The Bailout State E-Book

Martijn Konings

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 406

Veröffentlichungsjahr: 2024

Beschreibung

How did we end up in a world where social programs are routinely cut in the name of market discipline and fiscal austerity, yet large banks get bailed out whenever they get into trouble?

In The Bailout State, Martijn Konings exposes the inner workings of this sprawling infrastructure of government guarantees. Backstopping financial markets and securing banks’ balance sheets, this contemporary Leviathan manages the inflationary pressures that its generosity produces by tightening the financial screws on the rest of the population.
 
To a large extent, the bailout state was built by progressives seeking to buttress the institutions of the early postwar period. The resulting tide of capital gains fostered an asset-centered politics that experienced its heyday in the nineties. But ever since the financial crisis of 2007-08, promises of inclusive economic growth have looked increasingly thin. A colossus locked in place, the bailout state disburses its benefits to a rapidly shrinking group of property owners.  Against the backdrop of a ferocious post-pandemic turn to anti-inflationary policy, the only remaining way to exit the logic of the bailout, Konings argues, is to challenge the monetary drivers at the heart of capitalist society.

Leseprobe

CONTENTS

Cover

Table of Contents

Endorsements

Title Page

Copyright

Dedication

Preface

Notes

1. How Did We Get Here?

Earning market confidence

The credit boomerang

From welfare to bailout state

Bailouts in the age of free markets

All Keynesians

Roadmap

Notes

2. What Keynes Missed

Keynesianism and the money question

The monetary/fiscal divide

Financial Keynesianism

Chronic inflation

Keynesianism in government

The inflation problem

Notes

3. How Welfare Capitalism Worked

New Deal reforms

Stagnation and war

The Federal Reserve refounded

Containing Keynesianism

White middle class

Notes

4. The Promise of Growth

Financial constraints

The power of credit

Financial transformations

Harnessing finance

Notes

5. The Inflation Decade

Challenging welfare capitalism

Conceptualizing stagnation

Democrats managing change

Reinforcing the supply side

Financial deregulation

Notes

6. Building the Bailout State

Resetting expectations

Stabilizing expectations

Separating the inflation cousins

Notes

7. Asset-Driven Growth

New Keynesians

The asset economy

The asset state

The Great Moderation

Expanding the bailout state

Notes

8. Bailouts and Austerity

Deploying the bailout state

Half-hearted stimulus

Leveraging public money

Wholehearted austerity

Notes

9. Locked in Place

The backstop state

Losing the middle class

Locked in place

Diagnosing stagnation

Notes

10. The Future of Bailouts

The return of inflation

A new supply-side Keynesianism?

Leveraged buy-ins

Implicated

Keynesianism for the twenty-first century

Notes

Postscript

Notes

Index

End User License Agreement

Guide

Cover

Table of Contents

Endorsements

Title Page

Copyright

Dedication

Preface

Begin Reading

Postscript

Index

End User License Agreement

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Praise for The Bailout State

“The Bailout State is a brilliant exercise in unmasking. With subtlety and sophistication, Konings cuts through both technical tangles and political mystification to open a path towards making a monetary architecture that spreads rather than concentrates wealth. A must-read for those seeking to understand – and to act on – contemporary capitalism.”

Christine Desan, Harvard University

“In this brilliant, lucidly written book, Konings offers a new understanding of the past in order to ‘re-see’ the present – and imagine a different future. The Bailout State unpacks the deeply imbricated relation between the state and finance in the modern era and shows how Keynesianism was repurposed to pave the way from the welfare to the wealthfare state.”

Katharina Pistor, Columbia Law School

“Martijn Konings’ The Bailout State offers a bracing and often infuriating account of how we ended up in a world where creditors are routinely offered state bailouts when their investments go south, but debtors and workers are routinely hung out to dry, especially when either inflation rises or the economy takes a nosedive.”

Nils Gilman, Chief Operating Officer and Executive Vice President at the Berggruen Institute, and co-author of Children of a Modest Star

“Martijn Konings delivers an ultimatum: if we do not confront how we are all both beneficiaries and captives of the bailout state, then we are getting nowhere.”

Quinn Slobodian, Boston University

“This brilliant book offers a spellbinding journey through the archives, hopes, and unconsciousness of the contemporary bailout state. What emerges is a Minskyan appreciation of the deep roots of stabilizing an unstable financial system which reveals postwar Keynesianism as a direct precursor to our own impasse. The Bailout State takes us to the very edge of this predicament and helps us see why we are stuck.”

Stefan Eich, Georgetown University

“CEOs pretend their wealth and power comes from self-reliance and entrepreneurship. But whenever things go wrong – as they regularly do – they run to the nanny state for an expensive rescue. In this elegant and timely book, Martijn Konings proves that bank and corporate bailouts are the rule, not the exception, of financialized capitalism. The misuse of massive public resources to save capitalists from themselves is a deeply ingrained tradition. Progressives must understand the nature and workings of the bailout state, in order to imagine and win a different one – and this book will help enormously.”

Jim Stanford, Economist and Director, Centre for Future Work, Vancouver

The Bailout State

Why Governments Rescue Banks, Not People

MARTIJN KONINGS

polity

Copyright © Martijn Konings 2025

The right of Martijn Konings to be identified as Author of this Work has been asserted in accordance with the UK Copyright, Designs and Patents Act 1988.

First published in 2025 by Polity Press

Polity Press65 Bridge StreetCambridge CB2 1UR, UK

Polity Press111 River StreetHoboken, NJ 07030, USA

All rights reserved. Except for the quotation of short passages for the purpose of criticism and review, no part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher.

ISBN-13: 978-1-5095-6433-0

A catalogue record for this book is available from the British Library.

Library of Congress Control Number: 2024937054

The publisher has used its best endeavours to ensure that the URLs for external websites referred to in this book are correct and active at the time of going to press. However, the publisher has no responsibility for the websites and can make no guarantee that a site will remain live or that the content is or will remain appropriate.

Every effort has been made to trace all copyright holders, but if any have been overlooked the publisher will be pleased to include any necessary credits in any subsequent reprint or edition.

For further information on Polity, visit our website:politybooks.com

Dedication

For my family

Preface

In September of 2022, The Economist declared that the world had entered a new era: “Bailouts for everyone!” According to this leading voice of the global business community, the colossal bank rescues in response to the financial crisis of 2007–9 had created a veritable bailout state. During the following decade, governments had failed to roll back these extensive public guarantees for private balance sheets. And during the Covid crisis, when governments had broadened the safety net to prevent the economic hit of the pandemic from turning into a severe economic downturn, the bailout state had positively gone “into overdrive.” “We are all bankers now,” The Economist lamented, as if the democratization of that profession were a self-evidently bad idea.1

The existence of this bailout behemoth, the magazine went on to argue, meant that those who thought they were living in a “neoliberal” era, governed by free-market principles, were mistaken. That was a remarkable conclusion. During the previous decades, The Economist itself had played a prominent role mainstreaming neoliberal ideas, urging governments everywhere to rescind innovation-stifling regulations and cut back public spending. However, it had no difficulty identifying the appropriate response to the realization that its work was not done, demanding that economic and political leaders everywhere redouble their efforts to rehabilitate the neutral wisdom of markets against overweening state institutions.

Progressives, by contrast, have had a much harder time figuring out how to relate to the bailout state’s sprawling infrastructure of backstops, subsidies, and guarantees. The left’s understanding of the past century has been deeply shaped by the assumption that the shift from Keynesian state intervention to neoliberal free-market logics has been effective and in fact transformed our society to its core. In that picture, the growth of a bailout state just has no real place.

The resulting blind spot has done much to confuse centrist and left-wing politics. Quick to assume that public things are worth supporting, progressives have often thrown their weight behind programs that benefit primarily business and the affluent. Of course, accepting an uneven distribution of benefits to secure some gains for the less well-off can be a rational political strategy. But in practice this has been a very slippery slope, as the terms of such lopsided compromises are typically quickly assimilated into the default configuration of economic policy. Before long, enormous corporate tax breaks and financial market backstops sit below the public’s field of vision, attracting nowhere near the level of attention that comparatively inexpensive social programs do.

Getting the whole bailout edifice into view requires that we retrace how it was built. Only then can we understand how it became untethered from the political objectives that once drove its expansion, and what that growing disconnect means for the present.

The bailout state has deep historical roots. While its expansion to a size that makes it impossible to ignore occurred in recent decades, much of the scaffolding was put in place during what we remember as less economically tumultuous times. From early on in the post-World War II era, public underwriting of private financial risk was a key means for governments to manage the contradictions of welfare capitalism. As it proved an effective way to stabilize the economy and protect select constituencies from the effects of downturns, practices of risk socialization came to reshape the logic of economic policymaking from the inside out. There were significant side effects, however. Chief among these was inflationary pressure – the inevitable result of spreading downside risk across society without doing the same for upside exposure.

For progressively minded people of a certain generation (my own, in any case – old enough to have some sense of historical longue durée, but too young to recall a time when inflation played havoc with our parents’ household budgets), the idea of inflation has, until recently, always been abstract and hypothetical. Instead, we have tended to ridicule this peculiar obsession of economists, likening it to a professional deformation. But, while adopting a more nonchalant attitude, we have often ended up using the same technical language and narrow definitions that mainstream economists use to think about inflation, obscuring what is at stake.

Developing a better language to talk about inflation requires some work. This book considers why it has been such a challenge for progressives – specifically, why it was so easy for Keynes to miss its full significance and how it went on to bedevil the Keynesian tradition. Keynes and many of his followers never fully broke with traditional theories of money, which tend to think of it as a freely available infrastructure for private commerce, with any malfunctioning the result of external forces. Such a perspective makes it difficult to recognize inflation when it becomes a chronic affliction, as it would during the twentieth century, not generated by policy mistakes but embedded in the most basic operations of economic life.

Conservatives have typically advocated fighting inflation with monetary contraction and fiscal austerity, but such policies posed a threat to key parts of the progressive agenda. To undercut inflation in different ways, postwar Keynesians looked to supply-side measures such as tax breaks and investment subsidies, intended to incentivize business into delivering economic growth free of inflation. Such policies were expensive and made the impact of economic policy far less egalitarian, but they rarely did much to bring down inflation. Public generosity towards business was invariably followed by measures to tighten the monetary and fiscal screws elsewhere in the system.

By the 1970s inflationary pressures had become difficult to contain, and it proved fertile ground for the rise of free-market ideology. But even though the neoliberal program has reshaped the world in numerous ways, its accomplishments have never included a shrinkage of the bailout state. To the contrary, over the past half century derisking policies have been consolidated into the baseline settings of economic policymaking. And they have been allied to a semi-permanent austerity agenda that has, on the whole, been highly effective – at times too effective, as we will see – in managing inflation.

Just as the dance of bailout and austerity already shaped the landscape of welfare capitalism well before neoliberals ever appeared on the scene, so the expansion of the bailout state during the past decades has enjoyed significant progressive credentials. The stabilization of a growing financial system bolstered, for some time, a middle-class politics that increasingly centered not on wage growth but on asset appreciation and capital gains. It experienced its heyday in the 1990s – a decade that has recently replaced the 1950s as the object of middle-class nostalgia.

Following the 2007–9 crisis, the ties that had bound the expansion of the bailout state to the advancement of broader social and political objectives came undone. Large banks and other too-big-to-fail institutions had long benefitted disproportionately from the arrangement, but since the Global Financial Crisis the bailout state’s disbursements have flowed almost exclusively to Wall Street and its clients, benefitting a steadily shrinking group of ever-wealthier property owners. Promises of inclusive economic growth have looked increasingly thin.

True to its laissez-faire roots, The Economist occasionally expressed worry that a financial system depending so heavily on political grace and favor could lose legitimacy and invite ill-advised left-wing experiments. The economic policy response to the Covid crisis provided a taste of what that could look like, a glimpse of what could happen if the democratic public were to get its hands on the machinery of the bailout state. In fact, The Economist had neatly timed the announcement of its discovery to coincide with coordinated action by central banks around the world to get a grip on resurgent inflation, seeking to legitimate renewed financial austerity by publicizing neoliberal common sense. How could an economic system providing everyone with a bespoke bailout not be inflationary?

That question, however, does not have to be asked in a purely rhetorical register. It has actual answers, and one does not have to look too far back in history to find examples of how one can expand the remit of public generosity without undermining the stability of the monetary standard. In recent years, that point has been pressed by Modern Money Theory (or Modern Monetary Theory, but either version is better known as MMT), a theoretical framework that has existed for some time but rose to prominence as during the 2010s the policy formula of “bailouts for banks, not people” became more flagrantly absurd. When inflation made a comeback in the midst of the pandemic, and mainstream economists demanded sacrificial austerity, MMT proponents like Stephanie Kelton pointed out the hypocrisy.2

The idea of democratizing the banking profession is not as absurd as The Economist would have us believe. As Hyman Minsky, an economist whose work has deeply shaped the ideas presented in this book, put it, we can all issue an IOU – the trick is to get people to accept that note in payment for other debts without demanding a massive discount. The rules that determine whose debts get to circulate at par are shaped not by timeless economic laws, but by social conventions and political forces. Those rules will continue to evolve, and the only real question is how – whether they will evolve to drive an evergreater concentration of wealth, or if democratic publics will find ways to put in place protocols to spread wealth.

The story told in this book concentrates on the United States. As Leo Panitch and Sam Gindin have argued, the twentieth century’s wave of working-class revolutions was managed by a new imperial system that had its apex in the American state.3 Even the public welfare states that arose in Western Europe, often held up as an alternative to American capitalism, were only viable because they occupied a particular, highly privileged place in the global dollar order. Contrary to the expectations of many observers, the past decades have not eroded but intensified the dependence of the global political economy on the dollar system. As Adam Tooze has shown, that trend accelerated following the Global Financial Crisis, and during the Covid crisis the American central bank led global recession-fighting by extending support to other nations’ central banks and treasuries.4 Just as the dollar is the world’s money, the US government manages the world’s bailout state. In the next chapters, we will see how the bailout colossus was built.

Notes

1.

“The World Enters a New Era: Bail-outs for Everyone!”,

The Economist

, September 25, 2022.

2.

Jeanna Smialek, “Is This What Winning Looks Like?”,

New York Times

, February 7, 2022.

3.

Leo Panitch and Sam Gindin,

The Making of Global Capitalism: The Political Economy of American Empire

, Verso, 2013.

4.

Adam Tooze,

Crashed: How a Decade of Financial Crises Changed the World

, Penguin, 2018; Tooze,

Shutdown: How Covid Shook the World’s Economy

, Viking, 2021.

1How Did We Get Here?

As the end of the Covid pandemic came in view, the world was confronted with another emergency: the return of inflation. Before anyone had caught on to what was happening, the purchasing power of the average family had shrunk by several percentage points. By early 2022, inflation was a headline issue. As price rises ate away at spending power, pundits debated what was to be done.

For a while, the argument that inflation was “transitory” – a temporary effect of the supply-chain disruptions caused by the pandemic – had significant traction. But as inflation refused to die down, “hawkish” voices soon dominated the conversation. They urged the Federal Reserve, as well as other central banks around the world, to act decisively and to slow down economic growth by raising interest rates.

More “dovish” commentators objected that this would have a devastating impact on employment and income, dealing yet another blow to American families recovering from the pandemic. They pointed out that the American economy was not yet experiencing a wage–price spiral like that of the 1970s. Back then, unions had demanded wage rises to compensate for the rising cost of living and so made the inflation problem worse. Fifty years later, with unionization rates a fraction of what they were, workers were in no position to demand compensation for anything.

Such arguments were to no avail. The Federal Reserve is legally responsible for ensuring price stability, and it has only one instrument to do so. In March of 2022, it started raising interest rates, rapidly increasing the federal funds rate from its historic low of zero to over 5 percent. In essence, the Federal Reserve tried to engineer an economic recession.

As is so often the case, the consequences have fallen disproportionately on those who have least to fall back on. There is, however, something unique about the current crisis: its effects have gone right to the heart of middle-class life.1 We are in the midst of what has been dubbed a “cost of living crisis.” Amidst declining real incomes, rising energy prices, and increased mortgage payments, it is only the most affluent who escape the pocketbook squeeze altogether.

As this crisis took shape over the course of 2022 and 2023, many left-wing commentators continued to point out the growing evidence that inflation was being driven not by wage growth but by energy shocks and staggering corporate profits. And they insisted that workers should not be made to bear the brunt of a crisis they had not caused.

From the Federal Reserve’s point of view, such objections were largely beside the point. Regardless of what may have triggered inflation initially, the danger was that inflationary expectations could take hold and set in motion a self-perpetuating spiral. That the logic of expectations could be a powerful force not only in wage demands but also in corporate price setting is not thinkable within the framework of modern, mainstream economics.

This gave rise to some strange intellectual acrobatics. On Twitter, Olivier Blanchard, former chief economist of the International Monetary Fund, worried about the practical difficulty of persuading workers that higher unemployment was necessary to control inflation in a situation where wage rises were not responsible for inflation.2 When his comment set off a storm of ridicule, he quickly apologized for the unfortunate phrasing, stressing that he too lamented the fact that the Federal Reserve only had the one blunt instrument for managing the price level – but he stuck to his point.

In other hands, this same line of thinking took on meaner qualities. Throughout 2022, Larry Summers – another leading Keynesian economist, who had occupied key economic policy positions in both the Clinton and Obama administrations – had urged the Federal Reserve to pursue its anti-inflation program more energetically. Moderation and gradualism could only provide false comfort.

Summers was not afraid to put numbers on it, either, demanding specific percentages of unemployment for set periods of time. His interest in sorting human livelihoods on the basis of back-of-the-envelope calculations seemed to take economic expertise beyond its reputation for cheerlessness into a more sinister realm. But Summers was only spelling out, in unpleasant detail, what it meant to think about inflation in the way that had been so widely endorsed by the mainstream media.

In early 2023, Summers went on Bloomberg TV to express his satisfaction that the Federal Reserve had come to accept his view on the seriousness of the situation. Zooming in from a tropical beachside location, he intoned once again that “there’s going to need to be increases in unemployment to contain inflation.”3 Soon after, in a widely publicized interview with comedian Jon Stewart, Summers likened himself to a doctor prescribing medication that would have side effects. Obviously, he wished he could spare his patient the side effects – but there was simply no alternative. In fact, if it was important to assign blame, it should be placed squarely on the spendthrift Biden administration – if you keep running the water, the bathtub will eventually overflow. But this was all just crying over spilled milk, a distraction from what needed doing.

If hard-nosed discipline was the cure for the economy as a whole, sometimes economic necessity pointed in another direction. When, in May of 2023, the Silicon Valley Bank was about to fail, Summers urged the government to step in and provide guarantees for the bank’s financial commitments. Although he expressed some doubt that the failure of the bank would have a particularly broad impact, he nonetheless insisted that a blanket of public insurance to cover both SVB and any other exposed institutions was required to maintain the confidence of financial markets.

Summers understood all too well that a bank bailout will draw significant criticism at the best of times. And this was a bailout for a bank serving the most affluent Americans at a time when the population at large was being forced to tighten its belt. So, preemptively, he warned people not to succumb to the temptations of populism. Now was not “the time for moral hazard lectures or for lesson administering or for alarm about the political consequences of ‘bailouts’.”4

Why did the emergency of SVB justify taxpayer assistance, while the financial distress of ordinary Americans warranted nothing but further austerity and discipline? Even Forbes Magazine, a business publication perhaps best known for its annual ranking of billionaires, was getting a little lost. Had not the same Summers recently argued passionately against student debt forgiveness, rejecting it as a bailout that would introduce perverse incentives into young people’s menu of choices?5

The tendency among non-economists and the general public is to assume that, even if the apparent inconsistencies of their thinking confuse us, people like Summers understand something about how money works that we do not. But what if that is not the case? What if the hard-nosed realism of America’s leading economic commentator is simply an elaborate web of rationalizations and excuses hiding the fact that there are in fact no good reasons to reserve bailouts for the affluent?

Earning market confidence

The worldview of economists like Blanchard and Summers says that there exists a “natural” rate of unemployment. If unemployment falls below that rate, it will produce upward pressure on the general price level; and if it goes over, the result will be deflation. When they talk about “full employment,” they don’t have in mind an economy where everyone who wants a job has one. What they mean is a level of unemployment that is consistent with price stability (or, more specifically, with a low and stable level of inflation).

That there exists such a level of unemployment is one of the key tenets of contemporary economic orthodoxy, New Keynesianism. What is that magical number? Nobody knows: formal estimates have closely tracked actual unemployment rates. The “non-accelerating inflation rate of unemployment,” better known as the NAIRU, is a fiction, invented by modern-day alchemists. To be sure, the basic idea itself has a long history. The notion that capitalism requires a “reserve army” of surplus workers is often considered to be one of Marx’s most radical ideas. However, suitably rephrased, it would have been perfectly comprehensible to almost all political economists of the nineteenth century. Without an oversupply of labor, wages are likely to increase, workers will not be as productive, and prices will be higher.

Nineteenth-century British political economists generally held that there existed a “wage fund,” a specific amount of money that could be spent on wages without upsetting the laws of economics. Such thinking started to shift only towards the end of the nineteenth century with the rise of modern, micro-level economic analysis – so-called “neoclassical” economics, which concerns itself with how supply and demand are balanced in specific markets. It fostered the notion that labor was like any other commodity, and that labor markets should clear like any other market.

The rise of organized labor gave the idea of full employment political teeth, and mass unemployment during the Great Depression propelled it to mainstream respectability. The existence of unemployment was the central concern of the most influential economics book ever written, John Maynard Keynes’ The General Theory of Employment, Interest and Money.6 For Keynes, there existed no more severe indictment of capitalism than its tendency to force idleness on people. He tasked governments with ensuring full employment, urging them to use their powers of taxing and borrowing to compensate for capitalism’s failings.

In the wake of the Great Depression, when unemployment reached unprecedented levels, political movements in several countries tried to make full employment a binding government objective. In the United States, a powerful push emerged to make permanent the state of real full employment that had arisen during the war. Recognizing what was at stake, business and conservatives fought it tooth and nail.

Had the movement for a full employment guarantee succeeded, postwar history would have looked very different. It would have forced the US government to manage inflation not by cutting spending, restricting credit, and pushing up unemployment, but through the kinds of price controls that were in place during the war. In that alternative history, the Federal Reserve would have remained a largely obscure regulatory agency, and we would be unlikely to know the name of its chairperson. To be sure, the 1946 Employment Act was hardly a victory for the capitalist class. But it forced the labor movement to accept trade-offs, and it shifted from strategies to expand the circle of solidarity towards an insider–outsider politics that aligned with America’s racial divide.

The benefits for those who enjoyed the protections of powerful unions were real. Wage labor was no longer a marker of second-class citizenship but a ticket to a middle-class lifestyle. For a broad middle class, it became possible to build up property through waged work and to map out what sociologists referred to as a “life course,” a privilege previously reserved for the bourgeoisie. The result was a society that could be depicted in the image shown below, a poster used by the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO) in the 1950s. It shows the living wage as the rock of American of society: family, community, and business were all built on the foundation that it provided.

For progressives, the early postwar period has always remained an important point of political orientation, a normative ideal. It showed, they claim, that a civilized capitalism is both possible and desirable. Needless to say, business leaders would always have taken issue with the AFL-CIO poster. But still, it captured a legitimate position in the mainstream debate. That is no longer the case. In the present, the logic depicted in the image simply no longer “makes sense.” To endorse it is to advertise one’s economic illiteracy. Even many labor leaders are likely to accept that wage growth can only ever be an effect, an outcome of economic growth or productivity increases – that wages are built on the strength of business, not vice versa.

Source: Division of Political History, National Museum of American History, Smithsonian Institution.

Of course, it is less and less clear what the business of America and other Western countries actually consists in. The time that we worried about the ability of manufacturing companies to remain competitive is long gone, a quaint concern of the 1980s. Instead, the concern is with “market confidence”: whether investors feel sufficiently optimistic about the future that they can resist the temptation to sell and cash out. Such confidence is easily damaged and not easily restored. That is how the logic of expectations works – sometimes it’s more akin to gossip and rumor than rational economic judgment. The volatility of financial sentiment has replaced the security of the living wage as society’s foundation.

On its face, the demand that we reorganize how our society works around the mercurial opinions of traders and investors might seem a little extravagant. But Summers’ worldview was shaped during the roaring nineties, when he was part of the Clinton administration’s economic policy team. Then, he had witnessed up close that when a government has the strength to stop promising handouts and free lunches, rewards will soon follow. After the hard work of financial belt-tightening was done, the second half of the 1990s saw low inflation, a rapid decline of unemployment, and booming asset markets that benefitted many working families.

So, when Summers was Treasury Secretary in the first Obama administration, the game plan was clear. That administration came into office at the height of the Global Financial Crisis, and it stabilized the financial system by bailing out the banks. That was expensive, but Obama’s economic team recognized the importance of paying one’s bills. Indeed, being better stewards of the nation’s public finances than profligate Republicans had become a major point of pride for Democrats. And so, the bailouts were followed by drastic cuts to other parts of the public budget.

But no economic boom like that of the 1990s ever materialized. Supported by the Federal Reserve’s asset-purchasing programs that went under the name of “quantitative easing,” asset markets did well – very well. But capital gains were far more concentrated among the wealthy than they had been before the financial crisis, and they did not produce a broader “wealth effect” or drive general economic growth. Faithfully pandering to the whims of the marketplace no longer produced economic magic.

The absurd spectacle – lavish government assistance for the affluent, austerity for the rest of the population – sent a wave of anger through American society. The wildly different forms that such discontent took (the misgivings of Occupy Wall Street protesters often sounded remarkably similar to the concerns of Americans who joined a local Tea Party chapter) have posed a major puzzle for electoral analysts and others trying to understand the logic of Americans’ political affiliations. But few any longer doubt that escalating inequality and political instability are connected.

After the financial crisis, progressives had hoped for a new beginning, and in the historic election of Barack Obama they yearned for the birth of a second New Deal. But by the end of Obama’s presidency, the net worth of the average American household was lower than it had been two decades earlier. Meanwhile, the asset portfolios of the wealthy had gone from strength to strength. Thomas Piketty’s unlikely bestseller Capital in the Twenty-First Century distilled the zeitgeist into a long series of charts, each showing the concentration of wealth in the hands of a steadily shrinking number of people.7

The weakness of the broader economic recovery was a source of tremendous confusion for Obama’s economic policy team. What had gone wrong? How could it be that the austere management of the public finances had failed to generate strong economic performance? What was never on the table was the way of thinking depicted in the AFL-CIO image: starting with a living wage, and then building other economic institutions around it.

The election of Donald Trump became a lightning rod for progressive concerns about the state of the republic and the world at large. It appeared both to symbolize and to consolidate the conquest of democracy by moneyed interests, in the most obscene way possible. But the roots of our troubles go much deeper.

The credit boomerang

In some respects, postwar welfare capitalism is better seen as a Faustian bargain than as a limited victory or a stable compromise. The steady jobs and manicured lawns of the middle class were themselves built on foundations that make no appearance in the AFL-CIO’s image of postwar society, above all severe racial inequalities.

Keynesian economists in the Kennedy and Johnson administrations worried about the concentration of disadvantage in a racially defined underclass. Their answer was to put economic growth at the center of their policy program. Wasn’t that exactly what Keynes had recommended three decades earlier? In a sense, yes. But for Keynes the program had seemed straightforward: the government needed to step in and use its budget to compensate for the shortfall in aggregate demand.

The main obstacles that Keynes discerned in his own time consisted in the strength of outdated laissez-faire ideology, the aristocratic power of rentiers, and the fetishistic attachment to the gold standard. In the early postwar era, each of these obstacles seemed to have disappeared. And yet the implementation of a demand-oriented growth program was fraught with difficulties. Specifically, inflation invariably reared its head well before the economy reached a state of full employment.

Postwar Keynesians (known as “neo-Keynesians” for how they translated Keynes’ insights into the formal demand-and-supply models of neoclassical economics) embarked on a long search for the missing ingredient, the key to non-inflationary growth. Increasingly preoccupied with the supply side of the economy, they developed an ever-expanding array of tax breaks and subsidies, hoping to incentivize corporations into making different investment and pricing decisions.

But there were no easy solutions. Supply-side politics has always been something of a bottomless pit: the more it has failed to be effective, the more plausible capital’s insistence has been that taxes are still too high, investment incentives not sufficiently generous, and labor too expensive for what it offers.

In their search for non-inflationary growth, time and again reformers ended up looking to finance, especially mortgage credit. In our own time, finance is seen as either hero or villain, an agent of market perfection or a parasite on the body economic. But progressives of the early twentieth century did not necessarily think that way.8 They viewed finance as a set of rules for economic life. Like all human institutions, it was both imperfect and susceptible to improvement. Finance was the nervous system of the economy, and adjusting its operating parameters could be a powerful way to change the behavior of the system for the better.

Marriner Eccles, an avid New Dealer who served as chair of the Federal Reserve from 1934 to 1948, referred to the government subsidization of lending as “the wheel within the wheel to move the whole economic engine.”9 Everyone could be happy about credit expansion: it provided new opportunities without making anyone worse off. If borrowers paid off their loans on time, there would be no reason for credit growth to be inflationary – it was just a matter of bringing opportunities forward in time.

Credit allowed workers to become owners. The reforms of the 1930s and 1940s created pathways from wage labor to property ownership – phenomena that had, until that point in history, rarely mixed. Our tendency to picture mid-twentieth-century capitalism with images of smokestacks and assembly lines notwithstanding, the postwar order did more to democratize rentiership than to euthanize it.

However, capitalism’s financial nervous system turned out to have its own logic after all. It was entirely capable of fueling inflation. But maintaining the constellation of credit programs and fiscal subsidies supporting the aspirations of a broad middle class was imperative. Instead, inflation was managed by shifting economic pressures away from the white middle class onto minorities. The Federal Reserve could tighten credit to slow down economic growth, and the resulting unemployment largely bypassed workers organized in powerful unions, always hitting minorities in insecure employment hardest.

As long as each new backstop was matched by the application of austerity elsewhere in the system, inflation could be held at bay. Keynesian economists rationalized the situation by redefining full employment as a specific level of unemployment, setting in train the process that over time resulted in the NAIRU.

For several decades, credit growth allowed Keynesians to foster generalized economic growth when their other policy instruments were failing. The unwanted side effects were real but, when seen from society’s center, appeared delayed and diffuse. By the 1970s, however, it worked like a boomerang, instantly creating as many new problems as it solved.

When the Federal Reserve came to the general public’s attention in the 1970s, it appeared as a paradoxical combination of independence and helplessness. It enjoyed significant autonomy from other government bodies, and it was in no way accountable to the elected representatives of the American people. But, despite this tremendous freedom of action, it was unable to do the one job it had – control inflation.

In that context, real full employment re-emerged as a political objective, propelled by an alliance that challenged the divide-and-rule tactics of the post-New Deal state. An enforceable right to employment would have disabled the Federal Reserve’s ability to inflict austerity in compensation for backstops and bailouts.

But the social and political landscape of the 1970s was different from that of the 1930s and 1940s. A middle class had grown up that owned houses and had pensions, and Keynesians had lost the ability to see how an economy of actual full employment might be run. Especially after Nixon’s experiment with price controls, such policies had become inconceivable – emergency measures acceptable only in wartime. Democratic politicians found themselves highly receptive to the arguments that the business community lobbed into the political arena. Those centered on the effects of outdated financial regulations, which were held responsible for weak investment and high unemployment.

The drive for a full employment guarantee was defeated, and Democrats and Keynesians did much of the heavy lifting. The watered-down legislation that was eventually passed – known as the Humphrey–Hawkins Act of 1978 – restated the Federal Reserve’s responsibility for both employment and price stability. But it did nothing to make the conflict between these two objectives more manageable. And it did much to legitimate the idea that the Federal Reserve had no choice but to focus on controlling inflation first and foremost.

Humphrey–Hawkins required the Federal Reserve to become less secretive. It instituted biannual Congressional hearings, where lawmakers would interrogate monetary policymakers about why and how they were letting down the American people. The new Act did not do anything to resolve the Federal Reserve’s dilemmas, but it did expose the institution to the glare of public opinion, putting more pressure on it to exercise agency where it could.

From welfare to bailout state

Paul Volcker was appointed Federal Reserve chairperson after he assured Jimmy Carter that he would do what it took to conquer inflation. The significant pain that his policy would inflict was regrettable but unavoidable – his predecessors had allowed the problem to get out of hand. They had let the Federal Reserve get roped into maintaining an ever-expanding safety net, with generalized inflation as the unsurprising outcome. Volcker kept his word, and skyrocketing interest rates soon plunged America’s economy into a ferocious recession.

He did not imagine that he could solve the problem on his own. He could help to reset expectations, but unless it was followed up by a broader process of adjustment, a program to truly break the back of inflation, it would only provide temporary respite. Volcker was not naïve about what it would mean: “The standard of living of the average American has to decline.”10

Whereas mainstream economists think of Volcker’s policy turn as the inauguration of a golden age of inflation targeting and neutral money, left-wing critics have described the same event as a frontal attack by capital on workers, democracy, and the welfare state. Such arguments have the virtue of highlighting the political stakes. But they greatly overestimate the precision of the Federal Reserve’s policy tools. The Federal Reserve sets some of the main parameters for the operation of the American (and global) credit system. But it is not able to directly set employment levels or other macroeconomic indicators, and it is also not able to ensure that wide swathes of the business community will not get caught in the gears of a financial contraction.

If Volcker’s program was class war, it was so in a very indirect way. During the 1980s, a seemingly unstoppable wave of failures rippled through the American economy. As the number of failures increased, it became clear that some banks were “too big to fail”: their failure would have dragged down wider parts of the economic system. Volcker had always understood that the key nodes of America’s financial system could not be allowed to collapse. The point of his policy shift was to stabilize the American currency, not to undermine it.

Volcker had put an abrupt end to the expansive, open-ended socialization of risk. But something, a more selective regime, needed to be put in its place. After-the-fact bailouts could only bring so much order to the system. They did not provide much “forward guidance,” as we would now call it. The bailout of the mortgage sector during the late 1980s provided some clarity. An extraordinary amount of financial mischief had been pursued in what most Americans thought of as a wholesome, community-oriented sector. To let these institutions go to the wall would have been to punish the American middle class for the exploits of financiers. And so, the American government rescued not a specific firm but an entire financial sector.

Somehow, inflation did not return. During the previous years, a great deal of deadwood had been flushed out of the system. More importantly, the Reagan administration had worked hard to deliver on Volcker’s declaration that the American standard of living needed to decline. Embattled unions were struggling to keep the deals they had and to prevent their plants from closing.

With Greenspan at the helm, the Federal Reserve became more and more comfortable with the logic of backstops and bailouts. The expectational regime became clear to the markets, if not always to social scientists and other onlookers: the public protection one will be able to claim is proportional to the threat one poses. With a government floor under asset markets, finance took the lead. A lackluster and uneven recovery morphed into the roaring nineties.

It took Clinton a little while to recognize history’s gift. His initial plans had revolved around a radicalized supply-side Keynesianism, whereby the government would invest heavily in infrastructure and training. It had taken significant pressure from the financiers in his administration, led by Summers’ mentor Robert Rubin, to convince Clinton to step back from those ambitions. But he was eventually convinced that the asset-driven growth of the 1990s, distributing its fruits to a broad middle class, was due to the budgetary rectitude his administration had displayed.

Critics never stopped pointing out that the tail was wagging the dog, that the dominance of finance over industry was not a sustainable basis for economic growth. They often invoked Keynes’ dictum that “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlwind of speculation.”11

These same critics pointed out the hypocrisy in the austerity recipe. It never seemed to apply to items favored by conservative political sentiment, such as America’s rapidly expanding prison complex or the military. More flagrantly, the very same bankers who insisted aggressively on public austerity were quick to demand and receive government assistance when times got tough – they were benefitting from exactly the kind of Keynesian government programs that their free-market dogmas declared anathema.

But the wave that the New Democrats were riding had longevity. Spectacular bailouts themselves became episodic. Far more significant was the growth of a web of subsidies and backstops, all uncertainly situated at the intersection of the public and private spheres. A drip-feed of liquidity support stabilized expectations and sustained asset prices. Again and again, the critics of “speculative bubbles” were left looking like desperate doomsayers.

Economic success made for ideological thickening. New Keynesianism, which emphasized the importance of “anchoring” inflationary expectations, migrated from academic theory to the public sphere. The financial safety net did not appear in its models. But it fully accepted the existence of a natural rate of unemployment. Left-wing critics have often been tempted to set this way of thinking aside as little more than Keynesian retreat in the face of the conservative Reagan revolution. But that is to downplay the energy that it brought to the reformulation of Keynesianism, and the political purchase that its promises of synergistic, inclusive, and non-inflationary growth found.

Bailouts in the age of free markets

If the bailout state is such a sprawling behemoth, why has it been so hard to see? Of course, specific groups often have reason to divert attention from the policies that benefit them. Furthermore, the bailout state works through expectations, mental maps of the future that often remain invisible. But those considerations apply to many institutions. Even experts may struggle to understand the complex details of their operation, but it is rarely reason to overlook them altogether.