Web Extra: Read an Excerpt of David Stockman's New Book

PHOTO: "The Great Deformation: the Corruption of Capitalism in America" by David Stockman.

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Excerpted from THE GREAT DEFORMATION: THE CORRUPTION OF CAPITALISM IN AMERICA by David A. Stockman by arrangement with PublicAffairs, an imprint of the Perseus Books Group. Copyright © David A. Stockman, 2013.



When the great financial bubble finally burst in September 2008, AIG's credit default insurance was shockingly exposed as bogus. Given this evidence of utterly reckless and massive speculation, the Fed was handed, as if on a platter, one final chance to restore a semblance of capital market discipline.

By that late hour, however, the Fed was not even remotely interested in financial discipline. The Greenspan Put had now been superseded by the even more insidious Bernanke Put. In defiance of every classic canon of sound money, the new Fed chairman had panicked in the face of the first stock market tremors in August 2007 (see chapter 23), and thereafter the S&P 500 had become an active and omnipresent transmission mechanism for the execution of central bank policy. Consequently, after the Lehman event the plummeting stock averages had to be arrested and revived at all hazards. Accordingly, the bailout of AIG was first and foremost an exercise in stabilizing the S&P 500.

The cover story, of course, was the threat that a financial contagion would ripple out from the corpus of AIG, bringing disruption and job losses to the real economy. As has been seen, however, there was nothing at all "contagious" about AIG, so Bernanke and Paulson simply peddled flat-out nonsense in order to secure Capitol Hill acquiescence to their dictates and to douse what they derisively called "populist" agitation; that is, the noisy denunciation of the bailouts arising from an intrepid minority of politicians impertinent enough to stand up for the taxpayer.

But this hardy band of dissenters—ranging from Congressman Ron Paul to Senator Bernie Sanders—was correct. Everyday Americans would not have lost sleep or their jobs, even if AIG's upstairs gambling patrons had been allowed to lose their shirts. Still, the bailsters peddled a legend which has persisted; namely, that in September 2008 the nation's financial payments system was on the cusp of crashing, and that absent the bailouts American companies would have missed payrolls, ATMs would have gone dark, and general financial disintegration would have ensued. But this is a legend. No evidence has ever been presented to prove it because there isn't any.

Had Washington allowed nature to take its course in the days after the Lehman collapse on September 15, the only Wall Street furniture which would have been broken was the potential bankruptcy of Goldman Sachs and Morgan Stanley, the two remaining investment banks. Needless to say, the utterly myopic investment banker who was running the US government from his Treasury office wasted not a second ascertaining whether the public interest might diverge from Goldman's stock price under the circumstances at hand.

According to his memoirs, Secretary Paulson already "knew" on the very morning Lehman failed that the last two investment banks standing needed to be rescued at all hazards: "Lose Morgan Stanley, and Goldman Sachs would be next in line—if they fell the financial system might vaporize and with it, the economy."

Tendentious and sophomoric would be a more than generous characterization of that apocalyptic riff. Yet groundless as it was, the fact that Paulson and his posse treated it as truth is deeply revealing. It underscores the extent to which public policy during the bubble years had been taken captive by the satraps and princes seconded to the nation's capital by Wall Street. Such self-serving foolishness would never have been uttered in earlier times, not even by the occasional captain of industry or finance who held high financial office.

Certainly President Eisenhower's treasury secretary and doughty opponent of Big Government, George Humphrey, would never have conflated the future of capitalism with the stock price of two or even two dozen Wall Street firms. Nor would President Kennedy's treasury secretary, Douglas Dillon, have done so, even had his own family's firm been imperiled. President Ford's treasury secretary and fiery apostle of free market capitalism, Bill Simon, would have crushed any bailout proposal in a thunder of denunciation. Even President Reagan's man at the Treasury Department, Don Regan, a Wall Street lifer who had built the modern Merrill Lynch, resisted the 1984 bailout of Continental Illinois until the very end.

Once the Fed plunged into the prosperity management business under Greenspan and Bernanke, however, the subordination of public policy to the pecuniary needs of Wall Street became inexorable. No other outcome was logically possible, given Wall Street's crucial role as a policy transmission mechanism and the predicate that rising stock prices would generate a wealth effect and thereby levitate the national economy.

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