The Great Deformation

The Corruption of Capitalism in America


By David Stockman

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A New York Times bestseller

The Great Deformation is a searing look at Washington’s craven response to the recent myriad of financial crises and fiscal cliffs. It counters conventional wisdom with an eighty-year revisionist history of how the American state — especially the Federal Reserve — has fallen prey to the politics of crony capitalism and the ideologies of fiscal stimulus, monetary central planning, and financial bailouts. These forces have left the public sector teetering on the edge of political dysfunction and fiscal collapse and have caused America’s private enterprise foundation to morph into a speculative casino that swindles the masses and enriches the few.

Defying right- and left-wing boxes, David Stockman provides a catalogue of corrupters and defenders of sound money, fiscal rectitude, and free markets. The former includes Franklin Roosevelt, who fathered crony capitalism; Richard Nixon, who destroyed national financial discipline and the Bretton Woods gold-backed dollar; Fed chairmen Greenspan and Bernanke, who fostered our present scourge of bubble finance and addiction to debt and speculation; George W. Bush, who repudiated fiscal rectitude and ballooned the warfare state via senseless wars; and Barack Obama, who revived failed Keynesian “borrow and spend” policies that have driven the national debt to perilous heights. By contrast, the book also traces a parade of statesmen who championed balanced budgets and financial market discipline including Carter Glass, Harry Truman, Dwight Eisenhower, Bill Simon, Paul Volcker, Bill Clinton, and Sheila Bair.

Stockman’s analysis skewers Keynesian spenders and GOP tax-cutters alike, showing how they converged to bloat the welfare state, perpetuate the military-industrial complex, and deplete the revenue base — even as the Fed’s massive money printing allowed politicians to enjoy “deficits without tears.” But these policies have also fueled new financial bubbles and favored Wall Street with cheap money and rigged stock and bond markets, while crushing Main Street savers and punishing family budgets with soaring food and energy costs. The Great Deformation explains how we got here and why these warped, crony capitalist policies are an epochal threat to free market prosperity and American political democracy.



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 its 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.

It has also crushed the interest rate mechanism as an honest price signal in the financial markets; turned the treasury yield curve into a frontrunner’s paradise; and fueled massively leveraged carry trades which feed the 1 percent with windfalls while these trades work and generate petulant demands for bailouts when they crash. Turning Wall Street into a reckless, dangerous, and greed-riven casino, the Fed has at the same time crucified the nation’s savers on a rack of ZIRP (zero interest) and fueled a global commodity bubble that erodes Main Street living standards via soaring food and energy prices—inflation that the Fed then fecklessly deletes from the CPI.

Needless to say, it took a long time to get to this lamentable state; nearly one hundred years, in fact. And that is what I now trace: a revisionist history of our era. It shows how the state-wreck ahead was fostered by FDR’s repudiation of the bipartisan tradition of sound money and the New Deal’s incubation of crony capitalist government. The Great Deformation was then put into brief remission during the mid-century golden era of sound money and fiscal rectitude under Dwight Eisenhower in the White House and William McChesney Martin at the Fed.

After that, the incipient state-wreck was powerfully revived by Nixon’s perfidious weekend at Camp David in August 1971, where Tricky Dick blatantly and defiantly defaulted on the nation’s debt obligations under the Bretton Woods gold standard. Taking the United States off the gold standard was the starting point for the present era of floating money, massive debt creation, and a dangerously unstable global money-printing spree. Nixon’s malefactions were then further nourished by the final destruction of fiscal rectitude during the Reagan era, enabling both the warfare state and welfare state to balloon without the yoke of taxes weighing on the people. In the final descent into bubble finance, the Greenspan and Bernanke Fed institutionalized the financial repression, wealth effects, and Wall Street–coddling policies that have triggered the crisis at hand.

The order of this book is not exactly chronological. It aims first to unpeel the onion of obfuscation that has emanated from Wall Street, bailout apologists, and the trio of Washington economic doctrines that assume the state can revive a failing economy when, in reality, it is a failing state that is crushing what remains of Main Street prosperity.

Part 1 on the BlackBerry Panic, that historic moment in September 2008 when Washington flooded Wall Street with bailout money, refutes the hoary urban legends that were used by the Fed and the Treasury to panic the Congress into passing TARP and to justify the Fed’s balance sheet explosion. The so-called financial meltdown was purely in the canyons of Wall Street where it would have burned out on its own and meted out to speculators the losses they deserved. By contrast, the Main Street banking system was never in serious jeopardy, ATMs were not going dark, the money market industry was not imploding, and there was never any Great Depression 2.0 remotely in prospect.

That’s important because it demonstrates that the September 2008 Wall Street crisis did not arrive mysteriously on a comet from deep space, thereby justifying emergency heat shields of money printing, deficits, and bailouts which broke all the rules. Instead, it grew out of decades during which Washington defied the rules, corrupting the nation’s financial condition with unfinanced wars, tax cuts, and welfare state expansion, permitting rampant special interest plunder of the public purse and conducting a financial casino out of the Fed’s headquarters in Washington.

Part 2, “The Reagan Era Revisited: False Narratives of Our Times,” unpeels another layer of the onion that obscures a clear-eyed view of the Great Deformation’s deeper history. It debunks the GOP’s nostalgic claim that despite the mysterious ailment that caused the financial disasters of recent years, all would be well by simply going back to undiluted Reaganism. But “Morning in America” never happened and a fiscal disaster most surely did. Likewise, part 3 clears away the other short-circuit to comprehending the historical depth of the current crisis; namely, the claim of present-day high priests of Keynesianism that the New Deal already wrote the sacred texts and now they only need to be aggressively followed in order to clear the decks. In fact, the New Deal, despite its vaunted place in the history books, was largely a political gong show that didn’t cure the Great Depression, which, in any event, was caused by a global trade and commodity collapse that is totally irrelevant to America’s current traumas.

The Great Deformation is a story that evolves decade by decade after the First World War. It is a historical sketch of what happened and a polemic about what went wrong. It features a gallery of policy villains, that is, proponents of unsound finance, including Franklin Roosevelt, Richard Nixon, Arthur Burns, Walter Heller, Milton Friedman, John Connally, George Schulz, Art Laffer, Cap Weinberger, Alan Greenspan, Newt Gingrich, Bob Rubin, George W. Bush, Hank Paulson, Tim Geithner, Jeff Immelt, John Mack, Paul Krugman, Larry Summers, Barack Obama, and most especially Ben Bernanke. Alongside is a cast of policy heroes who champion the cause of sound money and fiscal rectitude at crucial times, including, in the early periods, Carter Glass, Professor H. Parker Willis, Calvin Coolidge, Herbert Hoover, Lewis Douglas, James Warburg, and later, Harry Truman, Dwight Eisenhower, George Humphrey, William McChesney Martin, Douglas Dillon, Bill Simon, Paul Volcker, Howard Baker, Pete Domenici, Bill Clinton, Paul O’Neill, Ron Paul, Richard Shelby, and Sheila Bair.

The battle turns out to be not equal. By the end of the story it will be apparent how crony capitalism won the struggle, why the fiscal cliff is insurmountable, and how a Keynesian state-wreck is at hand. The final chapter assays another road that could be taken: one that is compelling but, given the roots of the Great Deformation, difficult in the extreme.








The Needless Rescue of AIG and Wall Street

IN THE SECOND DECADE OF THE TWENTY-FIRST CENTURY, AMERICA IS faltering under the weight of a dual crisis. Its public sector teeters on the ragged edge of political dysfunction and fiscal collapse. At the same time, its private enterprise foundation has morphed into a speculative casino which swindles the masses and enriches the few. These lamentable conditions are the Janus-faces of crony capitalism—a mutant régime which now threatens to cripple the nation’s bedrock institutions of political democracy and the free market economy.

A decisive tipping point in the evolution of American capitalism and democracy—the triumph of crony capitalism—took place on October 3, 2008. That was the day of the forced march approval on Capitol Hill of the $700 billion TARP (Troubled Asset Relief Program) bill to bail out Wall Street. This spasm of financial market intervention, including multi-trillion-dollar support lines provided to the big banks and financial companies by the Federal Reserve, was but the latest brick in the foundation of a fundamentally anti-capitalist régime known as “Too Big to Fail” (TBTF). It had been under construction for many decades, but now there was no turning back. The Wall Street bailouts of 2008 shattered what little remained of the old-time fiscal rules.

There was no longer any pretense that the free market should determine winners and losers and that tapping the public treasury requires proof of compelling societal benefit. Not when AAA-rated General Electric had been given $30 billion in taxpayer loans and guarantees to avoid taking modest losses on toxic assets it had foolishly funded with overnight borrowings that suddenly couldn’t be rolled over.

Even more improbably, Goldman Sachs had been handed $10 billion to save itself from alleged extinction. Yet it then swiveled on a dime and generated a $29 billion financial surplus—$16 billion in salary and bonuses on top of $13 billion in net income—for the year that began just three months later.

Even if Goldman didn’t really need the money, as it later claimed, a round trip from purported rags to evident riches in fifteen months stretched the bounds of credulity. It was reminiscent of actor Gary Cooper’s immortal 1950s expression of suspicion about Communism. “From what I have heard about it,” he told a congressional committee, “it isn’t on the level.”

Nor was Washington’s panicked bailout of Wall Street on the level; it was both unnecessary and targeted at the wrong problem. The so-called financial meltdown was not the real crisis; it was only the tip of the iceberg, the leading edge of a more fundamental economic malady. In truth, the US economy was heading for the wringer because a multi-decade spree of unsustainable borrowing, speculation, and financialization of the national economy was coming to an abrupt end.

In the years after 1980, America had undergone the equivalent of a national leveraged buyout (LBO). It was now saddled with $30 trillion more in combined public and private debt than would have been the case under the time-tested canons of financial discipline and prudence which prevailed during the nation’s long economic ascent. This massive debt burden had fueled a three-decade prosperity party by mortgaging the nation’s future. Now the bill was coming due and our national simulacrum of prosperity was over.

This rendezvous with the limits of “peak debt,” however, did not mean that the Main Street economy was in danger of collapse into an instant depression. That was the specious claim of the bailsters. What did threaten was a deeper and more enduring adversity. The demise of this thirty-year debt super cycle actually meant that it was payback time. Instead of swiping growth from the future, the American economy would now face a long twilight of debt deflation and struggle to restore household, corporate, and public sector solvency.

This abrupt turn in the road should not have been surprising. America’s fantastic collective binging on debt, public and private, had no historical precedent. During the century prior to 1980, for example, total public and private debt on US balance sheets rarely exceeded 1.6 times GDP. When the national borrowing spree reached its apogee in 2007, however, the $4 trillion of new debt issued by households, business, banks, and governments amounted to 6 times that year’s $700 billion gain in GDP. Plain and simple, what was being recorded as GDP growth was little more than faux prosperity borrowed from the future.

In fact, by the time of the financial crisis total US debt outstanding was $52 trillion and represented 3.6 times national income of $14 trillion. Accordingly, there were now two full turns of extra debt weighing on the nation’s economy. And the embedded math was forbidding: at the historic leverage ratio of 1.6 times national income, which had prevailed for most of the hundred years prior to 1980, total US public and private debt would have been only $22 trillion at the end of 2008.

So the nation’s households, businesses, and taxpayers were now lugging around the aforementioned $30 trillion in excess debt. This staggering financial burden dwarfed levels which had historically been proven to be healthy, prudent, and sustainable. TARP and all its kindred bailouts and the Fed’s ceaseless money printing could not relieve it. And Washington’s reckless use of Uncle Sam’s credit card to fund the Obama stimulus actually made it far worse by attempting to revive the false prosperity of the bubble years. The obvious question remains: Why did this plague of debt arise? Did the American people suddenly become profligate and greedy through a mysterious process of moral and social decay?


On Sale
Apr 2, 2013
Page Count
768 pages

David Stockman

About the Author

David A. Stockman was elected as a Michigan congressman in 1976 and joined the Reagan White House in 1981. Serving as budget director, he was one of the key architects of the Reagan Revolution plan to reduce taxes, cut spending, and shrink the role of government. He joined Salomon Brothers in 1985 and later became one of the early partners of the Blackstone Group.

During nearly two decades at Blackstone and at a firm he founded, Stockman was a private equity investor. Stockman attended Michigan State University and Harvard Divinity School and then went to Washington as a congressional aide in 1970. He is also the author of the New York Times bestseller The Triumph of Politics: Why the Reagan Revolution Failed.

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