The repeal of Glass-Steagall pre-dated the fall of the major investment banks, but these had not been its beneficiaries. Rather, the Gramm-Leach-Bliley repeal bill aligned the politics of all the financial players. Zingales thinks that this is one of the reasons we got Wall Street bail-outs. But that brings on public anger and populist politics. We are now, therefore, in a dangerous place.
We thus stand at a crossroads for American capitalism. One path would channel popular rage into political support for some genuinely pro-market reforms, even if they do not serve the interests of large financial firms. By appealing to the best of the populist tradition, we can introduce limits to the power of the financial industry — or any business, for that matter — and restore those fundamental principles that give an ethical dimension to capitalism: freedom, meritocracy, a direct link between reward and effort, and a sense of responsibility that ensures that those who reap the gains also bear the losses. This would mean abandoning the notion that any firm is too big to fail, and putting rules in place that keep large financial firms from manipulating government connections to the detriment of markets. It would mean adopting a pro-market, rather than pro-business, approach to the economy.
The alternative path is to soothe the popular rage with measures like limits on executive bonuses while shoring up the position of the largest financial players, making them dependent on government and making the larger economy dependent on them. Such measures play to the crowd in the moment, but threaten the financial system and the public standing of American capitalism in the long run. They also reinforce the very practices that caused the crisis. This is the path to big-business capitalism: a path that blurs the distinction between pro-market and pro-business policies, and so imperils the unique faith the American people have long displayed in the legitimacy of democratic capitalism.
Unfortunately, it looks for now like the Obama administration has chosen this latter path. It is a choice that threatens to launch us on that vicious spiral of more public resentment and more corporatist crony capitalism so common abroad — trampling in the process the economic exceptionalism that has been so crucial for American prosperity. When the dust has cleared and the panic has abated, this may well turn out to be the most serious and damaging consequence of the financial crisis for American capitalism.
Arnold Kling says: "What de-regulation"?