PRAISE FOR The Great Deformation A New York Times and Wall Street Journal National Bestseller “Whether you love or loathe Stockman’s diatribe, the fact remains that it would be a mistake to ignore it.”—Gillian Tett, Financial Times Magazine “Stockman produces a persuasive and deeply relevant indictment of a system dangerously a kilter What Stockman has written is a book that makes clear we are that future generation of the past, inheritors of all the wishful thinking, simple illogic and flawed compromises that produced the near-term benefits our parents and grandparents worried about but ultimately wanted And now it’s payback time.”—Washington Post “A welcome thrashing of the ruling classes in both parties Mr Stockman’s essential critique is accurate: that Fed and federal officials sheltered malefactors from gargantuan losses and made current taxpayers— and future ones—pick up the tab His warning that we have done grievous harm to the free-enterprise system is worth paying attention to.”—Wall Street Journal “I don’t know which is sadder: That the Fed’s low interest-rate, easy-money policies are literally creating the next financial bubble right in front of our eyes, or that Krugman, supposedly one of our greatest economic minds, can’t see it, even though the very same thing happened just eight years ago and led to the Great Recession of 2008 Either way, I agree with Stockman We’re in for trouble, and sooner than we care to admit.”—Bloomberg “For anyone who agrees with Stockman that crony capitalism and corruption have led both fiscal and monetary policies into a cycle of everincreasing stimulus and ziggurats of debt, The Great Deformation is gloomily persuasive—and bodes ill for the future.”—Reuters “One of the most comprehensive narratives of the financial system’s history in years”—Brett Joshpe, Forbes “As a book critic and investigative reporter, I have absorbed a dozen of those previous books Stockman’s is my favorite because of his original research, the context he presents (starting with the economic depression of the 1930s), his former insider status, and his apparent political non-partisanship during the endeavor.”—Steve Weinberg, USA Today “Proof of reading The Great Deformation should become a requirement for voting Bring your dog-eared copy to the polls or stay home The selfconfessed smartest guy in the room has written a compelling, intensely readable book that exhumes aspects of economic history that both Democrats and Republicans likely wish would have stayed hidden The Great Deformation is the book that everyone in Washington, at the White House on both sides of the aisle in Congress, at the Treasury, and in the lobbyists’ offices on K Street, fervently prays that you never read.”—Michael Levin, Huffington Post “I’d read this book 10 times before I read another possible presidential candidate’s memoir of how his Real American Story schooled him in the Audacity of Hope a coherent vision of a World Without the Fed.”—Dave Weigel, Slate “Stockman performs a real service when he debunks the myths that have been associated with Reagan’s conservatism and promotes Eisenhower’s fiscal and military conservatism Stockman forcefully conveys enormous amounts of knowledge.”—Kirkus “In The Great Deformation, David Stockman—former US congressman and budget director under Ronald Reagan—tells the story of the recent crisis, and takes direct aim at the conventional wisdom that credits government policy and Ben Bernanke with rescuing Americans from another Great Depression In this he has made a seminal contribution .Thanks to The Great Deformation, not a shred of the regime’s propaganda is left standing This is truly the book we have been waiting for, and we owe David Stockman a great debt.”—LewRockwell.com “This thought-provoking book will contribute to important debates on these issues.”—Booklist “No wonder [David Stockman] triggers wild anger, hatred, and revenge Yes, he’s a truth-teller And truth hurts So you hate him Big mistake.”— Paul B Farrell, Marketwatch “This is a history book It’s a detailed account of the key events since the Depression that have shaped modern finance I love history, and I’m familiar with those events Stockman’s spin on financial history makes for a very good read There’s something for everyone.”—Brucekrasting.com “A scintillating analysis of where, why, and how America went wrong, starting with the New Deal and ending with the Great Recession of ’08 and the subsequent Obama-Bernanke attempts to re-inflate the bubble of America’s debt-driven ‘prosperity.’ The Fed, instead of acting as a neutral arbiter and manager of the money supply, has engaged in ‘prosperity management,’ as he terms it, implanting a ‘borrow, spend, gamble, and getrich-quick regimen’ that poisoned and deformed the economy ,and the culture.” —Antiwar.com “Agree with Stockman or not, one can’t deny that he’s a colorful writer!” — Townhall.com “What a title what a book what a dude!”—Rick Santelli, CNBC “Squawk on the Street” THE GREAT DEFORMATION THE GREAT DEFORMATION THE CORRUPTION OF CAPITALISM IN AMERICA DAVID A STOCKMAN PUBLICAFFAIRS New York Copyright © 2013 by David A Stockman Published in the United States by PublicAffairs™, a Member of the Perseus Books Group All rights reserved No part of this book may be reproduced in any manner whatsoever without written permission except in the case of brief quotations embodied in critical articles and reviews For information, address PublicAffairs, 250 West 57th Street, 15th Floor, New York, NY 10107 PublicAffairs books are available at special discounts for bulk purchases in the U.S by corporations, institutions, and other organizations For more information, please contact the Special Markets Department at the Perseus Books Group, 2300 Chestnut Street, Suite 200, Philadelphia, PA 19103, call (800) 810-4145, ext 5000, or e-mail special.markets@perseusbooks.com Library of Congress Cataloging-in-Publication Data is available for this book ISBN 978-1-58648-913-7 (eBook) Editorial production by Marrathon Production Services www.marrathon.net BOOK DESIGN BY JANE RAESE Text set in 10-point Utopia FIRST EDITION 10 To my daughters, Rachel and Victoria, whose future inspired me to start this book, and my wife, Jennifer, whose patience and loving support enabled me to complete it tax cuts and, 552 Romney, Mitt/wealth Delphi and, 664 misunderstanding bubble finance, 557–558, 559, 570–571 See also Bain Capital Roosa bonds (US), 251 Roosevelt, Franklin D “bank holiday,” 150, 158 banking crisis and, 138–139, 150 Exchange Stabilization Fund (ESF), 188–189 gold price and, 161–162, 187–189, 190 gold standard, 139, 140–142, 149, 157, 158, 161–162, 189–190, 192, 194 Hoover and, 138, 139, 155–156 internationalist advisors, 192 London Economic Conference (1933) and, 139, 144–145, 187, 190, 191 miracle legend, 150 “monetary economics” and, 160–163 monetary policies (World War II), 131, 196–197, 199–204 panic responsibilities, 156–159 policies, 89 See also Great Depression; New Deal Roosevelt, Teddy, 317 Rostenkowski, Dan, 310 Rosy Scenario errors, 91–95 Rove, Karl, 50, 446, 536, 673 Rubin, Robert, 21, 332, 399 Rumsfeld, Don defense spending, 689, 690 Ford administration, 305 Russell 2000 index, 654–657 Russian default (1998), 15, 16, 62, 332–334 Ryan, Paul auto industry bailout and, 620 blaming Obama for recession, 556–557 budget, 222, 552–553, 554, 675, 689 S&P futures contracts during 2000s, 329–330, 341, 363–365, 481 growth rate (1990s), 329, 334 launch, 313 panic of October 1987, 314–315, 318, 320 portfolio insurance, 313, 317–318 problems with, 305, 313 Safire, Bill, 120 Salomon Brothers in 1980s, 385–386, 387–388 financial futures, 301–302, 306–308 mergers, 398 “profitability,” 385–386 Salomon, William, 306 Samsung, 516, 517 Samuelson, Paul, 174–175, 595n Sanders, Bernie, 19 Sarbanes-Oxley statements, 473, 708 Savings/savers Fed strategies’ effects on, 496 household consumption/debt vs., 371–373 Schlesinger, Arthur, Jr., 150 Schlesinger, James, 600 Schultze, Charles, 132 Schwartz, Alan, 392 Schwarzman, Steve, 11 Schweiker, Richard/plan, 101–103 Seevers, Gary, 312 Shadow banking system, 375, 376, 478 Shale oil production, 522, 694–695 Shearson and Co., 306, 398 Shelby, Richard, 621 Shiller, Robert, 428 Shultz, George background, 121 floating currency and, 120, 123, 281, 284, 292 monetary advice to Nixon, 106, 119, 120, 121, 122, 123, 127, 131, 265 welfare state and, 219 Simon, Bill Ford administration, 20, 127, 305 Melamed financial futures, 305, 306 monetary beliefs, 20, 127–128, 129 Simon, Paul, 309 Six Day War, 252 Skilling, D Van, 568 Smith, Adam, 160, 191, 274, 317, 416 Smith, Al, 141 Smith Barney, 388, 398 Smithsonian Agreement (1971), 282–283 Smoot-Hawley tariff bill, 138, 144, 190 Snyder, John W., 206–207 Social insurance abolishing, 708–709 block-grant proposal and, 553 financial crisis aftermath, 590–591 future costs/problems, 686–688, 692 means-testing and, 172, 173, 175, 553, 554, 709 payroll tax, 173–174, 175 Peak Debt and, 648 problems, 173–175, 553, 648, 676–677, 686–688 Reagan and, 103–105 Romney-Ryan and, 552, 553–554 spending, 174, 553 stimulus (after 2008 financial crisis), 591, 593, 594, 595, 611–612 See also specific types Social Security description/problems, 172–175 Greenspan/Reagan rescue plan, 98, 99–100, 101–104 New Deal origins, 172, 174, 175 Nixon’s “double indexing” provision, 100–101, 131, 173 See also Social insurance Social Security Act (1935), 172 Société Générale, 7, 10 Solutions federal agencies to eliminate, 709 free market/state separation, 708–709 honest public finance and, 674–676 Keynesian doctrine and, 673, 674, 676–677 means-tested safety net, 709, 710 Omnibus Amendment, 707–708 overview, 672–674 steps overview, 706–712 Solyndra, 600–602 Soviet Union collapse/aftermath, 75, 78, 86 crop failure (1963–1964), 247 Sower, Mark, 482 Speculative finance beginnings, 286–287, 288–289 description, 289 futures markets beginnings, 286–288 hedging, 288, 289, 292 pork-belly markets, 286–287 See also Financial futures Sprague, Oliver, 198 Sprinkel, Beryl background, 263, 301 financial futures, 302 “monetarist cone,” 263 St Germain, Freddie, 177–178 Stage Stores Inc., 562–563, 564 Staples, 563–564 “Starve the beast” myth, 87, 99 Starwood Hotels and Resorts, 534 Steagall, Henry B., 176, 178 See also Glass-Steagall Stein, Herb, 123, 219, 311, 315 Stemberg, Tom, 563 Stimulus (after 2008 financial crisis) debt and, 589, 593 description, 167, 591–597 education, 593, 594, 595–596 electric vehicles/batteries development, 602–607 ERP (“Economic Recovery Payment”), 592–593 inequities, 591–592, 593 legislation, 584 light rail, 610–611 Medicaid, 593, 594 MWP (“Making Work Pay”), 591–593 needs and, 611–612 New Deal and, 139, 140 payroll taxes and, 592, 593, 594 process, 588–589 project examples/funding amounts, 608–609 roads, 609–610 social insurance and, 591, 593, 594, 595, 611–612 Solyndra, 600–602 special interest groups and, 593–594, 595–596 state/local funding vs federal funding, 597 tax credits, 592 Stock buybacks company examples, 456–458, 459, 460–470, 472 company executive pay, 457–459, 464–465 effects (summary), 470–471, 478 Fortune top companies, 466–467 “prosperity” illusion with, 467, 471 role/description, 455–456, 457–458, 478 “sunset” strategies and, 459, 460 taxes and, 457–458, 459–460, 467 Stock market bubbles ADC loans, 325 Bernanke ignoring, 449–450 capital gains changes, 590 company examples, 354–359, 487–489 early 2000s downturn and, 373–374 following 1987 crash, 322, 328–329 Greenspan bubbles (summary), 479 Greenspan/Federal Reserve and, 322–325, 329–332, 345–346, 361–364, 375, 448–449, 450–451 Greenspan ignoring, 330–332, 335–336, 337–338, 340, 358–360, 449 household finances and, 361–364 mortgages, 324, 376 NASDAQ index, 329–330, 336, 337, 346, 365, 481 savings vs., 337–338, 359–360, 361, 362, 363, 364 Stock market crash (October 1987) comparison to 2008 financial crisis, 577–578 description, 303, 305, 314–315, 326, 403 Greenspan and, 303, 305, 314–317, 318, 319, 320–321, 350 meaning of/ignoring, 318–321 Stock markets bull market culture (1980s–2000), 343–344, 349–353 crash (1929–1930), 137, 146, 150, 344–345 “exit” transactions, 509 “free market” illusion (by 2007), 475–477 Japan’s “zaitech” theory/effects, 210–211 margin (brokers’) loans, 209–210 meltdown (2000–2001), 345–346, 374, 505, 577–578 Panic of 1907, 366–367, 700 “price discovery” and, 476, 503 transformation to gambling (summary), 478–479 See also specific events; Wall Street companies Stockman, David Blackstone, 11, 512, 516, 560 Collins & Aikman, 572–576, 660–661 indictment/dropped charges, 571, 573–574 Reagan administration, 73, 94, 100, 107, 263, 405, 416, 588, 690 Salomon Brothers, 385, 387 Stone, James, 310 Strong, Benjamin, 208, 700–701 Subprime mortgages See Housing bubble (1990s–2000s) and subprime mortgages Suez Canal closing, 252 Summers, Larry financial crisis/bailout (2008), 399 junk bonds, 526 stimulus, 139, 167, 592, 594 SunAmerica, Taft, Robert, 689 TARP (Troubled Asset Relief Program) bill/vote, 3, 32, 33–34, 45, 49, 55, 57 Tax Reform Act (1986), 451 Taylor, Maxwell, 216 Taylor rule, 63 TBTF See “Too Big to Fail” (TBTF) Technology boom examples/description, 354–358, 451–453 impacts and, 325–326, 328 peak, 329 tax rates, 451–453 Telecom companies and stock market, 356 Telser, Lester G., 163–164 Tennessee Valley Authority (TVA), 159 Tesla Motors federal funding, 604, 605, 606–607 stimulus, 602 stock prices, 605–606 Thomas Amendment AAA and, 160 ESF, 189 Fisher and, 183, 186–187, 188 gold standard and, 140, 141, 186, 187–188, 190, 193 money printing and, 184, 185–186 options description/problems, 184–188, 193 Thomas, Elmer, 183, 185, 187 Tillerson, Rex, 458, 459 Time magazine, 249, 250 Time Warner Inc AOL merger, 465, 466 M&A deals, 457, 465–466 stock buybacks, 457 stock prices, 465–466 Tobin, James, 247–248 “Too Big to Fail” (TBTF) “contagion” and, 13 financial crisis (2008) and, LBOs and, 526 panic of 1987 and, 315–316, 319 post-LTCM Federal Reserve actions, 334–335 solution to, 13 Wall Street mergers, 397 Tower, John, 71, 72, 73 Toxic assets description, 22 investment banks, 22–23 Toys R Us Inc., 514, 515–516 TPG, 523, 529 Trade credit, 661 Trade deficit Nixon and, 117–118 US 1991–2000, 61 Travelers, 388, 398 Traylor, Melvin, 156 Treasury bill futures “interest rate futures,” 306 Melamed and, 301–306 Treasury bill standard beginnings, 276–278 British consol comparison, 382–383 effects, 375 Friedman and, 273, 277–278 Triumph of Politics, The (Stockman), 107 Troubled Asset Relief Program (TARP) bill/vote, 3, 32, 33–34, 45, 49, 55, 57 Truman, Harry budget/taxes and, 84, 96, 214–215, 216, 220, 221–222, 231 financing Korean War, 195, 204–205, 232 monetary policy, 206–207 Tugwell, Rexford, 155, 156–157 TXU Corporation background, 520 LBO, 518–519, 520–522, 523 Tyco, 483–484 Unemployment rate future and, 687–688 Nixon presidency, 113 See also Jobs market Velvet Revolution (1988), 75, 78 Verizon M&A deals, 524 Veterans bonus payment (1936), 163–164 Vietnam War conventional forces and, 76, 216 deficit spending, 205, 217, 247, 256, 257, 258 unemployment rates, 228 Volcker, Paul Federal Reserve term, 207 firing of, 111, 266, 348 gold standard and, 282, 283–284 inflation and, 88, 92, 94, 95, 105, 111, 112, 132–133, 263–264, 266, 293, 313, 346–347, 348, 383, 404 monetarist cone and, 263 1981–1982, 584 reappointment, 264 speculators and, 332 Wachovia Bank Extended Stay America financing, 539, 540, 541, 542 financial crisis (2008) and, 544–545 as mega-bank, 393, 399 Wagner Act (1935), 159, 160 Wal-Mart effects on other stores, 514, 515, 562, 564 Main Street America and, 649–650 Wall Street companies accounting changes, 472–474 financial crisis/main street banks vs., 27–32, 35 financial futures beginnings, 301–303 fiscal cliff and, 668, 679, 680, 681, 691 “gambling” continuation after 2008, 542–545, 546–547 “investment” illusion, 485–486 “operating earnings”/“earning ex-items,” 472–474 prime brokerage operations, 493–494 trading/clearing function, 493 See also Stock markets; specific companies; specific individuals Wall Street/Federal Reserve August 2007 to 2008 financial crisis, 475–477 bond dealers and, 321–323 changes needed, 672 Fed as hostage, 338–340, 375–376, 475, 477–479, 500 Fed assumption of control, 338–340 loss of checks/balances (summary), 477–479 monetizing government debt, 322 See also Stock market bubbles; specific events Wall Street growth bond market, 382, 383–384, 385–387 Federal Reserve ignoring problems, 393–394, 398–399, 400, 401–403 interest rates, 384, 385 “investment banking” houses (overview), 384–387 junk assets, 391–393, 400, 401–402, 403 LTCM bailout and, 390–392 M&A deals, 456, 462 mega-banks/mergers, 393–399 mergers false claims, 394–397, 462, 511 See also specific companies Wall Street Journal, 307, 561 Wallace, Henry, 155 Walton family, 599, 600 Wanniski, Jude, 88 Warburg, James, 143 Warren, George F., 161, 162 Warsh, Kevin, 378–379 Washington Mutual, 27 “Wealth effects” doctrine Federal Reserve, 13–15, 20–21, 26, 211–212, 366, 374, 380, 393, 428, 463, 467, 477 US Main Street economy (after financial crisis) and, 631, 633, 634, 637, 649, 652–653 Wealth tax, 710–711, 712 Weill, Sanford background, 306, 398 Citigroup, 394, 540 Melamed and, 306 Weinberger, Caspar defense budget, 72, 80–83 welfare state, 219 Welch, Jack, 356–357, 468, 472 Wells Fargo, 393 Wesley Jessen, 568–569, 570 Western National, White, Harry Dexter, 237 Whole Foods, 649, 650 Wigmore, Barrie A., 157–158 Williamhouse, 565, 566 Willis, Parker crash of 1929 and, 345 Federal Reserve design, 176, 208, 209, 268 Wilson, Charles, 220 Woodin, William, 156, 161 Works Progress Administration (WPA), 163–166 WorldCom, 479–480, 481 WPA (Works Progress Administration), 163–166 Wright, Jim, 308–309 Yellen, Janet, 657, 658 Yeltsin, Boris, 71 ZIRP (zero-interest-rate policy), 369, 546, 585, 630, 643, 644, 657 ABOUT THE AUTHOR © CARYL ENGLANDER DAVID 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 number one bestseller The Triumph of Politics PublicAffairs is a publishing house founded in 1997 It is a tribute to the standards, values, and flair of three persons who have served as mentors to countless reporters, writers, editors, and book people of all kinds, including me I.F.STONE, proprietor of I F Stone’s Weekly, combined a commitment to the First Amendment with entrepreneurial zeal and reporting skill and became one of the great independent journalists in American history At the age of eighty, Izzy published The Trial of Socrates, which was a national bestseller He wrote the book after he taught himself ancient Greek BENJAMIN C BRADLEE was for nearly thirty years the charismatic editorial leader of The Washington Post It was Ben who gave the Post the range and courage to pursue such historic issues as Watergate He supported his reporters with a tenacity that made them fearless and it is no accident that so many became authors of influential, best-selling books ROBERT L BERNSTEIN, the chief executive of Random House for more than a quarter century, guided one of the nation’s premier publishing houses Bob was personally responsible for many books of political dissent and argument that challenged tyranny around the globe He is also the founder and longtime chair of Human Rights Watch, one of the most respected human rights organizations in the world ••• For fifty years, the banner of Public Affairs Press was carried by its owner Morris B Schnapper, who published Gandhi, Nasser, Toynbee, Truman, and about 1,500 other authors In 1983, Schnapper was described by The Washington Post as “a redoubtable gadfly.” His legacy will endure in the books to come Peter Osnos, Founder and Editor-at-Large ... How the Fed Brought the Gambling Mania to America? ??s Neighborhoods 21 The Great Financial Engineering Binge 22 The Great Raid on Corporate Cash 23 The Rant That Shook the Eccles Building: How the. .. on the Street” THE GREAT DEFORMATION THE GREAT DEFORMATION THE CORRUPTION OF CAPITALISM IN AMERICA DAVID A STOCKMAN PUBLICAFFAIRS New York Copyright © 2013 by David A Stockman Published in the. .. compelling but, given the roots of the Great Deformation, difficult in the extreme THE GREAT DEFORMATION PART I THE BLACKBERRY PANIC OF 2008 CHAPTER PAULSON’S FOLLY The Needless Rescue of AIG