Capital City

I’ve got a big piece in the January issue of Mother Jones about the finance lobby and its near total domination of Congress, the Fed, the SEC, the executive branch, and just about everyone else who matters in and out of Washington DC. And now it’s online, so you can read it too! It starts with a bit of background: the collapse of Long Term Capital Management in 1998 thanks to massive overuse of leverage:

But a funny thing happened on the way to the crash: The New York Fed stepped in and arranged a bailout. Almost all of Wall Street’s biggest firms participated, and they did so for one reason: The Fed convinced them that LTCM was too big to fail. An uncontrolled bankruptcy might set off a domino effect that could bring down dozens of banks. A few months later, an interagency report concluded, “The near collapse of LTCM illustrates the need for all participants in our financial system, not only hedge funds, to face constraints on the amount of leverage they assume.” It was a bipartisan judgment, signed by Fed Chairman Alan Greenspan and by Robert Rubin, Bill Clinton’s treasury secretary.

In any sane world, it would have been a call to arms. After all, LTCM was only worth a few billion dollars. If a relative minnow like that could pose a risk to the global economy merely through the use of profligate leverage, what might happen if a money-center bank worth 100 times as much did the same thing?

But we don’t live in a sane world. We live in a world where leverage—as well as Wall Street’s nearly endless stream of new contrivances for exploiting it—is largely controlled not by regulators or congressional committees, but by the finance lobby. And the last thing the finance lobby wants is constraints of any kind. So Wall Street promised solemnly to take the lessons of LTCM to heart and then got right down to the business of ignoring them. In fact it spent the next decade not merely blocking reform, but making things worse by lobbying relentlessly to expand leverage, complexity, regulatory forbearance, and risk.

If the aerospace lobby had told us after the 1986 Challenger disaster that the key to better performance was to turbocharge the engines and quit performing preflight inspections, everyone would have agreed that they were crazy. Yet that’s essentially what the finance lobby has done over the past decade, and in some weird way we were too mesmerized to recognize it. Within months of a near catastrophe caused by one of the industry’s brightest stars, the lobbyists were busily making certain that it would happen again — and that when it did happen, it would be bigger and more disastrous than ever.

LTCM was basically a dry run for 2008: too much risk, too much leverage, and then a collapse when a specific piece of the economy took a dive. In 1998, it was Russia that sparked the problem and in 2008 it was the housing market. So we knew the problems perfectly well but chose to do nothing about them. Why?

This article is my best effort to explain the political and cognitive problems that caused us to court disaster for ten years. Read it and tell me what you think. On Friday, David Corn and I will be on Bill Moyers Journal to talk about it. Check your local listings for the air time in your neck of the woods.


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