM that pulls a lever for
> $80/hr.

Mar 31 02:10 PM

[mrmillergd:]

I don't want to demonize financiers (after all, I kind of am one ; ). I think we have developed some real wealth-creating innovations (driven by both the finance sector and technology sectors) in the past 30 years - just none in the past 10.

It's all just part of the cycle of greed and fear. There's nothing government can do to fundamentally fix the problem as it extends into the core of our perceptions of value.

Read some anecdotes about people's mindsets between the '20's and '30's (Studs Turkel is a personal fave) and you will find the similarities to today both striking and unsettling.

Mar 31 02:17 PM

[@TexasER:]

Those are extremely compelling (and worrisome) charts. I get the value of financial services. Managing risk is an important function, and companies should be paid to do it well.

But a third of all US business profits? Really? Seriously?

Mar 31 03:09 PM

[MinAkkar20:]

Or the Great Depression began when the government got in bed with banks by passing the Federal Reserve Act. Read some Rothbard and then tell me how the government "fixed" the great depression.

Your post is history 101. When you get to history 401 you will learn to question what you are told and won't make categorically wrong statements.


On Mar 31 04:27 PM Cetin Hakimoglu wrote:

> The Govt. can fix problems. The great depression worsened because
> the govt. didn't bail out the banks.
>
> This is just history 101.
>
> On Mar 31 02:17 PM mrmillergd wrote:

Mar 31 05:55 PM

[The Geoffster:]

The pendulum swings. This too shall pass. But just in case, keep some gold on the side and be ready to lock and load. Meanwhile, preserve your capital and enjoy your favorite adult beverage.

Mar 31 06:47 PM

[jstratt:]

I like most of Tim's perspectives better than this one.

Yes he makes many valid points and adds some insight. Still to suggest the US currency compares to a banana republic is a farce.

I guess we are getting to the point in a severe recession where these kind of suggestions take hold and are not disputed.

Mar 31 07:03 PM

[austrian63:]

Tim,

The most imortant topic that is missing from your article and the comments above, save one, is the Federal Reserve. It is not possible to blame the financial crisis on deregulation, greedy bankers or the Easter Bunny, when it is the Fed that has complete monopoly control of the (1) supply of money and (2) the price of money - interest rates.

If we embarked on a credit craze in the 1980's what drove this? Was it because the "free" market reduced interest rates so much that Ma and Pa Kettle and every one else decided to go on a debt binge or did an organization whose Chairman serves at the pleasure of the President and who is confirmed by the senate make money (via cheap debt) easily available to every one? Who is the "lender of last resort" the banks always look to? You think if you had a rich dad that ALWAYS got you out of trouble you would be very good at managing risk? Go ask Paris Hilton if always having a lender/bailer out of last resort teaches you how to live or manage your business responsibly.

As Thomas Woods states, "The Fed is the elepahant in the room that no one wants to talk about." The Fed, Fannie and Freddie are organizations of the government which also supposedly did not regulate us enough over the past 30 years to keep us from misbehaving. Maybe deregulation was the problem: the Fed did not regulate itself well enough and Freddie and Fannie did not regulate themselves well enough. Kind of like the fox guarding the hen house.

If you really want to understand what caused this crisis you must first learn to recognize and appreciate the business cycle. Next you must learn to identify, call out, the primary drivers of the boom-bust business cycle. Wasn't the Fed supposed to "stabilize" the economy and get rid of the terrible business cycle? How many business cycles have we had since 1913? I count at least 10 including the Great Depression. That's at least one every decade. Looks like the Fed's done a damn good job of providing stability - NOT. Seems like our intellectual superiors at the Fed have not yet learned to look in the mirror when they start searching for the cause of each cycle.

As we speak the Fed and our other wise rulers, damn they are so much smarter than we are, are telling us that if we can just get more credit out there and if we will just keep spending every dollar we make and then borrow more from anyone who will lend it and them (TALF,....) and make sure we don't save anything for a rainy day, since that's so selfish and provincial, our economy will pick right back up where it left off.

What chances would you say we have of creating an economic recovery by borrowing and spending more? If we keep consuming, where will the capital come from to enable future production since we are supposed to comume it? Will we be able to consume more in the future if production is starved of capital to stimulate consumption?

Mar 31 07:18 PM

[Moresby:]

There is a huge advantage in being a few trillions in debt, the lenders want to be paid and will help to keep the US going.
Not unlike drug pushers, they need the drug addicts alive..... will the Americans ever kick their spending habit? Who knows?
Is the US a banana republic? Yes, except it has a big enough banana skin for the rest of the world to skid on, so we cannot treat it as a joke like Zimbabwe.
I hope the government has plan on controlling the inflation to come, unless Obamanomic can tread on water.

Mar 31 08:35 PM

[Al-USA:]

The USA remains me of the classic book, "The Rise and Fall of the Roman Empire", where, basically, a parasitic elite cannibalized the institutions of the empire for its own ends.

All the while, the barbarians where massing on the borders, and when winter came, the hordes swarmed over the frozen Germanic rivers and, the rest is history...

It actually took years to happen, but when the hordes started moving, it was too late, the empire fell over of its own decaying weight.

The last crisis of capitalism of similar magnitude occurred during the 1930's, and only the production necessary to win WWII saved capitalism from the collapse engineered by the capitalists of that era. There is nothing now on the horizon which will serve to force a use of the productive forces as WWII did. In other words, this is the best time since the 1930's for other economic models to be introduced and send capitalism to the dust bin of history, once and for all...

We have all to thank the capitalist financial elites themselves for doing the job as Lenin described: "The capitalists will sell the rope used to hang them". Although it will probably take years to unfold, it is now, as expected, coming to pass...

Banks Counted on Looting America’s Coffers
tinyurl.com/bkezmt

The Quiet (American) Coup
www.theatlantic.com/do...

America the Tarnished
www.nytimes.com/2009/0...

Fluke? Credit crisis was a heist
tinyurl.com/cgugqm

The Obama Deception Full Length
video.google.com/video...

Welcome to America, the World's Scariest Emerging Market
www.washingtonpost.com...

Following the A.I.G. Money
www.nytimes.com/2009/0...

Mar 31 11:12 PM

[Fighting Yoda:]

The bankers have been looting Americans and rest of the world for the last two decades by blowing bubbles. It is one crisis after another – Junk bond crisis in mid 80s, immediately followed by S&L, LTCM in the late 90s, then the big daddy dot com scam, now the biggest of them all. The whole Wall Street business model is a giant Ponzi scheme – create bubbles – early entrants get paid by later entrants, last ones hold the bag.

Bankers have simply cornered the system – monopolizing the money flow, and getting everyone hooked to credit. It is like drugs – once you are hooked you are done. There is a lot of blame to go around from Reagan to Greenspan, now Bernanke and Paulson. Wall Street guys simply play with house money, if their casino bets work out – they make out like bandits, else it the investor, and now much worse the tax payer, who gets stuck with the losses. Their pay and incentives are ridiculously high, as the author points out, and the incentive structures are simply perverse – short term gains.

These guys are simply parasites, their job is to simply route the money – this is not an industry in itself. We on Main Street toil and actually take risks and produce innovative products. Our pay structures are so much lower.

This banker strangle hold must be broken, let there be class warfare, it is time, I am ready.

Apr 01 01:49 AM

[drevno:]

Maybe it's time to create a parallel banking system based on brand new banks established along the standard banking principles.

They can be capitalized by the money now earmarked for bailing out failing financial institutions plus the deposits by individuals and companies fed up with the existing banks that willfully put their depositors, shareholders and the whole system at risk.

These BRAND new banks, properly managed, regulated and overseen would constitute a nucleus of rebuilding the financial system based on honesty, transparency and good economic and financial sense.

Apr 01 04:10 AM

[I am not a ...:]

Add to that ...Australia.
A former prime Minister,Paul Keating once said Australia was in danger of becoming a banana republic. he was of course ,very sadly,Correct. Our economy is based on selling ore and so on to the Chinese and importing most of our food and nearly everything else back from them. Not a very pleasant situation I can assure you. Our prssent PM,the manadarin speaking K Rudd is at this very moment organising loans of 48 billion USD from the Chinese to give away over the next few months in a fiscal stimulus package. ....hey mistuh tally man ,tally me bananas .....I better get practicing.


On Mar 31 10:40 AM Divebus wrote:

> I define a Banana Republic as an underdeveloped country which would
> export raw materials to an industrialized nation and import manufactured
> goods made from them.
>
> The U.S. has been a Banana Republic for decades.

Apr 01 05:34 AM

[kelm:]

A banana republic is generally characterized by a weak and corrupt government and police in the pay of the wealthy, poor eduction (except for the elites), an unstable currency that drives those with the ability to keep their money offshore, and a lack of investment in developing their own industry and economic capabilities.

Canada has exported raw materials throughout the world for decades but they also have some of the world's strongest banks and a large manufacturing base. So they do not fit the mold. Australia too exports raw material but their government and banks don't fit the category.

We are heading i the banana direction due to a weak government, a venal financial establishment, fiscal policies that debase the currency, and a failure to grow our industrial base. Ten years ago US banks dominated the world - no longer. Descent takes a long time but like any journey starts with the first step and we have certainly made those first steps.

Apr 01 10:17 AM

[fireball:]

gold and silver look better everyday.
bananas don't store well unless dried. i would insist on gold or siver or other useful items for my banana chips.
i vote for dismantling the fed (the root of our trouble, damnduck hunters).

Apr 01 11:25 AM

[svkoho:]

Thanks again for another great post Tim with good supporting data and concise writing.You did fail to mention that Barak's administration is doing nothing to change the policies of the last 30 years and IMO is running this country off a cliff.

Apr 01 11:33 AM

[austrian63:]

Your description of a Banana Republic reminds me of the U.S. (1) A weak and CORRUPT government, (2) police and add all government institutions in the pay of the wealthly, and don't forget political class and (3) poor education - don't forget he government has monopoly on education - you have to pay for reduculously bad and corrupt public education whether you want or not and no matter how bad the product.

Welcome to America!


On Apr 01 10:17 AM kelm wrote:

> A banana republic is generally characterized by a weak and corrupt
> government and police in the pay of the wealthy, poor eduction (except
> for the elites), an unstable currency that drives those with the
> ability to keep their money offshore, and a lack of investment in
> developing their own industry and economic capabilities.
>
> Canada has exported raw materials throughout the world for decades
> but they also have some of the world's strongest banks and a large
> manufacturing base. So they do not fit the mold. Australia too exports
> raw material but their government and banks don't fit the category.
>
>
> We are heading i the banana direction due to a weak government, a
> venal financial establishment, fiscal policies that debase the currency,
> and a failure to grow our industrial base. Ten years ago US banks
> dominated the world - no longer. Descent takes a long time but like
> any journey starts with the first step and we have certainly made
> those first steps.

Apr 01 12:20 PM

[hroni:]

I work hard, save and dream of retiring in a Banana Republic. Now, I'm working twice as hard to earn less, my savings will be hyper-inflated to 0 so f___ it, but hey, I don't have to move anymore!

Apr 01 01:34 PM

[henarl:]

Yep - and we don't even have bananas.

Apr 01 02:18 PM

[john s. gordon:]

in a banana 'republic' (some have been dictatorships) 99% of the national wealth is controlled by 1% of the population,a legacy of the spanish colonial system.
adding up all the worldcoms, enrons, everything else what we have is a casino republic.
> jack

Apr 01 03:40 PM

[Fabien Hug:]

This will not happen; people leaving the US to go live somewhere else, at least not during the span of the Western civilization. Compare to why is the US$ so strong. The problem is for the middle class. If you are an UAW worker, fly away from this country. You have nothing to gain here. If you are very rich, it's great, you can even buy yourself a congressman/woman. If you are in the middle, you have nowhere to go.


On Mar 31 10:29 AM Husker Mark wrote:

> I have often considered retirement in a Banana Republic where the
> stability of the US$ would increase my buying power. I guess I can
> put those dreams on the shelf as the US$ may be worth less in the
> future relative to the Banana Republic currencies.
>
> Having said that, I remain optimistic for the long run, at least
> for the short term. Confused? Okay, let's just say that the good
> ol' US of A has seen some pretty difficult times before and somehow
> we've weathered them all and come out stronger. I haven't yet given
> up on that principle. But the operative word in that last sentence
> is "yet."
>
> I am generally a glass half-full type of guy. I'll wait it out a
> few more years in hopes that the America I live in and still love
> returns. But I, like many others who could live anywhere they decide,
> will not wait forever. My greatest fear is that the opportunities
> to move up the social ladder, to go from rags to riches in a lifetime,
> to live the American Dream may no longer be available here in the
> future. When that happens, the bright, the determined, the hard-working,
> never-give-up sort of people that have made this country great will
> emigrate to where the opportunities can be found.
>
> Possibly a key to watch for clues to the future of American prosperity
> is immigration, legal and otherwise. When the number of people wanting
> to come to America starts to wane and more people with US citizenship
> start take up foreign residence, it may be time to look elsewhere.
>
>
> Now, see here, I am not predicting the fall of America. I still
> have hope, and I still expect things to turn out for the good. All
> I'm saying is that a touch of caution and an eye on down the road
> would be a prudent practice for the next few years. I'm still clinging
> to my hopes and supressing my fears. But I don't want to be caught
> wtih my commom sense down.

Apr 01 04:37 PM