Sceptical about the government's reason for buying up all those banks' bad debts?

Rescuing overextended financial institutions and speculators from their own folly was a national "first" of the 1980s and 1990s-and an ill omen. In previous crashes, they had been allowed to collapse. Mark Twain was on a speaking tour of the Pacific Northwest when the Panic of 1893 hit the stock market, and he was struck by the damage. Banks in Seattle, Portland, and San Francisco toppled like Douglas fir trees. Fortunes were lost in the collapse of watered railroad bonds.

When the panic hit, not a few of the financiers who had reveled in the prior Gilded Age boom were shattered in the bust, joining farmers and miners who had been losing ground for decades. The federal authorities provided no refuge from the gales of the marketplace. No one bailed out the flattened banks and traumatized investors. Moreover, once politics changed to reflect voters' loss of faith in unbridled speculation, populist-progressive reforms reshaped the economic landscape, reining in the giant trusts, establishing a progressive income tax, and creating the Federal Reserve Board to supervise the banks. But because the creative cycle of American capitalism worked, another generation of entrepreneurs and speculators would roar again in the 1920s.

When the next crisis came in 1929-33, the process of destruction and renewal was even tougher. The coal miners, railroaders, and farmers who had all been losing ground in the 1920s, early victims of the financial boom, were joined by investors, bankers, and financiers. Washington did not move to suspend market forces. The Bank of the United States and thousands of lesser institutions shut their doors; Samuel Insull's giant public utilities holding company empire collapsed. Cartoons showed Manhattan hotel clerks asking pinstrlped guests whether they wanted a room for sleeping or jumping. President Hoover, to be sure, made a small attempt to slow the downward spiral with the Reconstruction Finance Corporation and a few other emergency steps. But the administration's dominant philosophy rang out in the famous words of Treasury Secretary Andrew Mellon: "Liquidate labor, liquidate stocks, liquidate real estate. . . values will be adjusted, and enterprising people will pick up the wreck from less-competent people."

And that is how the cycle worked, because the financial purge was massive, with the Dow:Jones industrial average losing 80 percent of its value, commercial real estate values plummeting, and banks closing everywhere. Thereupon, the political countertide of the New Deal proved even more powerful than that of the populist-progressive era. In the 1932 presidential campaign, Franklin D. Roosevelt had talked about driving the money changers from the temple, and in a number of ways, he did. Critics might carp about the president's tenderness toward banks, but the larger effect of the New Deal was to toughen financial regulation, place the SEC as a watchdog over Wall Street, crack down on public utility holdings companies, and increase taxes on the rich through the Wealth Tax Act of 1935. FDR could fairly say, in a 1936 speech, that in his first administration the forces of privilege had met their match, and that in his second administration he hoped they would meet their master.

For over a century, this had been the genius of American political finance. The legacy of these cycles, of the buoyant capitalist expansion that comes first, followed by a speculative excess, a crash of some degree, and then a populist-progressive countertide, is simply this: they have managed to give America the world's most successful example of self-correcting capitalism. Or at least that has been true until now. If, as we saw earlier, the genius of American politics was that once a generation or so the tidal wave of a new politics would sluice out Washington, the comparable renewal process of the modern American political economy was that once a generation or so a wave from the collapse of market speculation and financial excess would wash away the speculators, failed banks, and investment firms and discredited devices of the U.S: financial sector. Then a new public philosophy would complete the reform process. None of these transient speculative financial elites was able to achieve entrenchment. Each time, American capitalism came back stronger-not as the stagnant, hereditary vocation of rentiers or speculators, but as a dynamic culture still broadening the economy, still boosting America's share of world manufacturing and GNP.

This has not repeated in the 1990s, and the change looks dangerous. Financial mercantilism-government-business collaboration calculated to suspend or stymie market forces - has at least partly replaced yesteryear's vibrant capitalism. The eighties, for their part, had mirrored the start-up patterns of previous capitalist-conservative go-go eras, fulfilling ten critical parallels with the Gilded Age and the Roaring Twenties that ranged from conservatism in power and popular suspicion of government to pro-business attitudes, tax cuts, disinflation, concentration of wealth, and record levels of leverage, debt, and speculation. Then, in 1990-91, as the bubble started to burst, even major business and financial publications were unnerved by the abundance of parallels to yesteryear's speculative blow-outs: savings and loan institutions were collapsing from New England to California, the junk bond market was reeling, commercial real estate was losing 30-40 percent of its value in major cities, and hundreds of commercial banks, including behemoths like New York-based Citicorp, were failing or flirting with the possibility. Some saw the specter of another decade like the 1930s.

But whatever had happened in Hoover's White House and Mellon's Treasury Department sixty years earlier, no one in the Bush White House or Treasury-or, for that matter, in the Federal Reserve of Alan Greenspan-was talking about stock market liquidation therapy or touting bank failure as the latest fashion in creative Darwinism. Not with the possibility of another huge speculative debacle. Besides, the president and his closest political ally, Secretary of State James Baker, were Texans who had watched bankruptcy and the failure of financial institutions cut a swathe through their home state business circles in the 1970s and again in the mid-1980s; it was no abstraction to them. And Greenspan, as a New York economist and money manager during the 1980s, had been a consultant to high rollers like Charles Keating of Lincoln Savings & Loan.

Tolerance for the purgative side of market forces was also fading politically; the bailout device had been gaining increasing acceptance in Washington for two decades. In the America of the 1890s and 1930s it had still been possible for large enterprises to fail. Since the 1930s, however, a new climate had emerged: small enterprises might fail- family farms, let us say, or local hardware stores-but not big ones. Lockheed was saved in 1971 under the Republicans, Chrysler in 1979 under the Democrats, Continental Illinois Bank in 1984 and several big Texas banks during the mid-1980s under the GOP. There would be many more in the late 1980s and especially in the 1990s, as banks and S&Ls by the hundreds had to be rescued by the ambulances of federal deposit insurance.

National leaders do not rush to say so, but the bailout of the early 1990s was the biggest in America's history. Bert Ely, a Virginia-based banking consultant, calculated that the percentage of total U.S. deposits held in financial institutions forced into FDIC and FSLIC rescues in the late 1980s and early 1990s exceeded the percentage of national deposits lost in the institutions that had failed outright and closed their doors in the late 1920s and early 1930s! This time, however, because of the hundreds of billions of dollars spent in federal deposit insurance bailouts, the financial dominoes did not topple as they had in the 1930s. Only a few pieces of the speculative framework collapsed; most of it survived. In the wake of the 1987 stock market crash, some observers had blamed the new electronic speculation techniques-so-called program trading and portfolio insurance. However, the curbs subsequently imposed were minor, so that spectronic devices continued to proliferate rather than being reined in by regulation. By mid-decade, derivatives and program trading were once again dislocating the markets. A similar point can be made regarding the 1989-92 bailout of financial institutions. Abuses were protected. Share-holders did not lose their shirts, and big depositors generally got paid off by federal authorities even when their multimillion dollar deposits were far above the insurable limits. As with the rescues of Lockheed and Chrysler, this was achieved with the public's money. Within a few years, not a few large financial institutions that had been on the edge of the abyss were making record loans to speculators-or speculating themselves.

Other important components of the bailout were less overt. The Federal Reserve, which had rescued the post-crash stock market with liquidity in 1987-88, came through again in 1990-91. Tumbling interest rates expanded the money supply. So-called overnight loans were made to troubled banks to keep them afloat. The Fed's action in driving down interest rates was a particular gift for two sectors: overleveraged corporations, especially those in hock from unwise leveraged buyouts, were able to refinance their debts, while shaky banks reveled in huge gains on the spread between high long-term interest rates and low short-term borrowing costs. This indirect assistance was almost as important as the institutional bail-outs. By the mid-1990s, banks and investment firms were not only liquid again, but had enjoyed several years of high profitability. The investment community also buzzed with another rumor that the Federal Reserve, sheltered in the secrecy of its unsupervised, free-from-audit status, had gone even further by quietly buying S&P 500 futures to prop up the stock market on critical days.

There can be no doubt: serious damage would have occurred had a willing Washington not joined with a worried Wall Street in history's biggest financial rescue mission. Large banks and corporations guilty of overspeculating and overleveraging would have gone under, as the capitalist process of destruction and renewal suggests they should have. The stock market would have plummeted; so would Wall Street's ascendancy. Instead, overleveraged firms that headed everyone's list of the living dead-from Citicorp, America's largest bank, to RJR Nabisco, the leveraged buyout made infamous in the late 1980s-survived after a year or two of grave-watching. Wall Street had a decent year in 1991 following a bad one in 1990. Then profitability mushroomed. The linchpin was unprecedented Washington-Wall Street collaboration. Through a combination of monetary policy favors from the Federal Reserve, help from the first White House in history headed by a president (George Bush) whose family members were mostly in the investment business, and collaboration by a Congress full of senators and representatives who knew the warm, tingly feeling of being able to count on top executives of Goldman Sachs, Bear Stearns, or Merrill Lynch for an emergency fund-raising dinner, the capital city extended the kind of help never seen in any prior downturn.

Cynics worried that the bailout itself was part of a new debacle in the making-a bigger speculative bubble blown up around the earlier one that came close to imploding. The lasting damage of 1989-92 had been confined to savings and loans and commercial real estate. Junk bonds and other speculative devices shuddered but recovered in 1991. The various stock markets bounced back. The shudder of 1990 turned into a 1991-92 surge: major indexes kept reaching new highs, with the help of interest-rate cuts from the Federal Reserve that forced Grandma and Grandpa in Fort Lauderdale to abandon certificate-of-deposit rates nearing 3 percent and put their faith in God and the Fidelity family of mutual funds. The Dow-Jones, the S&P 500, and the rest continued to set records even when the economic news was bad-and it made no difference to securities traders or brokerage analysts when the governor of the nation's most populous state announced that after two years, California was still in its worst downturn since the Great Depression. The truth behind a cloud of wordy explanations, was that the financial markets were riding on a different set of shock absorbers: unprecedented federal favoritism. Whatever might be happening to aerospace workers in Burbank or real estate developers in San Diego, bond traders and derivatives marketers thrived as declining interest rates took the pressure off speculative finance, liquidity kept flooding the system, and official Washington backed away from populist gestures.

Worry about a new speculative bubble was well founded. The excesses of the 1980s had only been camouflaged, not pruned. The concerns of the 1990s focused on the hundreds of billions of dollars chased out of bank certificates and accounts into rapidly swelling mutual funds, as well as the trillion-dollar uncertainties surrounding the new derivative products and techniques. Few senior managers fully understood the techniques, risks, or liabilities. E. Gerald Corrigan, the president of the New York Federal Reserve Bank, had warned in 1992 against the complexities and dangers of the new fad: "High-tech banking and finance has its place but it's not all it's cracked up to be...The growth and complexity of off-balance-sheet activities and the nature of the credit, price, and settlement risk they entail should give us all pause for concern." A year later, the International Monetary Fund issued a similar concern about the risks in derivatives such as futures contracts and currency and interest-rate swaps. But most of the financial establishment hastened to offer reassurances.

The second caution lay in the lingering two-tier quality of the economy after the great scare of l990-91. On one hand, the money that the Fed kept pumping out sloshed around the financial markets, pushing them up. But in the real economy, big companies kept announcing reductions of thousands-or tens of thousands-of jobs that no one expected to come back. Economists will never agree on what was happening. However, the case can be made that the unprecedented liquidity and favoritism extended to the financial sector, going well beyond the taxpayer bailout, served to further divide America into two economies. The self-corrective balance had been suspended. Major financial institutions, largely shielded or rescued from the prior decade's mistakes, entered the mid-1990s basking in record profits, political influence, and power. Much of the nonfinancial, noninvestor economy, meanwhile, was left sputtering along on three cylinders amid a pall of gloom over what the future had in store for Cincinnati and Los Angeles.

If this collaboration between government and finance was unprecedented in the twentieth-century United States, so was the scarcity of insistence on the kind of financial reform typical of a post-speculative era - the regulatory accomplishment of both the Progressive and the New Deal eras. Clinton had won the White House in 1992 as an outsider running on a relatively populist platform, including campaign speeches that used Wall Street and the University of Pennsylvania's Wharton School of Finance as backdrops for criticism of the financial elites for the greed and speculation of the 1980s. No one can be sure how much of it he meant. But even before the man from Arkansas was inaugurated, it was clear that strategists from the financial sector, more than most other Washington lobbyists, had managed the Bush-to-Clinton transition without missing a stroke. Well-connected Democratic financiers stepped easily into the alligator loafers of departing Republicans. The accusatory rhetoric of the campaign dried up. The head of Clinton's new National Economic Council, Robert Rubin, turned out to have spent the 1980s as an arbitrageur for Goldman Sachs. The unpurgable Washington was now being joined by part of what was beginning to look like an equally unpurgable Wall Street. Moreover, the distance between the two was narrowing every year as the financial sector turned its huge resources to cementing its influence in politics and public policy. Washington power brokers and exiting cabinet members, in turn, were coming to an important new realization: that the greatest rewards after high government service now lay in the big investment firms or in specialized financial boutiques rather than in law firms as of yore. Even the ambition of politicians was being financialized.