Legacy of the Clinton Bubble: The Crisis in the Washington Consensus and the Return to Marginalist Analysis

Abstract

This article, an early draft of which was published in the summer 2008 issue of Dissent magazine, analyzes the Clinton administration's record of financial deregulation, the continuities in policies between Democratic and Republican administrations, and the relationship between deregulatory policy and market developments in housing, credit and currency markets. Deregulation is examined on several levels: (1) selective credit controls in housing, consumer and stock market sectors, with particular attention to rules on minimum down payments (otherwise known as margin requirements); (2) the regulatory barriers between financial entities, with particular attention to the Glass-Steagall Act firewalls that had separated commercial banking, investment banking, insurance and securities; and (3) the regulation of financial instruments, with particular attention to derivatives. The analysis concludes that all three deregulation trends interacted in ways that undermined that safety and soundness of the entire financial system: deregulation of margin requirements contributed to speculative lending in housing and securities; deregulation of derivatives contributed to the securitization of shaky mortgage loans, particularly in the subprime sector; and the demise of Glass-Steagall permitted banks to load up on such derivatives in off-balance sheet entities.

The deregulation agenda of the Clinton and Bush administrations is placed in the larger context of the Washington Consensus agenda of central bank autonomy, fiscal austerity, privatization, and trade liberalization. The autonomy of the Federal Reserve was a euphemism for agency capture, making margin regulation a political impossibility and leaving the central bank reliant on one and only one monetary policy instrument, the short-term interest rate. This led to a stop-and-go monetary policy that contributed to an ever larger bubble economy. The article raises important questions about the nature of financial regulation. Some scholars, such as Cass Sunstein, reflecting Chicago School thinking, have called for increased disclosure and transparency. The Securities and Exchange Commission's recent decision to abandon Generally Accepted Accounting Principles (GAAP) for the London-based International Financial Reporting Standards (IFRS) gives support to this approach. But the SEC timetable of waiting until 2016 for this move from GAAP to IFRS suggests that disclosure alone is insufficient at a time when many large financial institutions are sitting on mountains of bad debt and would likely be insolvent under IFRS. Canova's approach combines a return to the "command and control" bright line approach of margin requirements with the neutralization of monetary policy and reinvigoration of fiscal policy. The Marginalist school (the pre-Keynesian school which founded economics as a science) is thereby seen as providing the necessary corrective to the excesses of financial deregulation while opening the way to a new Keynesian agenda.