Inside Job (4 page)

And the bankers’ final crime was that, far from channelling funds into productive uses, the financial sector has become parasitic and dangerous—a semicriminal industry that is a drag
on the American economy. The banks have destabilized the financial system, wasted
huge sums of money, plunged millions of people into chronic poverty, and crippled economic
growth throughout the industrialized world for many years to come. The proper job of bankers is to allocate capital efficiently by assembling savings from households and businesses, and to place
that money into the investments that produce the highest long-term returns for the economy. That is how the financial sector creates jobs and prosperity—or so economic theory says it
should.

But the housing boom of the 2000s, which was based on a combination of unsustainable consumption and outright fraud, brought no real economic improvement. The financial system deliberately
shifted its focus toward people who were either bad credit risks or easy victims, creating new products to entice and defraud them.

By the autumn of 2005, Merrill Lynch estimated that half of all US economic growth was related to housing—including new construction, home sales, furniture, and appliances. Much of the
rest came from the Bush administration’s enormous deficit spending. America was living in a fake economy. Finally, in 2008 the banks ran out of victims, and the bubble collapsed.

NONE OF THE FINANCIAL
destruction wreaked by the bankers was an act of God. Nor was it unforeseen. Voices were raised in warning early in the 2000s,
and in greater and greater volume, as the bankers plunged into ever more exotic universes of risk. Some of them are in my film
Inside Job
—Raghuram (Raghu) Rajan, Charles Morris,
Nouriel Roubini, Simon Johnson, Gillian Tett, William Ackman, Robert Gnaizda, the IMF, even the FBI. They were all ignored, even ridiculed, by those who were profiting from the situation. To a
great degree, of course, the outlines of this story are now known, and I will spend relatively little time on it. Most of this book is therefore devoted to two issues: first, the rise of finance as
a criminalized, rogue industry, including the role of this criminality in causing the crisis; and second, an analysis of the wider growth of inequality in America.

The book therefore proceeds as follows: Chapter 2 offers a short history of the twenty-year period that led to the rise of a deregulated, concentrated, destabilizing
financial sector, including the reemergence of financial crises and criminality.

Next, I describe the available evidence about banking behaviour during the 2000s, including the role played by criminal behaviour in the bubble and crisis. Chapter 3 examines mortgage lending;
chapter 4, investment banking and related activities; chapter 5, the coming of the crisis and the behaviour it produced. Chapter 6 surveys the rise of financial criminality, and the case for
criminal prosecutions. Not all of the bankers’ actions were criminal, of course, but some were—especially if we apply the same standards that sent hundreds of savings and loan
executives to prison in the 1990s, not to mention what happened to people not lucky enough to be working for major investment banks when they committed fraud or laundered criminal money.

The last four chapters of the book are a wider analysis of America’s recent changes. Starting with financial services, and then turning to academia, other economic sectors, and the
political system, I discuss America’s descent over the last generation into an economically stagnant, financially unstable, highly unequal society. I begin in chapter 6 by examining the
financial sector’s transformation into a parasitic industry that increasingly confiscates, rather than creates, national wealth.

In chapter 8, I turn to academia. Many viewers of
Inside Job
commented that the most surprising and shocking element of the film was its revelations about academic conflicts of interest.
Here I provide a far more detailed and extensive examination of how the financial sector and other wealthy interest groups have corrupted American academia, changing its role from independent
analysis to an additional tool for corporate and financial lobbying. In chapter 9, I consider the broader decline of the economic and political systems. Chapter 10 concludes the book with a
discussion of the alternative futures facing the US and Europe, the large-scale policy changes required to reverse American
decline, and finally the potential avenues for
achieving these ends through social and political action.

This last task will not be easy. The conduct of the Obama administration provides a painfully clear example. For reasons described in the final chapters of this book, a political duopoly is now
highly entrenched in the US and it is resistant to change. Despite their populist pretensions, both American parties depend on the money that flows to them because they, and only they, control
electoral politics, and both parties would fiercely resist any challenge to this arrangement.

And there is a final problem. To some extent, it must sadly be admitted, this decline has been tolerated by the American people. Over the last thirty years Americans have become less educated,
less inclined to save and invest for the future, and, understandably, far more cynical about participating in politics and other institutions. Consequently, it has proven disturbingly easy for the
new oligarchy to manipulate large segments of the population into tolerating, even supporting, policies that worsen the world’s economy. And, of course, many young people have simply given up
on politics, particularly after numerous betrayals, including by the Obama administration; many are now profoundly disturbed that Obama turned out to be more of the same.

To reverse this decline, it will first be necessary to reverse the consolidation of economic power now wielded by highly concentrated industries, the financial sector, and the extremely wealthy.
In addition, it will be necessary to shift economic priorities towards education, saving, and long-term investment, and away from excessive reliance on cheap energy and, in the case of the US,
military power. And finally, it will be necessary to profoundly change the role of money in politics—in campaign contributions, political advertising, revolving-door hiring, lobbying, and the
enormous disparities between public and private sector salaries that have taken over the American system and threaten to take hold elsewhere.

There are three alternative routes for achieving deep systemic reform, both in the US and farther afield: a successful insurgency in one of the existing political parties; a true third-party
effort; and a nonpartisan
social movement perhaps analogous to the civil rights or environmental movements of a generation ago. All of these paths are difficult. But we have
done difficult things before, even when they faced powerful opposition. Often the most remarkable achievements come in part because of remarkable leaders who have been committed to remarkable
goals. Let us hope we see such leaders again.

CHAPTER 2

I
T WAS IN THE
1970s that the US first encountered many of its current economic problems. But it was in the 1980s
that America began to harm itself in earnest. The Reagan administration provided an eerie sneak preview of the Bush administration, complete with politically popular tax cuts, resultant budget
deficits, widespread unemployment, and a sudden rise in economic inequality.

It was in the 1980s that declining American industries and their complacent, outdated, but politically clever CEOs first noticed that paying off lobbyists, politicians, boards of directors, and
academic experts was much less expensive, and much easier, than improving their actual performance. And it was also in the 1980s that America’s newly deregulated financial sector got back in
touch with its dark side, starting a thirty-year phase of consolidation, financial instability, large-scale criminality, and political corruption. In the late 1980s, America experienced its first
financial crises since the Great Depression, although by current standards they seem quaint. One crisis was caused by deregulation
and rampant criminality; the other, by a
complex financial innovation that supposedly
reduced
risk, but that actually increased it. Sound familiar?

Even though hundreds of financial executives went to prison, dozens of financial firms were bankrupted by their executives’ corruption, and we endured our first serious postwar financial
crises, by the end of the 1980s the financial sector was wealthier and more politically powerful than ever. It was a genie that America hasn’t yet been able to return to the bottle.

THE DECADE BETWEEN
1972 and 1982 was a very rough period for the US. Between 1973 and 1975 alone, the country went through the Watergate hearings,
Richard Nixon resigning in disgrace to avoid impeachment, the Yom Kippur war, the first OPEC oil embargo, the fall of South Vietnam, and a sudden recession caused by the first OPEC oil shock. Just
as the effects of the first oil shock had receded, an Islamic revolution deposed the Shah of Iran and OPEC tripled oil prices again in 1979, yielding an unprecedented combination of recession,
inflation, and high interest rates. Then, for the icing on the cake, the Soviet Union invaded Afghanistan.

But it was also in the 1970s that America first encountered its more fundamental economic challenges: the long-term costs of its military when it was misused in distant, poorly managed wars; the
complacency and internal decay of America’s largest companies and industries; Asian competition based on the “just in time” or “lean” production model; the growth of
outsourcing permitted (even driven) by information technology; the declining market value of unskilled labour; and the need to raise the educational level of the population.

By 1980 it was increasingly clear that the long, lazy, global dominance of American industry was over. American productivity growth declined, from 3 percent per year in the 1950s and 1960s to
less than
1 percent in the 1970s and 1980s. Cars imported from Japan were not only less expensive and more fuel efficient than those from Michigan but also
better
—fewer assembly defects, longer lifetimes, less expensive to maintain. Similar effects were seen in consumer electronics, machine tools, steel, even semiconductor memories and
IBM-compatible mainframe computers, high-technology markets that Japanese firms entered aggressively in the late 1970s. American specialists noticed that Japanese firms often adopted new
technologies faster than their American rivals, even technologies that had been invented in America. Similarly, although Japan was far more dependent on imported oil than the US, its economy
recovered much faster from the 1970s oil shocks.

This unfamiliar combination of low growth, two oil shocks, recessions, and rising foreign challenges led to sudden anxiety and rising anger. In 1980 MIT professor Lester Thurow published an
imperfect but very prescient book,
The Zero-Sum Society,
arguing that we had entered a painful phase of low growth and distributional conflict. In policy circles, an intense debate started.
Some argued in favour of protectionism, others for aggressive government investments and industrial policy.

Many economists dismissed both Thurow’s book and the entire issue. Others argued that increased savings and investment, together with a gradual depreciation of the dollar, would take care
of America’s trade deficits and “competitiveness” problem. All mainstream economists (including some who now say otherwise) denied that the entrenchment of incompetent management,
globalization, low-wage Asian competition, or Asian national strategic industrial policies could cause a decline in living standards. To be sure, it was a confusing time; America had never
experienced anything like it before. (As a young academic I participated in some of those debates, and I didn’t get everything right, either.)

America’s political leadership seemed adrift. And unfortunately, Americans were not, at that moment, ready to be told that America’s easy domination of the world economy was over,
and that America
needed to refocus on saving, improved education, information technology, tougher antitrust policy, energy conservation, and greater understanding of other
nations.

Or perhaps, actually, Americans
would
have listened, if their political leaders had told them the truth. But they didn’t. They lied, and with occasional exceptions they have
continued to lie ever since. By 1980 America was ripe for a simplistic, reassuring story about how everything would be better if only taxes were lower, government regulation scaled back, and the
American military strengthened.

With those crude ideas Ronald Reagan sailed into office, on little more than his grin and his optimism, in part because President Jimmy Carter did not offer a coherent alternative. Carter was
sincere, but he seemed ineffectual and timid. In contrast, and to the surprise of many, Reagan proved a strong president who accomplished much of his agenda—sometimes for good, often for ill.
Tax cuts and deregulation became the order of the day. Even from the start, though, there was a big element of dishonesty in Reagan’s strategy. He cut taxes, but
not
government
spending, so America’s economic recovery came in part from unsustainable deficits. Government officials claimed that tax cuts would pay for themselves, which they knew was a lie. And what
they called “deregulation” was often simply political corruption. Lobbyists and industry executives were appointed to run government agencies, and several industries sharply increased
their spending on political donations, lobbying, and revolving-door hiring.

Nowhere was this clearer than in finance. It was in financial services that the Reagan administration initiated America’s descent into criminality, financial crisis, political corruption,
inequality, and decline.