Taking Measure of the Bust

By Kevin Phillips
Viking, 239 pages, $25.95

Remember the good old days? No, I don’t mean the sun-drenched, suburban 1950s. Nor do I refer to the go-go giddiness of the ’90s. I’m talking about last summer—before the days of “credit crunch” and “market downturn” and all the other phrases commentators trot out to signal that the American economy is on the verge of unraveling altogether. In those days, less than a year ago, we might not have been booming, but we weren’t busting, either.

What’s happened since then, and why, is hard to explain, even for the experts. Kevin Phillips, a longtime observer of American politics and finance, takes a stab at it in Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. The epicenter is the intersection of the housing and credit markets. Several years ago, consumers flocked to buy subprime mortgages. These mortgages were sliced and diced by creative financiers into little pieces, then resold as complex financial packages to institutional investors, everyone from hedge funds to pension funds.

At the same time, large numbers of homeowners began to “use their homes as ATMs,” as Mr. Phillips and many others have put it. They borrowed against the value of their homes in order to obtain easily spendable cash; as long as the value of the homes continued to rise, owners could afford to pile on debt. During this period, Mr. Phillips reports, the housing sector was responsible for about 40 percent of all GDP growth. This state of affairs, as we know now, was not sustainable. The bubble, like all bubbles, eventually burst—and as it did, heavily leveraged homeowners couldn’t cover their debts, and subprime mortgage holders couldn’t cover their monthly payments, and the whole mess imploded. Failure then spread from one bank to the next, like a contagious disease.

That, at least, is the story circulated in recent months. Mr. Phillips takes a longer view. He argues that the roots of the trouble can be traced back far earlier than last August, or even the glistening ’90s. Long-term economic trends—not to mention historical precedent—has been working against us for some time. The good old days, it turns, out, weren’t that good after all.


THE OVERARCHING TREND he decries is the increased financialization of the economy. In the past four decades, the financial services industry has displaced the manufacturing sector as the preeminent line of work. In 1950, manufacturing contributed 29.3 percent to the GDP, and financial services 10.9 percent. By 2003, the totals were almost reversed: manufacturing made a 12.7 percent contribution; financial services, 20.5 percent. Today, the financial services sector is the largest part of our economy.

All this is a fancy way of saying that we don’t make things anymore. We import most of our products from overseas. And spurred on by the steady march of federal deregulation of the banking industry, we now lead the globe in inventing ways to turn money into more money. The 1999 Financial Services Modernization Act, which abolished old barriers between commercial and investment banking, has proven particularly calamitous. As Mr. Phillips writes, “The financial sector got too big too carelessly, and in too much of a hurry.”

What’s wrong with the financial service industry’s explosive growth? Who could object to increased wealth? Mr. Phillips notes that the wealth that financialization has created is not fairly shared; executive pay has skyrocketed, and income disparity has increased concomitantly. More importantly—and this is where the author dons his historian’s hat—the recent financialization of our economy mirrors the financialization that occurred right before the Great Depression. As Mr. Phillips demonstrates, in the Roaring Twenties, the wizards of Wall Street were idolized for their ability to turn water into wine. The last decade or two has witnessed a similar deification of the money manager and the private-equity firm, as well as a similarly systematic dependence on credit. Will the next decade, then, be a repeat of the 1930’s?


KEVIN PHILLIPS THINKS that we may be headed for even worse. Much of Bad Money is premised on an idea articulated at the beginning of the book: “History does seem to repeat itself, if only in outline or rhyme.” That this is an obvious cliché doesn’t mean it shouldn’t be taken seriously. Yet it seems to me that Mr. Phillips is taking it too seriously.

Taking Measure of the Bust