David Stockman's dystopiaApril 4, 2013: 6:38 AM ET
Ronald Reagan's former budget director, David Stockman, talks about his new book, what Republicans got wrong, and why private equity is the great deformation.
FORTUNE -- The sun shines on David Stockman, streaming through floor-to-ceiling windows in a conference room high above Midtown Manhattan. Stockman, 66, is smiling, thoroughly relishing our conversation about his new book, The Great Deformation: The Corruption of Capitalism in America. It's a 700-page polemic full of doom and gloom with something for everyone to hate, including Republicans, Democrats, central bankers, and Wall Street executives of all stripes. He calls them out for destroying the economy and the country, each in their own special way.
In a nutshell, Stockman lays out a painstaking account of how the country has deformed over the last 75 years. The title of the book is a riff on the Great Depression, which encouraged government growth and activist fiscal policy in a way that he says deformed "the two institutions that modern life depends on," politics and free markets.
In Stockman's estimation, Richard Nixon and Ronald Reagan manipulated central bankers and federal budgets to burnish their reputations and strengthen their political influence. Subsequent presidents continued to embrace Keynesian economic policy -- explicitly on the left and covertly on the right -- to hide the fact that the real economy was weak. The true beneficiaries have been the military industrial complex and Wall Street. He mourns the passing of the gold standard. He wants to shutter the Environmental Protection Agency, slash the defense budget, and regulate Wall Street.
In the book and in conversation Stockman gleefully rips apart Hank Paulson, Alan Greenspan, Ben Bernanke, and Tim Geithner. He ruefully shreds the legend of the Reagan Revolution. He just cannot stand Willard M. Romney and the Wall Street machine that Romney represents, spending a hundred pages comparing the former presidential candidate to Jim Carrey in The Truman Show. Not to leave anyone out, he holds Barack Obama up as a paragon of crony capitalism.
The Great Deformation is like a funhouse mirror version of Stockman's own career, where his greatest accomplishments are -- to use a favorite Stockman word -- shibboleths. As an undergrad at Michigan State he protested the Vietnam War and was a member of the left-wing activist movement Students for a Democratic Society. After a turn at Harvard Divinity School, he served as U.S. Congressman from Michigan from 1977 until 1981, when he resigned to serve as Ronald Reagan's budget director. He worked at Salomon Brothers and The Blackstone Group (BX), and then formed his own private equity firm Heartland Industrial Partners. (The government investigated Stockman after Heartland's portfolio company Collins & Aikman filed for Chapter 11 but decided not to prosecute him.)
Indeed, a true despair lies beneath Stockman's pointed critiques.
"Well, I guess you could say that I'm pessimistic. The book is pessimistic. It's revisionist history that says we're not just going on some progressive path to bigger and better things, more prosperity with a stronger social order, financial system, opportunities and so forth.
"We've been living on borrowed time, borrowed money. And this is catching up with us. When the sins become this great, this massive, this ... you have to pay for it. So therefore the whole book is to say there really isn't much hope. We're at the Sundown era. But I wanted to end it by saying, yes, there are some ways out of this massive -- let's say, box canyon that we're in. But those solutions are so radical that in light of everything the reader would have read to that point about what went wrong, and the way the system deformed over decades, it's pretty obvious that most of them can't be done."
Clearly Stockman has a lot to say. But following a bombastic op-ed in the New York Times called "Sundown in America," he was quickly dismissed as a delusional goldbug , a crank, an empty ranter, and a parody of the iconoclast he used to be. No matter what you think of Stockman, he knows how to make people react.
The following are excerpts from his conversation with Fortune:
Why write this book? There have been countless financial crisis post-mortems.
The Keynesian state has failed. Washington used the central banking branch and the Treasury to flatten the business cycle. It led to an apparent prosperity that the world had never seen before in the 1990s and the first seven years of this century. But it wasn't real. The financial crisis was a wake up call.
There's a notion that the Wall Street meltdown, Lehman and so forth, was like a comet from deep space that hit the earth. The government responded immediately. Bernanke was a hero. Paulson pulled a near coup d'etat in D.C. to stabilize the system. And this horrible thing was stopped cold.
I just knew it wasn't right. Washington simply doubled down on what caused the crisis -- low interest rates and and crony capitalism, the very things that led to a failing, bankrupt, paralyzed state.
Then it was clear to me that the financial crisis needed context. It needed history. We needed to understand how we got to a point when this could be taken seriously by Washington. It's how the book got to be so long, but I wanted to show that this didn't just happen overnight.
Your description of this process seems akin to recency bias -- where you base what you should do in the future on the most recent results.
Yes. That's why I had to go back to periods in history where things that we believe today would have been thought to be utterly ridiculous or complete apostasy. I wanted to show that the most recent ways are not necessarily the correct ways to do things. Low interest rates are just taken for granted because ideology seeps into the daily churning of the system and the discourse. We're so short-term-oriented because of the way the media works today. After a few weeks or months or years of a behavior, what would have been radical in 1990 or 1998 even is taken as a fact of life.
Recency bias has hurt us badly. For example, look at Kevin Warsh. He was nominated to the Federal Reserve Board in 2006, and he was just a kid [Warsh was 35]. The big investment banks had about $4.5 trillion of assets sitting on $4.3 trillion of debt. There's almost no equity under the thing. No shock absorber. The system had drifted into that position over 15 years, so all Warsh had ever known was a world where this kind of stuff was fine. That's how a spokesman who was supposed to be the guy at the Fed who really understood Wall Street could think that these balance sheet conditions, 30:1 leverage, several trillion dollars of hot money were somehow evidence of stability and resilience.
Would you ever re-enter politics, to try to work from within to fix some of the problems you've outlined?
No, it's truly futile.
Do you identify with either the right or the left?
I'm a lapsed Republican at best. I became a Republican because I believed in small government, free enterprise, and sound money, and I thought that was the party that would further those goals. But the Reagan Revolution was thwarted not just by the Democrats or the public, but mainly by hypocritical Republicans. They could give a good speech against big government, but were unwilling to take on Social Security and Medicare.
The broken system can't be fixed by either party, which exist merely to help politicians compete for interest group money. And party identification never was that important because I've been an ideologue all my life. Ever since I marched on the Pentagon in 1967 to protest the Vietnam War I've changed my position many times over a lifetime of 40 years in Washington and Wall Street. The only time I've ever agreed with Keynes was when he said, "When I discover new facts, I change my opinion. What do you do, sir?"
You seem to have a particular loathing for the Republicans
The Republican Party is just a coalition of four gangs. The neocons are interested in pursuing an imperialistic, militaristic foreign policy that has served us poorly for many decades. The social-cons want the government involved in issues it has no business being remotely near -- choice, gay marriage, all the rest. The tax-cons think they can make everything better by cutting taxes. Then there are the rank-and-file Republicans who talk about the virtues of free enterprise and the evils of big government but never vote that way. These gangs won't solve any problems.
We need to move to a citizen government model. That's why in the book I propose a constitutional amendment allowing people to serve any office for six years and never run for reelection or lobby. It's the only way to recapture government from the cronies of capitalism and from the K Street lobbies and have any sense of a democracy.
I'm hearing echoes of the Tea Party and Occupy Wall Street.
Well, this is what I think goes on. They -- the state, the big government that we constantly talk about -- use a crisis like the Gulf of Tonkin to start a war in Vietnam. Bernanke and Paulson use the shock of Lehman's failure in order to stop the meltdown that was going on in the canyons of Wall Street. But Lehman should have gone down because it would have cleaned out a lot of the rot that had built up in the financial system. It would have re-introduced discipline.
Now you're venturing into Shock Doctrine territory.
The idea that the system exploits shocks in order to further the goals of various players and interest groups is correct. I don't see how you work your way out of that syndrome with a status quo view of the constitutional structure and the existing process of democratic governance.
As a result of those shocks, you have these different movements from different points on the spectrum that are reaching out for answers.
You protested the Vietnam War. You lived through a time of intense social upheaval in the 1960s when people actually rioted over racism and the Vietnam War. As angry as you are now in this book, as angry as you sense some people may be today, why haven't we seen another revolution in the U.S.?
It may just be a matter of time. You could read essays by thoughtful people in 1964 asking why everybody was so complacent in America, wondering if we were too fat and happy and addicted to TV to act. All of a sudden it just exploded a few years later.
In one of the most interesting moments in the book, you use your role in the bankruptcy of Collins & Aikman to criticize the private equity industry. Did you write this book to explain yourself or the things you wish you'd done differently?
I've been a party to the things that I criticize. I've had my own recency bias. Collins & Aikman had taken on too much debt, but everybody in the buyout business was leveraged that way. We had downside cases that were not remotely bad enough to encompasses what would happen if the world unraveled; and the auto industry fell apart. I couldn't cut fast enough. I couldn't fire enough people. I couldn't impair the future of the company enough in order to pay the interest on the debt.
I realized that the leveraged buyout business is one of the great deformations of modern policy. That's why I have some sections on it. It's an artifact of a very artificial policy environment that really shouldn't exist. You shouldn't be able to borrow that much money, and the whole tax system is biased in favor of capital gains and debt, and against equity. You shouldn't have such low interest rates that junk bonds and other speculative investments become larger because investors have to stretch for yield.
You say you're for free enterprise, but it sounds like you think Wall Street needs more restrictive incentives, or even regulation.
Banks are not free enterprise institutions. I'm very anti-regulation as you could tell from the book, and I say to deregulate true free enterprises. But banks are wards of the state. They need deposit insurance. They need access to the Fed window. They take demand deposits and loan them out for several years, while still promising depositors they can have their money back anytime. It's a dangerous business. Given all those characteristics, you need very comprehensive regulation of banking charters and banking behavior and banking balance sheets. Otherwise you'll have financial bubbles and blowups time and again.