The Fiscal Crisis: Transatlantic Misunderstandings

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The Fiscal Crisis: Transatlantic MisunderstandingsBernard E. BrownPublished online: 21 Sep 2009.

To cite this article: Bernard E. Brown (2009) The Fiscal Crisis: Transatlantic Misunderstandings, American Foreign PolicyInterests: The Journal of the National Committee on American Foreign Policy, 31:5, 313-324

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The Fiscal Crisis: TransatlanticMisunderstandings

Bernard E. Brown

AbstractIt is widely believed in Europe that the fiscal

crisis was caused by the absence of government

regulation of the financial sector in the United

States. This belief, the article argues, is an over-

simplification that encourages unrealistic hopes

for quick solutions and for a drastic shift of the

balance of power from the United States to the

European Union and other actors. In conclu-

sion, the article points to underlying problems

of the ‘‘market-state,’’ the dominant economic

model in all advanced democracies today.

‘‘

L’argent est le nerf de la guerre,’’ say

the French, who have had much

experience in the matter. Money provides the

sinews of military power, which is the ultimate

force behind diplomacy. This Gallic folk wisdom

seems to be vindicated by the financial crisis

that erupted in the United States in

mid-September 2008. The massive effort

required to recapitalize and stabilize the

financial system and the simultaneous effort

to stimulate the economy will necessarily

reduce the resources available for the military.

Perhaps more important is the impact on

‘‘soft power.’’ Most people now believe that the

United States is responsible for plunging the

world into a recession or, worse, a depression.

In negotiations for rebuilding the global

economy, Americans face questioning and oppo-

sition from allies and foes alike. The result for

many observers has been a shift in the global

balance of power away from the United States

and toward, notably, the European Union

(EU) and the BRIC nations (Brazil, Russia,

India, and China) along with increased impor-

tance for developing nations. But destabiliza-

tion may have perverse consequences for

Europe as well. To take but one possible sce-

nario: Some of the countries formerly part of

or dominated by the Soviet Union are now on

the brink of economic collapse, particularly

the Baltic states, Ukraine, Hungary, and

Romania. If political chaos follows, Russia

may be able to reestablish a sphere of influence

in much of Eastern Europe. The European

Union might not survive if some of its new

members fall once again under Russian domi-

nation. Rarely have the links among economics,

politics, diplomacy, and power been so clearly

and dramatically illuminated. Before drawing

any conclusions, however, we should look more

closely at the American economic model and the

causes of the financial meltdown.

The View from France:A Personal Note

When the global fiscal crisis exploded in

mid-September 2008, I was beginning a

three-month stay in Paris with a ‘‘mission’’

(suggested by my French publisher)—to try to

explain to francophones the issues in the

American presidential election then in full

American Foreign Policy Interests, 31: 313–324, 2009

Copyright # 2009 NCAFP

ISSN: 1080-3920 print=1533-2128 online

DOI: 10.1080/10803920903240239

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swing. In numerous radio and television pro-

grams, other public appearances, and inter-

views with journalists, I was constantly asked

during the final stages of the campaign and

then after Obama’s victory how and why the

subprime bubble was allowed to form and then

to threaten and possibly destroy the global

economy. This was an unusual perch from

which to view and assess differences and simi-

larities between American and European

economies and politics. It provided me with a

perspective on transatlantic misunderstand-

ings that others may also find useful as a guide

through an immensely complicated event.1

The immediate reaction of the French politi-

cal class to the fiscal crisis was an explosion of

criticism of the American model of capitalism

on the right and of capitalism itself on the

left. One political leader proclaimed that for

Americans, the free market is always right

[‘‘le marche a toujours raison],’’ which he

characterized contemptuously as a crazy idea

[‘‘une idee folle’’]. Another leader declared that

American capitalism had gone off the rails [un

‘‘capitalisme devoye’’]. A third said on a popular

television talk show that President Bush

should get on his knees and demand pardon

from every American voter and citizen and

every European as well for his policies of the

past eight years. And these were leaders of

the right! They were, respectively, the presi-

dent of the Republic (Nicolas Sarkozy), the

prime minister (Francois Fillon), and the presi-

dent of the French business lobby (Laurence

Parisot). As for the left: the subprime crisis

was the definitive end of Anglo-Saxon-style

capitalism [‘‘ultraliberalisme’’], probably of

capitalism in any form, perhaps of globaliza-

tion, and for some even of Western civilization.

Similar views were expressed by leaders

of virtually all of the political parties and

groupings in France, from far left to far right.

They can be restated as four propositions:

(1) American banks are not regulated; (2)

European banks are innocent victims; (3) The

crisis can be ascribed to the ‘‘failed policies’’ of

the Bush administration; and (4) the Bernanke–

Paulson rescue plan was in itself a repudiation

of the American model of capitalism and an

admission of the need for state intervention

in the economy. (One headline proclaimed

the bailout as the ‘‘second death of Milton

Friedman.’’) I will argue that each of these prop-

ositions is either flatly untrue or a stereotype

based on insufficient knowledge, ideological

predispositions, or wishful thinking. Stereo-

types in political discourse in normal circum-

stances are merely irritating; but they can

have dangerous consequences if made the basis

of policy decisions. This is not to suggest that

the American economic model and policies are

beyond criticism; in view of the magnitude of

the crisis, that would be absurd. There are

indeed serious problems in the ‘‘market-state’’

(to use a term popularized notably by Columbia

University political and legal theorist Philip

Bobbitt) that has come into existence not just

in the United States but in all advanced

Western democracies.

American Banks AreRegulated

When the crisis broke, a New York Times

business writer, Charles Duhigg, recounted

the travails of three players in the unfolding

drama: Daniel Mudd, Enrico Dallavecchia,

and Jack Reed—which I found useful in

explaining the intricacies of American politics

to a foreign audience. Mudd was the head of

Fannie Mae, Dallavecchia was his chief risk

officer, and Jack Reed was and still is a Demo-

cratic senator from Rhode Island. When he was

hired in 2006, Dallavecchia warned Mudd that

a housing bubble was forming and that the

company was taking on too many risky loans.

He was told that the market, shareholders,

and Congress believed that Fannie should be

taking more risks, not fewer. ‘‘Who am I sup-

posed to fight first?’’ Mudd asked. (Mudd

314 Bernard E. Brown

American Foreign Policy Interests

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denied that he had made that comment.)

According to several people interviewed, Mudd

told employees to ‘‘get aggressive on risk-taking

or get out of the company.’’ Mudd did not recall

making such a statement and claimed that he

had attempted to balance risks and act pru-

dently. Nonetheless, he conceded that Fannie

was afraid of losing market share to new

lenders. ‘‘Congress would feel like we weren’t

fulfilling our mission,’’ he explained. ‘‘The

market was changing, and it’s our job to buy

loans, so we had to change as well.’’ During a

congressional hearing in 2006, Mudd was

grilled in particular by Senator Jack Reed,

point man on housing for the Democrats, who

complained loudly that Fannie was not making

enough loans to low-income groups.2

This typical snapshot of the American

political process is enough to show that the

housing market in the United States is far

more complicated than suspected by most

foreign observers. It is not merely a matter of

individuals seeking loans from banks in order

to buy their residences. There is at a minimum

Fannie Mae—risk assessment within that

company (and all financial institutions)—and

a role for Congress. And this only scratches

the surface. How come? To put it briefly, the

housing market does not operate independently

of political controls. Fannie Mae, short for the

Federal National Mortgage Association

(FNMA), was created in 1938 as a state agency

for the purpose of making mortgages available

to low-income groups. In 1968 Congress con-

verted Fannie into a Government Sponsored

Enterprise (GSE) in order to remove it from

the annual federal budget and make it more

efficient. It became a private shareholder

owned corporation but subject to regulation

by the Office of Federal Housing Oversight.

Congress is specifically given the authority to

determine whether the company is managing

risk adequately and to adopt capital reserve

requirements; hence the hearing in which

Daniel Mudd was subject to harsh questioning

by Senator Reed. When he took over as head

of Fannie Mae in 2004, Mudd came under

intense pressure from regulators to set more

ambitious goals for ‘‘affordable housing.’’

Within two years Fannie Mae, trying to fulfill

the mission given to it by Congress, was buying

some 40 percent of all U.S. mortgages. It then

resold most of them to investors with a promise

to redeem the loan in case of default.

GSEs are an integral part of an extensive

network of public agencies that orchestrate

and regulate American financial institutions.

These include the U.S. Treasury, the Federal

Reserve Bank, the Department of Housing

and Urban Development, the Securities and

Exchange Commission, the U.S. Congress

(primarily through oversight exercised by the

finance and banking committees) as well as

the attorneys general of individual states

(with those of New York and Illinois playing

an especially important role), and state and

federal courts. Indeed, it is in the nature of

the ‘‘market-state’’ that overall objectives for

the market are set by state agencies, which is

precisely what happened in the United States

(and elsewhere as well). The subprime crisis

was precipitated not by banks acting on their

own but by banks acting with the approval

and encouragement—even at the specific

commands—of government, including courts.

If anything, there were too many regulators

who too often worked at cross purposes; and

the regulations were based on faulty premises.

You do not have to be American to create

credit bubbles with disastrous consequences.

In the 1990 s there were two such bubbles—in

Japan and Sweden—as devastating in those

countries as the present crisis in the United

States. They did not have the same global con-

sequences because of the smaller size of their

economies and the lesser degree of globaliza-

tion at the time. The Swedish case is particu-

larly interesting. The Social Democratic party

was in power for four decades, except for a

Centrist interlude from 1976 to 1982, up to

the election of Centrist Carl Bildt as prime

minister in October 1991. Swedish banks were

The Fiscal Crisis 315


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far from being deregulated; if anything, the

problem was excessive regulation. As Bildt tells

the story, the Swedish economy by 1992 was on

the brink of collapse. Five of the seven largest

banks were basically insolvent; nonperforming

loans far exceeded the total equity capital of

all banks; coverage for losses on loans was

equivalent to 12 percent of GDP; and unem-

ployment zoomed from 3 to 12 percent. The

Swedish government under Bildt issued a guar-

antee protecting all bank creditors except

shareholders and created a special agency to

deal with bad loans. In many ways, says Bildt,

the Swedish crisis in 1992 was more acute than

the American crisis in 2008 because Sweden

had a slow-growth economy along with more

severe structural problems. There was no

demand in Sweden for permanent nationaliza-

tion of the financial sector after the bad loans

had been liquidated.3

European Banks Were NotInnocent Victims

Housing bubbles have formed many times

all over the world and have generally been

corrected by the market itself. The 2008 crisis

was distinctive in that the crisis in the housing

sector spread through an entire national econ-

omy and then globally. Innovative financial

instruments (the now notorious ‘‘derivatives’’)

that spliced and diced risk throughout the

entire financial system were created by young

technicians. It was assumed that higher pre-

miums would enable those who insured risk

to make up for defaults. Instead, the defaults

swamped the insurers. The notion that

European bankers were innocent victims is

misleading. American bankers may have been

among the pioneers in creating derivatives;

but European bankers participated enthusias-

tically in creating, selling, and buying securi-

tized obligations. They helped finance the

American subprime market directly through

their American branches (notably Deutsche

Bank, Credit Suisse, Barclays, and Societe

Generale) They also financed subprime loans

in their own countries with the encouragement

of their governments, including left govern-

ments in the United Kingdom and Spain.

Normally conservative banks and investment

houses in Austria and Italy as well as other

European countries took enormous risks in

lending or investing in post-Communist

Central and Eastern Europe in order to make

enormous profits. They did so with the encour-

agement of their governments in order to

achieve praiseworthy goals: to facilitate rapid

economic development and democratization in

potentially volatile societies.

European banks, like American banks,

boast departments that analyze risks. They

are also subject to supervision by regulatory

authorities. But the new financial instruments

were not understood by the older generation

of financiers in either the United States or

Europe. (Robert Rubin, for example, remarked

that he had not understood the dangerous

implications of derivatives.) It was not lack of

regulation that caused the meltdown but lack

of understanding on the part of American and

European regulators in place both within finan-

cial institutions and government. Risk analysts

were simply unable to keep up with and rein in

the innovators.

It Was Not Only Bush

It is only natural that incumbents pay the

price for economic downturns, and the Republi-

can party did so in 2008. Barack Obama was

able to exploit the crisis skillfully by blaming

it entirely on the ‘‘failed policies’’ of the Bush

administration, denouncing the Republican

party’s glorification of the market and hostility

toward government intervention in the economy.

Nonetheless, he endorsed the Bernanke–

Paulson–Bush rescue plan, with minor reser-

vations. John McCain seemed uncertain about



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the fundamental causes of the crisis and

what to do about it. President Bush mused

that ‘‘Wall Street got drunk, and we got the

hangover’’—which hardly refutes claims by

the Democrats. It is certainly the case that

Republicans embraced the principle of an

‘‘ownership society,’’ which encourages people

to take responsibility for their own welfare.

Alan Greenspan, for example, declared in

his memoir, published in 2007, that expansion

of ownership to nearly 69 percent of house-

holds ‘‘gave more people a stake in the future

of our country and boded well for the cohesion

of the nation. . . . Home ownership resonates

as deeply today as it did a century ago.’’

Protection of property rights, he continued,

‘‘so critical to a market economy, requires a

critical mass of owners to sustain political

support.’’4

But in championing the ownership society,

Republicans were joined by Democrats. Presi-

dent Bill Clinton proudly adopted the ‘‘National

Homeowners Strategy’’ as a centerpiece of

his social policy. In so doing he built upon

the Community Reinvestment Act adopted in

the administration of Jimmy Carter. Clinton

declared that he did not believe in big govern-

ment, but rather in ‘‘smart’’ government, one

that would create conditions making it possible

for people to develop their full potential. Help-

ing those without money buy a home was a

perfect example of such a policy. Democrats

and Republicans alike argued that people who

own their apartments do not vandalize eleva-

tors; they do not cover their buildings with

graffiti; they do not set fire to their apartments

in order to be placed higher on a list for more

desirable apartments.

Two powerful Democrats played key roles

in developing and administering Clinton’s

National Homeowners Strategy: Henry Cisneros

and Franklin Delano Raines. Cisneros was a

former mayor of San Antonio who became head

of the Department of Housing and Urban

Development (HUD). Under his leadership,

lending requirements imposed by HUD were

relaxed. Home ownership increased from 64

percent in 1994 to just over 67 percent at the

end of Clinton’s mandate. Perhaps, Cisneros

said recently, we should have stopped at 69

percent ownership. A voice should have said,

‘‘We should not go further. There are people

who should remain renters.’’ Cisneros resigned

in 1997 after an unrelated scandal. He joined

the board of a developer (KB Home) and then

the board of Countrywide (an aggressive sub-

prime lender and one of Fannie Mae’s biggest

clients). A fellow member of the board of KB

Home was the former chief executive of

Fannie Mae. As observed by journalists David

Streitfeld and G. Morgenson: ‘‘it made for a

cozy network.’’ Cisneros recently remarked

that Countrywide’s engagement in subprime

was a ‘‘fatal error,’’ and he faults himself for

not seeing it.5 Franklin Delano Raines, as the

CEO of Fannie Mae, spearheaded its develop-

ment as a financial titan by creating and servi-

cing new markets. In the process, he became

one of the most prominent and wealthy

African-Americans in the United States, earn-

ing $90 million from 1998 to 2004. Caught up

in a scandal involving dubious accounting, he

was compelled to resign in 2004.

Democrats and Republicans vied with one

another in urging and even requiring banks

and financial institutions to take huge risks

in order to expand home ownership. However,

Republicans tended to be somewhat more con-

scious of the risks and more wary of increasing

pressure on Fannie Mae and other financial

institutions to run those risks. For example,

in 2003 the Bush administration proposed to

transfer regulatory authority over Fannie

Mae from the office of Federal Housing Over-

sight to the Treasury Department. The propos-

al was rejected by Congress—with Democrats

leading the opposition. Declared Barney Frank,

ranking Democrat on the House Financial Ser-

vices Committee: ‘‘These two entities—Fannie

Mae and Freddie Mac—are not facing any kind

of financial crisis. The more people exaggerate

these problems, the more pressure there is on



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these companies, the less we will see in terms of

affordable housing.’’ The rationale of the Demo-

cratic specialists on housing in Congress was

explained by Senator Jack Reed in the pre-

viously mentioned appearance by Daniel Mudd

in a 2006 congressional hearing. ‘‘When homes

are doubling in price every six years and

incomes are increasing by a mere 1 percent a

year,’’ he told the CEO of Fannie Mae, ‘‘Fannie’s

mission is of paramount importance.’’ To

hammer home the point, Senator Reed added:

‘‘In fact, Fannie and Freddie can do more, a

lot more.’’6

Alan Greenspan relates how the Fed began

in 2003 to curb ‘‘excesses’’ at Fannie Mae and

Freddie Mac. He was especially concerned

that subprime mortgage originations in 2006

constituted one fifth of the nearly $3 trillion

of home mortgage originations and interest-

only loans another fifth. He complained that

Fannie and Freddie had been using a federal

subsidy to ‘‘pad their profits’’ and grow. ‘‘But

their dealings had begun to distort and endan-

ger the markets and seemed likely to become a

bigger and bigger problem. The companies

employed skillful lobbyists and had powerful

advocates in Congress. President Bush had

very little to gain politically by supporting

a crackdown. Yet he backed the Fed through

a two-year struggle that resulted in crucial

reforms.’’7 Alas, the reforms were not crucial

enough.

The financial crisis ‘‘made in the U.S.A.’’

model differed in one important respect from

the credit crunch elsewhere: The main benefici-

aries of the aggressive policies of Fannie Mae

were African-Americans and Hispanics. Oppo-

nents of easy credit policies were portrayed as

racists. Among the strongest and most influen-

tial supporters of Clinton’s National Home-

owners Strategy were the members of the

highly influential Congressional Black Caucus,

a group of some 40 legislators, many of whom

occupied powerful positions in the congres-

sional committee structure. Critics of Raines

were denounced as ringleaders of a ‘‘political

lynching.’’ Fanny Mae hired a small army of

lobbyists who flooded the halls of Congress

and committee hearing rooms. Community

organizers mobilized people for street protests

demanding that banks open branches in poor

neighborhoods and lend money for mortgages

without requiring down payments; blocking

entrances to bank offices until demands were

met; initiating law suits against bank officials

for astronomical damages for violating laws

prohibiting racial discrimination (because most

poor applicants for credit were blacks and

Hispanics); and compelling public authorities

to direct banks to offer subprime loans. Some

court judgments even required banks to pay

community organizers (notably, leaders of

ACORN) lucrative fees for ‘‘finding’’ poor people

as recipients of loans. The pressure on banks

from the political and legal systems to increase

risks in financing mortgages was difficult if not

impossible to resist.8

Friedman Followed, NotAbandoned

At a 90th birthday party in 2002 in honor of

Milton Friedman, the lead speaker paying trib-

ute to the famed Chicago economist was none

other than Ben S. Bernanke, a conservative

Republican, then a governor of the Federal

Reserve Bank who acceded to the chairmanship

of the Fed four years later and played the most

important role in confronting the crisis of 2008.

After ticking off Friedman’s many seminal con-

tributions to economics, Bernanke talked at

length about ‘‘one of his greatest contributions,’’

nothing less than ‘‘the leading and most

persuasive explanation of the worst economic

disaster in American history, the onset of

the Great Depression’’—called by Friedman

and his collaborator, Anna Schwartz, the Great

Contraction. The error in 1929, as bothFriedman

and Bernanke viewed it, was that the Fed at

first remained on the sidelines, doing nothing.



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When it finally acted, it made the wrong

decisions, reducing liquidity and tightening

credit. Turning to Friedman and Schwartz

(also present), he ended with an emotional

flourish: ‘‘Regarding the Great Depression.

You’re right, we [the central bankers] did it.

We’re very sorry. But thanks to you, we won’t

do it again.’’

The lesson drawn by Bernanke from his

reading of Friedman: If the credit crunch

cannot be handled by the market alone in a

similar crisis, the Fed should act immediately

and forcefully, flooding the banks with liquid-

ity and restarting the credit system. The

villain in 1929 in the Friedman litany was

not Franklin Roosevelt but Herbert Hoover

along with the leadership of the Fed. When

the fiscal crisis struck in September 2008, both

Bernanke and Secretary of the Treasury

Henry Paulson told President Bush and then

Congress and the public that only the federal

government has the resources to clean up the

existing bad debt and hold on to it long

enough to get the investment back. They

intended to use state resources in order to

restore, not replace, the system. Whether they

were right or wrong is another question. They

believed they were applying the principles of

Milton Friedman, not departing from them.

Monetary economics is far more complex than

most European critics (and perhaps American

as well) are aware.9

A TransatlanticPerspective

Blaming greedy bankers, venture capital-

ists, and ‘‘the market’’ does not suffice as an

explanation of what went wrong in the United

States and for that matter in Europe and the

rest of the world. If we are to adopt relevant

and effective policies to ensure that similar

crises do not recur, we need a more comprehen-

sive perspective. It might be useful to view the

fiscal crisis within a long-term view of election

cycles.

While in France last fall I argued that the

forthcoming American presidential election

was historic but not ‘‘critical’’ in the sense used

by historians and political scientists. The elec-

tion was historic because the United States

would have either its first African-American

president or its first female vice president.

But it was not necessarily shaping up as a

‘‘critical’’ election—one that would represent a

fundamental change in the way people look at

relations among the state, on the one hand,

and, on the other, the economy and civil society.

The notion that some elections in the United

States can be considered turning points in

themselves is a shock to many French who like

to think that American campaigns are akin to a

Seinfeld comedy (that is, ‘‘about nothing’’). This

view was popularized by perhaps the greatest

French authority on the United States in mod-

ern times, Andre Siegfried. His books, pub-

lished in 1927 and 1954, set a long-lasting

tone for French studies of American politics

and ‘‘civilization.’’ In public appearances I

skipped the critical elections of the nineteenth

and early twentieth centuries to concentrate

on the last two: the election of Franklin D.

Roosevelt in 1932 and of Ronald Reagan in

1980. Persuading my audiences that the New

Deal represented a profound change was easy.

It was a commitment to use the power of the

federal government in dealing with economic

and social problems. None other than Richard

Nixon remarked in the 1970s that ‘‘we are all

Keynesians now’’—that is, we accept the princi-

ple of state intervention through the use of

fiscal controls as well as direct administration

of social and economic programs. Of course it

made a difference whether Democrats or

Republicans were in power between 1945 and

1980; each party tended to use a powerful state

in a way that favored its major social suppor-

ters (roughly low- and middle-income groups

versus middle and higher income groups, the

world of labor versus the world of business).



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The ‘‘Market-State’’—Rise

and . . .Demise?

Arguing that Ronald Reagan’s election in

1980 was a similar turning point is a harder

sell, particularly in France where Reagan was

disdained to a greater extent, if that is possible,

than most others who have occupied the office.

He confirmed their worst fears about American

‘‘civilization’’—an actor, a cowboy, a laissez-

faire conservative. How unlike the graduates

of the Ecole Nationale d’Administration and

the other ‘‘grandes ecoles’’ who govern in the

general interest—or so they would like to

believe. Rather than focus first on Reagan, I

called attention to global phenomena that the

French take very seriously indeed. The tradi-

tional sovereign state everywhere, including

France, has been losing power to forces both

above it and below. In Europe the members of

the European Community (later called Union)

began in the 1960s and then at an accelerating

pace to pool sovereign powers over the move-

ment of people and of capital, entrusting

them to supranational institutions. There was

even the beginning of a movement to create a

European common security and foreign policy

and defense force, the sacred domain of

nation-states. Power was also flowing down-

ward to civil society and a multitude of non-

governmental organizations (NGOs) and,

above all, to the market. The creation of the

Internet and the widespread use of personal

computers also meant that the state’s control

over the information flows was weakening—

an especially hard blow in communist systems.

There was a pervasive sense in democratic as

well as communist systems that sovereign

nation-states were becoming dysfunctional

because of the growing complexity of civil

society, the economy, and the technology of

communications.

A second phenomenon was the unantici-

pated collapse of European communism. The

Soviet Union had emerged from World War II

as a superpower and was an attractive model

to emulate for a significant portion of the

Western intellectual class. Communist parties

even became mass movements in France and

Italy. But it became increasingly evident in

the 1980s that communist nations and espe-

cially the heartland (the Soviet Union) were

characterized by low productivity and general-

ized poverty. The vaunted command economy

that was able, in tandem with Russian nation-

alism, to create a formidable military power

was incapable of satisfying consumer demands.

A related trend in Europe was the deradicaliza-

tion of social democratic movements. Socialist

parties, one after another, began to distance

themselves from nationalization as a policy,

becoming more and more the providers of social

welfare rather than the managers of the

economy. And even the welfare state (perfectly

compatible with Bismarckian rightist politics)

was encountering thorny problems. There was

widespread concern that well-intentioned

Social Democratic parties were creating a ‘‘cul-

ture of poverty,’’ rewarding people for passivity.

One indication of a change in political culture

was a movement among economists away from

Karl Marx, away even from John Maynard

Keynes (guru of the interventionist state), and

toward theorists like Milton Friedman who dis-

covered virtues in shifting decision-making

power from bureaucrats to individual actors

in the market.

In the 1980s a new relationship was

forming between states and markets every-

where. It was no longer a question of drawing

a line between the state and the private sector

but rather of using the mechanisms of the mar-

ket in order to achieve goals set down by the

state. Some extremists on the right wished to

eliminate the state altogether (save for the

‘‘regal’’ functions of security), and some extre-

mists on the left continued to cherish the

command economy or Bismarckian welfare

models; but a consensus gradually developed

that political scientists and historians have



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called the market-state—not a market without

a state or a state that absorbed the market but

a dynamic relationship between the two, which

includes the devolution of state functions upon

actors in civil society. The central notion is that

the market performs certain functions more

effectively than does the state. But the market

needs regulation, direction, and the rule of law,

all provided by the state. Margaret Thatcher

made a breakthrough in the United Kingdom

that was later assimilated and extended by

Tony Blair’s New Labour. Michel Rocard

recently observed that when he became prime

minister under Mitterrand, he found the coun-

try ‘‘on its knees’’ because of the extensive

nationalization introduced in 1981, which he

called archaic. He revived the economy by has-

tening privatization of the financial sector.

Remaining a Socialist, he declared that the

party must ‘‘modernize’’ by reconciling itself

to the free-market economy. Socialist Lionel

Jospin subsequently privatized more of the

French economy than all of the previous

governments of the right put together.

In America this global movement was

expressed through the election and reelection

of Ronald Reagan and the triangulation strat-

egy subsequently adopted by Bill Clinton. On

the occasion of Friedman’s death, Lawrence

Summers made a revelatory comment that

deliberately harked back to Nixon’s previously

cited statement, ‘‘We are all Keynesians now.’’

This dean of Democratic party economists,

who served as the last secretary of the treasury

under Clinton and is now chair of President

Obama’s Council of Economic Advisers, said,

‘‘We are all Friedmanites now.’’ All honest

Democrats, he continued, ‘‘will admit that they

have been influenced by Friedman.’’ Obama

himself was influenced by Friedman’s followers

during the time he served as an adjunct pro-

fessor at the University of Chicago Law School.

The command economy, or Soviet model, has

been discredited. The Social Democratic model

of a half-century ago has lost its magic. Few

people believe that whatever the market

decides is always right. What remains is some

form of the market-state.

But the political battle continues in all

market-states, that is, in the entire Western

world. Rival parties experiment with different

ways of utilizing market mechanisms in order

to achieve their goals under the direction of

and orchestrated by the state. As always, par-

ties seek to tilt those mechanisms in favor of

their social base (marked notably by income

level and ethnicity). After hailing Friedman’s

seminal contributions, for example, Lawrence

Summers made clear his political reservations.

He gives greater consideration to ‘‘social jus-

tice’’ and the capacity of ‘‘collective action’’ to

make people better off. The market should in

some cases be tempered, Summers says, not

venerated. If the fiscal crisis intensifies, the

political balance may swing so far in the direc-

tion of state intervention that a new relation-

ship (not yet defined) between the state and

the market could emerge. The 2008 election

may yet turn out to be ‘‘critical.’’10

Implications for the Global

Balance of Power

President Sarkozy went to New York for

top-level discussions shortly after the crisis

broke and delivered a political sermon: The cri-

sis began here (in New York, on Wall Street)

and must end here—presumably by having

the Americans take sole responsibility for the

crisis and accept European prescriptions for

reform of the American and global financial

systems. He had remedies at hand: ‘‘moralize’’

capitalism by instituting strict regulation by

the state and basically establish global govern-

ance over the American financial system so

that it will no longer drag down everyone else.

This would hasten a shift from dangerous

‘‘unilateralism’’ to a sane ‘‘multilateralism’’—

in which Europe would lead the world and

France would lead Europe.



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We are back to the issue stated at the

outset: What is the relationship among money,

power, and diplomacy? In general we can agree

that ‘‘l’argent est le nerf de la guerre.’’ Military

force does indeed back up diplomacy. The global

role played by Holland, Spain, France, and

Great Britain from the seventeenth through

the twentieth centuries reflected the ability of

each of those nations, successively, to take

advantage of commercial, industrial, and tech-

nological advances to build powerful armies

and navies, enabling them to dominate their

regions and extend their rule worldwide. But

many other factors must be taken into account

to explain the rise and fall of empires. Money

by itself does not always translate into power.

A nation must have a population, geographic

area, and natural resources large enough to

sustain its domination over immediate neigh-

bors as well as distant peoples. It must also

have a competent political class capable of

inspiring popular support. The use of military

force may provoke resentment and rebellion,

which undid European empires in the

Americas, Asia, and Africa (roughly in that

order). In some cases political will and a disci-

plined small population may enable relatively

poor nations to defy larger and wealthier

nations. North Korea today is an impoverished

nation yet a serious military threat to South

Korea, which is far more prosperous and has

twice as many people. North Korea even makes

threats against Japan and the United States.

The mighty Soviet Union was a superpower

after World War II, but its people had a far

lower standard of living than West Europeans

and Americans.

There is also a disease of affluence, as Emile

Durkheim pointed out, namely a loss of will and

of dynamism on the part of a ruling class, lead-

ing sometimes to decadence and anomie. The

‘‘haves’’ can become lazy and dispirited, while

the ‘‘have nots’’ become tough and ambitious.

Much depends on the ability of a political class

to adapt to new circumstances. It takes diplo-

matic skill to be able to judge when a nation’s

power either declines or increases. One of the

great miscalculations in the twentieth century

was the assessment by the German military

and political class in 1917 and again in 1941

that the United States would not be able to

mobilize effectively for war and then to bring

whatever force it could muster to bear decisively

in Europe. The price paid was not merely loss

of empire or influence but surrender in World

War I and defeat with occupation in World

War II. Yet the German military and universi-

ties were among the best in the world. The list

of such miscalculations is long. There is no

simple equation among financial power, mili-

tary power, and the maintenance of a favorable

balance of global power.

As the major nations struggle to contain the

fiscal meltdown, it is evident that the problem

was far more complicated than most Europeans

had assumed. If only the absence of state regu-

lation of banks had been the problem, then the

solution would be simple: The Obama adminis-

tration could put the state in charge. But the

state has been in charge all along. Government

regulation of banks in the United States is far

stronger than on the European Union level

(where it is virtually nonexistent) as well as

in many European nations. In sober retrospect,

two difficulties stand out. First, political lead-

ers set an illusory goal for the market: to elim-

inate poverty and spread prosperity by relying

on an automatic rise in housing values. Second,

regulators everywhere (as well as bank officials

themselves) failed to see the dangers of securi-

tization through the use of derivatives. How to

remedy the errors? It is not likely now or in the

near future that states will again permit (much

less require) banks to offer easy credit to people

who do not have the means to repay loans.

Nor is it likely that derivatives ever again will

be purchased blithely by banks, investment

houses, or hedge funds. Agreement is emerging

on the need for increased transparency and

elimination or neutralization of fiscal paradises

(Cayman Islands, Lichtenstein, and others).

Such measures and coordination of plans to



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stimulate the global economy may well be

useful—provided they do not stifle innovation.

The hopes of some Europeans that

they could establish primacy over the United

States or that the global balance of power

would shift drastically away from the United

States will be hard to realize. All great powers

have been laid low by the fiscal crisis. Neither

the European Union nor any other individual

nations or groups of nations are in a position

to assume a leadership role. Nor is it possible

that the United States in an Obama presidency

would stand on the sidelines and submit

meekly to commands from the outside world.

The negotiating team of economists on the

American side (notably Bernanke, Geithner,

and Summers) shows no signs of weakness

in negotiations with their international

partners—who find it difficult to agree in any

event on alternative plans.

The Classic Problemof Democracy

The current fiscal crisis is exactly the kind

of disaster that the United States Constitution

was intended to prevent. James Madison

referred in Federalist Paper number 20 to the

‘‘rage for paper money’’ in Rhode Island as a

compelling reason for the creation of a strong

federal government. The founders built a

complex federal system, deriving its legitimacy

ultimately from the people through elections

and based on the principle of the separation of

powers. Popular government was structured

in such a way that popular pressure for

immediate benefits could be resisted. But the

system failed in 2008 (and in the preceding

three decades). Populists on both the left and

the right gained sufficient control of the legisla-

tive, executive, and judicial branches to be able

to adopt an unrealistic policy: elimination of

poverty by using continually rising housing

values as a gigantic ATM. Perhaps the lesson

has been learned, the market can correct itself,

and only limited reforms are required. Or per-

haps, as in 1787, we need to devise new struc-

tures insulating popular government from

destructive short-term demands. Who will pro-

tect us from our elected guardians? Americans

and Europeans alike continue to wrestle with

that classic problem of democracy.

About the Author

Bernard E. Brown is director of the

Transatlantic Relations Project of the National

Committee on American Foreign Policy. Profes-

sor emeritus of political science at the City

University of New York (Graduate Center), he

is the author or editor of more than a dozen

books and numerous articles on comparative

politics.

Notes

1. Full disclosure. Bernard E. Brown, Tout

ce que vous avez toujours voulu savoir sur les

elections americaines (Paris, 2008).

2. Cf. Charles Duhigg, ‘‘Fannie Mae’s

Risky Path to Calamity,’’ International Herald

Tribune, October 6, 2008.

3. Cf. Carl Bildt, ‘‘Sweden’s Crash:

Lessons for the U.S.,’’ International Herald

Tribune, September 29, 2008.

4. Alan Greenspan, The Age of Turbulence

(New York, 2007), 230, 233.

5. David Streitfeld and G. Morgenson, ‘‘A

Stark Reckoning as a Leader in U.S. Housing

Looks Back,’’ International Herald Tribune,

October 20, 2008.

6. Congressman Frank is cited in Stephen

Labaton, ‘‘New Agency Proposed to Oversee

Freddie Mac and Fannie Mae,’’ The New York

Times, September 11, 2003. Senator Reed is

cited in Charles Duhigg, ‘‘Fannie Mae’s Rocky

Road . . . ’’ op. cit.

7. Alan Greenspan, The Age of Turbu-

lence, op. cit., 242.



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8. See Howard Husock, America’s Trillion-

DollarHousingMistake: The Failure of American

Housing Policy (Chicago, 2003) and Thomas

Sowell, Housing Boom and Bust (New York,

2009), especially chapter 2, ‘‘The Politics of

the Housing Boom.’’

9. On Friedman’s views: Milton Friedman

and Anna Schwartz, A Monetary History of the

United States 1867 to 1960 (Princeton, N.J.,

1963), especially the chapters on the ‘‘Great

Contraction’’ and ‘‘New Deal Changes.’’ An

updated version in nontechnical language is

Milton and Rose Friedman, Free to Choose

(New York, 1980), chapter 3, ‘‘The Anatomy of

Crisis.’’ See also the volume edited and coau-

thored by Ben S. Bernanke, Essays on the Great

Depression (Princeton N.J., 2000). In the pref-

ace, Bernanke confesses that he is a ‘‘Great

Depression buff.’’ His academic career was one

long preparation for the role he eventually

assumed in the current fiscal crisis. For the full

text of Bernanke’s tribute to Friedman, includ-

ing a review of recent scholarship on the causes

of the Great Depression, see: ‘‘Remarks by

Governor Ben S. Bernanke at the Conference

to honor Milton Friedman, 8 November 2002,’’

at www.federalreserve.gov/boarddocs/speeches/

2002. Note, too: Peter Baker et al., ‘‘A Professor

and a Banker Bury Old Dogma on Markets,’’

The New York Times, September 20, 2008,

despite the misleading title.

10. See Lawrence H. Summers, ‘‘The Great

Liberator,’’ The New York Times, November 19,

2006. He asserts boldly at the outset: ‘‘If John

Maynard Keynes was the most influential econ-

omist of the first half of the 20th century, then

Milton Friedman was the most influential

economist of the second half.’’ For a perceptive

analysis of the rise of the ‘‘market-state,’’ which

I have drawn upon here, see Philip Bobbitt, Ter-

ror and Consent: The Wars for the Twenty-First

Century (New York, 2008). On the significance

of Reagan’s election, see especially the work by

Yale political scientist Stephen Skowronek,

The Politics Presidents Make: Leadership from

John Adams to Bill Clinton (Cambridge, Mass.,

1993) and his essay, ‘‘The Setting: Change and

Continuity in the Politics of Leadership’’ in

Michael Nelson, editor, The Elections of 2000

(Washington, D.C., 2001), 1–25. Barack Obama

during the campaign and his chief of staff in the

White House, Rahm Emanuel, both have stated

that Ronald Reagan in their view changed the

political culture (the essence of a critical elec-

tion and a ‘‘transformational’’ presidency for

Skowronek), whereas Clinton did not.



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Documents

The Fiscal Crisis: Transatlantic Misunderstandings