This is both good news and bad. The prevailing version of unfettered capitalism that Milton Friedman propagated and previous Federal Reserve Chairman Paul Volcker turned into official policy, posited that minimal regulation and easy money supply could spur infinite growth. After the end of the Cold War, over-zealous faith in capitalism led the West to discard many of the regulations on raw market forces. This boosted global growth — for a while. Over time, Wall Street’s greed and unchecked power turned unfettered capitalism into crony capitalism. And at every turn, the US financial policy was twisted to suit the demands of Wall Street. But markets, like water, find their own level. A correction was due, more sober experts warned, and when energy- and food-fuelled inflation raised interest rates in the US, the billions of dollars Wall Street and other financial institutions had irresponsibly sunk into subprime mortgages disappeared. The New York Stock Exchange alone has lost about $1.2 trillion in value.

It is now commonly agreed that unfettered capitalism is dead. But crony capitalism is well and alive, as evidenced by the Bush Administration’s failed attempt to prop up markets with $700 billion of taxpayers’ money. The bailout was perceived as the worst kind of corporate welfare programme. The heads of banks and Wall Street firms that created the crisis in the first place would have got the bulk of it. Ordinary Americans — struggling to make payments on their homes and facing large-scale unemployment as the economy is headed into a likely recession that could rival the Great Depression of the 1930s — would have got peanuts.

HARD TIMES: The New York Stock Exchange alone has lost about $1.2 trillion in value — money that was manipulated by irresponsible bankers but owned by ordinary folks, including their retirement funds (Bloomberg)

If finance is the grease that moves the wheels of global commerce, that grease has congealed: the system is stuck, and we have a crisis of confidence as no financial institution is willing to lend because of the risk of not being repaid. Take KfW, the German development bank: one evening just before the close of business, it paid Lehman Brothers $350 million in what was the first leg of a swap transaction, only to find out overnight that Lehman was forced to file for bankruptcy. To the already high counterparty risk, we can now add settlement risk.

Michael Hartnett, chief emerging markets equity strategist at Merrill Lynch in New York says the “financial freak show” has investors on the edge and asking what could be done to reverse the panic. “If the massive expansion of the Fed’s balance sheet and other central bank liquidity injections can’t do the trick, then coordinated global rate cuts become likely and necessary,” he says. Read that to mean more government intervention to save participants in a free market.

While no one has acknowledged it as such, there is a growing body of opinion that thinks that unfettered crony capitalism — of which the financial markets have been the greatest exhibit — has to end. But what will take its place?

First Came Greed...
The wheels of history often turn full circle. In the ‘roaring’ 1920s, unfettered capitalism led to the Great Depression, which in turn led then US President Franklin D. Roosevelt to introduce regulation of the financial system (as well the social security system). The lynchpin of this was the Glass-Steagall Act, which separated commercial banking from investment banking. For example, the Act broke up the House of Morgan and into two halves; Morgan Stanley, the investment bank and JPMorgan, the commercial bank.

Between 1988 and 1996, US Republicans made four attempts to weaken or repeal parts of the Glass-Steagall Act; all failed. But then Federal Reserve Chairman Alan Greenspan did what the US Congress did not. In 1990, the Fed allowed JPMorgan — a bank — to underwrite securities, something once the preserve of investment banks. The move snowballed. In 1995, then US Treasury Secretary Robert Rubin testified before Congress saying “the banking industry is different from what it was two decades ago, let alone 1933”. In 1996, the Fed allowed commercial bank affiliates to have 25 per cent of their business in investment banking-type operations. Later that year, Sandy Weill, who headed Travelers’ Insurance, proposed an audacious merger: of Travelers, with Salomon Smith Barney, one of the largest investment banks, and what was then the largest commercial bank in the US, Citibank. The merger would not have been possible without the repeal of the Glass- Steagall Act; so in 1999, the Financial Services Modernisation Act, also called the Gramm-Leach-Billey Act after its sponsors, repealed key parts of Glass-Steagall and became law (parts of the media called it Sandy’s Law).