The great deformation, p.1

The Great Deformation, page 1


The Great Deformation

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The Great Deformation









  New York

  Copyright © 2013 by David A. Stockman.

  Published in the United States by PublicAffairs™, a Member of the Perseus Books Group

  All rights reserved.

  No part of this book may be reproduced in any manner whatsoever without written permission except in the case of brief quotations embodied in critical articles and reviews. For information, address PublicAffairs, 250 West 57th Street, 15th Floor, New York, NY 10107.

  PublicAffairs books are available at special discounts for bulk purchases in the U.S. by corporations, institutions, and other organizations. For more information, please contact the Special Markets Department at the Perseus Books Group, 2300 Chestnut Street, Suite 200, Philadelphia, PA 19103, call (800) 810-4145, ext. 5000, or e-mail

  Library of Congress Cataloging-in-Publication Data is available for this book.

  ISBN 978-1-58648-913-7 (eBook)

  Editorial production by Marrathon Production Services.


  Text set in 10-point Utopia


  10 9 8 7 6 5 4 3 2 1

  To my daughters, Rachel and Victoria,

  whose future inspired me to start this book,

  and my wife, Jennifer,

  whose patience and loving support

  enabled me to complete it.





  1Paulson’s Folly: The Needless Rescue of AIG and Wall Street

  2False Legends of Dark ATMs and Failing Banks

  3Days of Crony Capitalist Plunder




  4The Reagan Revolution: Repudiations and Deformations

  5Triumph of the Warfare State: How the Budget Battle Was Lost

  6Triumph of the Welfare State: How the GOP Anti-Tax Religion Was Born

  7Why the Chickens Didn’t Come Home to Roost: The Nixon Abomination of August 1971




  8New Deal Myths of Recovery

  9The New Deal’s True Legacy: Crony Capitalism and Fiscal Demise

  10War Finance and the Twilight of Sound Money

  11Eisenhower’s Defense Minimum and the Last Age of Fiscal Rectitude

  12The American Empire and the End of Sound Money

  13Milton Friedman’s Folly: Rise of the T-Bill Standard



  14Pork Bellies, Floating Money, and the Rise of Speculative Finance

  15Greenspan 2.0

  16Bull Market Culture and the Delusion of Quick Riches

  17Serial Bubbles

  18The Great Deformation of Capital Markets: How Wall Street Got Huge

  19From Washington to Wall Street: Roots of the Great Housing Deformation

  20How the Fed Brought the Gambling Mania to America’s Neighborhoods

  21The Great Financial Engineering Binge

  22The Great Raid on Corporate Cash

  23The Rant That Shook the Eccles Building: How the Fed Got Cramer’d

  24When Giant LBOs Strip-Mined the Land

  25Deals Gone Wild: Rise of the Debt Zombies

  26Bonfires of Debt and the Road Not Taken




  27Willard M. Romney and the Truman Show of Bubble Finance

  28Bonfires of Folly: Bernanke’s False Depression Call and the $800 Billion Obama Stimulus

  29Obama’s Green Energy Capers: Crony Capitalist Larceny

  30The End of Free Markets: The Rampages of Crony Capitalism in the Auto Belt

  31No Recovery on Main Street

  32The Bernanke Bubble: Last Gift to the 1 Percent

  33Sundown in America: The State-Wreck Ahead

  34Another Road That Could Be Taken

  Note on Sources


  About the Author


  Less than two weeks before The Great Deformation went to press, the powers that be in Washington pulled off a “deal” that allegedly stopped the country from going over the fiscal cliff. What they did, in fact, was to permanently add nearly $5 trillion to Federal deficits over the next ten years, ensuring that the national debt will continue to surge higher and that Washington will become strangled even more deeply in a fatal paralysis of governance.

  In truth, the fiscal cliff is permanent and insurmountable. It stands at the edge of a $20 trillion abyss of deficits over the next decade. And this estimation is conservative, based on sober economic assumptions and the dug-in tax and spending positions of the two parties, both powerfully abetted by lobbies and special interests which fight for every paragraph of loophole ridden tax code and each line of a grossly bloated budget.

  Fiscal cliffs as far as the eye can see are the deeply troubling outcome of the Great Deformation. They are the result of capture of the state, especially its central bank, the Federal Reserve, by crony capitalist forces deeply inimical to free markets and democracy.

  Why we are mired in this virtually unsolvable problem is the reason I wrote this book. It originated in my being flabbergasted when the Republican White House in September 2008 proposed the $700 billion TARP bailout of Wall Street. When the courageous House Republicans who voted it down were forced to walk the plank a second time in betrayal of their principled stand, my sense of disbelief turned into a not-inconsiderable outrage. Likewise, I was shocked to read of the blatant deal making, bribing, and bullying of the troubled big banks being conducted out of the treasury secretary’s office, as if it were the M&A department of Goldman Sachs.

  Most important, I had been an amateur historian on the matter of twentieth-century fiscal and monetary history, perhaps owing to my years on Capitol Hill and in the Reagan White House when they were embroiled in these topics. In fact, prior to my Washington years, while hiding out from the draft at Harvard Divinity School in 1968–1970, I had taken up serious study of the New Deal under the era’s great historian Frank Freidel, and had continued the inquiry ever since. So when Fed chairman Bernanke began running around Washington shouting that the Great Depression 2.0 was at hand, I smelled a rat.

  Then, when the Fed’s fire hoses started spraying an alphabet soup of liquidity injections in every direction, and its balance sheet grew by $1.3 trillion in just thirteen weeks compared to $850 billion during its first ninety-four years, I became convinced that the Fed was flying by the seat of its pants, making it up as it went along. It was evident that its aim was to stop the hissy fit on Wall Street, and that the threat of a Great Depression 2.0 was just a cover story for a panicked spree of money printing that exceeded any other episode in recorded human history.

  At length, the sweaty visage of Treasury Secretary Hank Paulson appeared on the TV screen yet again, this time announcing that Washington was writing a $13 billion check to bail out General Motors. That’s where I lost it. I had spent the two decades since I left the White House on Wall Street in the leveraged buyout business, and at that moment I was laid up on the injured reserve list because of my own fiery mishap in Detroit. I had organized, financed, and partially owned a $4 billion auto parts supplier that I had imprudently loaded up with massive amounts of debt, and which
had then been crushed by the bumbling corporate bureaucrats at GM (and Chrysler) ahead of their own crash landing.

  As a consequence of my Detroit experience, I was in the midst of proving to a US prosecutor that my company’s bankruptcy was due to leverage and stupidity (mine), not fraud. But three years of fighting an indictment concentrates the mind, and by then I knew one thing for certain: the Detroit-based auto industry was a debt-enfeebled house of cards that had been a Wall Street playpen of deal making and LBOs for years, including my own; it needed nothing so much as a cold bath of free market house cleaning, along with a drastic rollback of the preposterous $100,000 per year cost of UAW jobs.

  Paulson’s claim that the auto industry would disappear and that millions of jobs would be lost I knew to be laughable. My company had forty North American plants and I had traveled the length and breadth of the auto belt and had seen dozens of worn-out, broken-down UAW-controlled auto plants in the north that were redundant, and dozens of brand new, efficient state-of-the-art plants established by foreign automakers in the southern tier of states that could readily take up the slack. Absent the auto bailouts, there would have been no car shortage or loss of jobs—just a reallocation from the north to the South based on the rules of the free market.

  By the end of the Bush administration it was starkly apparent that a Republican White House had wantonly trashed all the old-time fiscal rules, and it had been done by political neophytes: Hank Paulson and his posse of eager-beaver Goldman bankers. But I had been at the center of the most intense fiscal battle of modern times during the early Reagan era and had learned something they apparently hadn’t: that the Congress is made up of representatives from 435 mini-principalities and duchies, and they reason by precedent above all else. Once Wall Street, AIG, and GM were bailed out, the state would have no boundaries: the public purse would be fair game for all.

  I found this alarming in view of the long ago Reagan-era battle of the budget that had ended in dismal failure. Notwithstanding decades of Republican speech making about Ronald Reagan’s rebuke to “big government,” it never happened. In the interim, Republican administrations whose mantra was “smaller government” only made Big Government more corpulent, so plainly by 2008 there was no fiscal headroom left at all to plunge into “bailout nation.”

  After I left the White House in 1985 I wrote a youthful screed, The Triumph of Politics, decrying Republican hypocrisy about the evils of deficit finance. But I had also tried to accomplish something more constructive: to systematically call the roll of the spending cuts not made by Ronald Reagan, and thereby document that almost nobody was willing to challenge the core components that comprise Big Government.

  Thus, the giant social insurance programs of Medicare and Social Security had barely been scratched; means-tested entitlements had been modestly reformed but had saved only small change because there weren’t so many welfare queens after all; farm subsidies and veterans’ benefits had not been cut because these were GOP constituencies; and the Education Department had emerged standing tall because middle-class families demanded their student loans and grants. In all, Ronald Reagan had left the “welfare state” barely one-half of 1 percent of GDP smaller than Jimmy Carter’s, and added a massive structural deficit to boot.

  But that was twenty-five years ago, and whatever fiscal rectitude had existed among the Republican congressional elders at the time had long since disappeared. During the eight years of George W. Bush, the GOP had pivoted from spending cuts not made to a spending spree not seen since the presidency of Lyndon Baines Johnson—adopting Medicare prescription drug benefits, massive growth in education spending, the monstrosity of the Homeland Security Department, sky-high farm subsidies, and pork-barrel excess everywhere. Worse still, the defense budget had doubled and the so-called Republican brand had been reduced to tax cutting for any reason and in whatever form the lobbies of K Street could concoct.

  George W. Bush thus left the White House trailed by previously unthinkable bailouts and a deluge of red ink which would reach $1.2 trillion and 10 percent of GDP, even before the Obama stimulus. What was truly galling, however, was that the Wall Street satrap occupying the third floor of the Treasury Building had talked the hapless Bush into a $150 billion one-time tax rebate to “stimulate” the economy.

  I had long since parted ways with the supply-siders and had left the White House with my admiration for President Reagan considerably dulled by his obdurate inflexibility on the runaway defense buildup, and his refusal to acknowledge that the giant deficits which emerged in the 1980s were his responsibility, not Jimmy Carter’s. But despite all this, I thought that the Paulson tax rebate was a sharp slap in the Gipper’s face. President Reagan’s great accomplishment had been the burial of the Keynesian predicate: the notion that Washington could create economic growth and wealth by borrowing money and passing it out to consumers so they would buy more shoes and soda pop.

  Now Paulson was throwing even that overboard. Didn’t the whirling dervish from Goldman know that once upon a time all the young men and women in Ronald Reagan’s crusade, and most especially the father of supply side, Jack Kemp, had ridiculed the very tax rebate that he peddled to Nancy Pelosi in February 2008 as Jimmy Carter’s $50 per family folly?

  At length, I saw the light, and it had nothing to do with Paulson’s apparent illiteracy on the precepts of sound fiscal policy. The bailouts, the Fed’s frenzied money printing, the embrace of primitive Keynesian tax stimulus by a Republican White House amounted to something terrible: a de facto coup d’état by Wall Street, resulting in Washington’s embrace of any expedient necessary to keep the financial bubble going—and no matter how offensive it was to every historic principle of free markets, sound money, and fiscal rectitude.

  The Obama $800 billion stimulus, which came within days of Bush’s vacating the White House, removed all doubt that Keynesian policies had come roaring back in close couple with Wall Street’s petulant demands for monetary juice to restart the bubble machine. This was self-evidently a deadly brew because it meant that policy action in Washington would be driven by fast-money speculators and trading robots on Wall Street, as had been so pathetically evident after the first TARP vote. And that meant, in turn, that the big spenders, the K Street lobbies, and the reflexive Republican tax cutters could all genuflect to the great god of the stock market, even as they collectively pushed the nation’s fiscal accounts into a tsunami of red ink on a scale never before imagined in peacetime.

  Obama’s $800 billion grab bag of consumer tax-cut handouts, business loopholes, money dumps to state and local governments, highway pork barrels, green energy giveaways, and hundreds more was passed in twenty-one days with no deliberation and after an epic feeding frenzy among the K Street lobbies. Literally decades of chipping away at the federal budget monster by fiscal stalwarts like Senators Pete Domenici and Kent Conrad were flushed away in a heartbeat.

  This all came tumbling down into some mind-bending questions. How did we get here? How did it happen that the nation’s central bank printed nearly twice as much money in thirteen weeks as it had during the entire century before? How had fiscal prudence been thrown to the winds so completely that between TARP and the Obama stimulus program Congress had authorized $1.5 trillion in the span of 140 days based on policies that had barely been inked onto legislative parchment, let alone read or analyzed? How had the stock market index cratered from 1560 in October 2007 to 670 in a mere fifteen months? How had the top-ten Wall Street Banks been valued at $1 trillion in mid-2007 only to crash into a paroxysm of failure and bailouts twelve months later? And then there was the subprime fiasco that had not been foreseen, the flame out of the giant Washington housing finance agencies, and the thundering collapse of the derivatives market in CDOs, CDSs, and the other toxic varieties. And most unaccountable of all: the stunning and precipitous meltdown of AIG.

  For me, AIG was the skunk in the woodpile. After twenty years on Wall Street I knew that the giant, globe-spanning AIG and i
ts legendary founder, Hank Greenberg, had once been viewed as not simply the gold standard of finance, but as seated at the very right-hand of the financial god almighty. And then, in a heartbeat, AIG needed $180 billion—right now, this very day, to keep its doors open? Worse still, this staggering sum of money—the size of the Departments of Commerce, Labor, Energy, Education, and Interior combined—had been ladled out as easy as Christmas punch: Bernanke just hit the “send” key on his digital money machine.

  Thus begins the inquiry that has resulted in this book. There had to be a pattern and history behind these momentous, unaccountable, and foreboding developments, I thought, because during the entire course of my career—nearly forty years in Washington and on Wall Street—none of these events would have been thought even remotely possible by most people. Zero percent interest rates? A 10 percent of GDP deficit? The bankruptcy of the $6 trillion edifice of Freddie Mac and Fannie Mae? A Great Depression 2.0 only a short time after Bernanke himself pronounced the arrival of the “Great Moderation”?

  Indeed, that was the heart of the matter and it is the foil for my thesis. Bernanke said in 2004 that prosperity would be everlasting because the state and its central banking branch had perfected the art of modulating the business cycle and smoothing the natural bumps and grinds of free market capitalism. This book argues the opposite; namely, that what is at hand is the “Great Deformation.” Free markets and prosperity are deeply imperiled because the state and its central banking branch have failed miserably due to overreaching, overloading, and outside capture. They have become the tools of a vicious form of crony capitalism and money politics and are in thrall to a statist policy ideology common to all three branches of today’s Washington economics: Keynesianism, monetarism, and supply-side-ism.

  Given the somber fiscal realities owing to the $20 trillion deficit abyss ahead, it is difficult to imagine worse, but the monetary dimension, in fact, is even more foreboding. At the heart of the Great Deformation is a rogue central bank that has abandoned every vestige of sound money. In so doing, it has enabled politicians to enjoy “deficits without tears” by monetizing massive amounts of the public debt.


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