1. The Administrative Liability of Under-Qualified Staff and Internal Disagreements

Missing the Early Warning Alarm: In hindsight, the inept response of the Bush administration to the devastation and destruction wrought by Hurricane Katrina in New Orleans was a warning siren about the broader threat posed by the administrative turmoil of the national American state. The president's public praise of his FEMA director Michael Brown—“Brownie, you're doing a heck of a job”—jarred with media images of a devastated city and shocking hardship for refugees forced to flee the city (Lee Reference Lee2006). The tragically inept response to New Orleans resulted from America's deadly combination of administrative weakness and racial ordering that historically perverted its rhetorical homage to equality (King Reference King2007; King and Smith Reference King and Smith2005).

The broader implications and foreboding threat suggested by FEMA's incompetence were lost in the onslaught of criticisms of President Bush and his administration. What was missed were the larger risks of persistently failing to recruit and retain civil servants who graduated from the premier colleges and universities (as is the case in Europe) and instead relying on political cronies (a problem identified as long ago as 1988 by the Paul Volcker-chaired National Commission on the Public Service and restated in a 2004 Brookings study that Volcker also helped chair). The blinking alarm that was missed after Katrina should have read: “The danger of relying on political loyalty instead of competence.” Indeed, the message coming out of political science was the rationality of political loyalty over competence (Moe Reference Moe, Chubb and Peterson1985).

The Bipartisan Embrace of State Weakness as Smart Policy: The weak capacity of the American state to identify risk combined with a bipartisan philosophy that embraced an uncritical commitment to markets invited and produced a series of regulatory decisions over the past three decades that opened the door for the financial and economic meltdown in 2008—events that were extraordinary in scope but not uncommon in practice (Brown and Jacobs Reference Brown and Jacobs2008).

The most recent iteration of this pattern of bipartisan policymaking were the decisions of the Clinton and Bush administrations to reduce the limits on speculative and heavily leveraged risk taking; the incentives to pursue those risks grew as regulatory controls were eased. The implosion of subprime loans to home purchasers who lacked the financial capacity to reliably repay their mortgages was the match that ignited the house of cards. But the house itself was built on an unsound administrative foundation, which permitted and, indeed, invited the packaging of debt as securities that were sold to investors around the world who purchased them on the assumption of competent oversight by the American state. In a sense, the 2008 financial meltdown illustrates the globalization of administrative incompetence or at least the global consequences of ineptitude.

The financial implosion of 2008 resulted from decided policy choices during the Clinton administration to repeal the Glass-Steagall Banking Act as well as the Bush administration's decisions with regard to oversight. The conditions that fuelled passage of Glass-Steagall in 1933 were remarkably similar to the circumstances leading to the present financial crisis. In the first third of the twentieth century, hundreds of mainly small retail banks throughout the United States set up investment operations that highly leveraged deposits to float bonds and underwrite corporate securities. These investment strategies generated enormous profits until the sharp drop in the stock market in 1929 prompted bank depositors to request withdrawal of funds that had been invested and lost. By the winter of 1933, over 4,000 banks declared bankruptcy. President Franklin Roosevelt recast the financial system by short-term steps (such as closing banks temporarily and soothing Americans into returning their savings to banks) and by a major new legislation landmark—the Glass-Steagall Banking Act in June 1933. (Congress concurrently enacted federal insurance of bank deposits, creating the still-existing Federal Deposit Insurance Corporation.)

Glass-Steagall erected a firewall between commercial retail banking, designed to protect the savings of depositors, and investment wholesale banking, which was permitted greater leeway for risk taking. As intended, Glass-Steagall restricted banks and investment firms from leveraging the enormous capital held by bank depositors to finance buy-out deals, mergers, equity investments, and other activities that would entail risk but would also hold out the promise of significant profit. Large banks and investment firms chaffed at these restrictions, which were portrayed as excessive government interference that stifled market innovation and growth; however, corporate lobbying efforts to repeal Glass-Steagall from the 1960s to the late 1990s were defeated. Memory of the financial implosion of the 1930s remained a steady bulwark against 11 initiatives introduced in Congress between 1980 and 1998 to end Glass-Steagall.

Even though Glass-Steagall's firewall between risky investment and protection of deposits remained into the late 1990s, restrictions on the financial institutions were loosened. In 1979, President Carter approved the U.S. Department of Labor's recommendation to permit pension funds to invest their assets in less established firms and corporations than the traditional blue-chip stock assets to which they had been restricted. This modification helped spur the explosion in venture capital between 1980 and 2002. In 1994, a Democratic president and Congress overturned the 1927 ban on retail banks opening new branches across state lines, a reform that encouraged takeovers and the development of supersized consolidated banks.

Although these reforms were relatively incremental, the Clinton administration at the urging of then Treasury secretary Lawrence Summers promoted and signed into law legislation that made two dramatic changes. First, the Gramm-Leach-Bliley Act of 1999 dismantled Glass-Steagall. Second, the new law divided government regulatory authority over commercial banking: responsibility of the investment firms' securities and brokerage operations was transferred from the Federal Reserve System to the SEC while the holding companies of these firms continued to be regulated by the Federal Reserve System. The 1999 legislation not only breached the firewall between commercial and investment banking but the two operations came under separate regulatory authorities, which did not necessarily communicate regularly or systematically about their respective spheres nor have the capacity or sense of mission to exercise similar levels of attentive oversight.

With the Gramm-Leach-Bliley Act of 1999 opening the flood gates for increasingly unconstrained financial activity, President Clinton signed legislation in 2000 that removed another brick from the regulatory infrastructure by granting more leeway for derivatives and credit-swap deals. Specifically, the new law removed these financial instruments from the purview of the Commodity Exchange Act, which propelled their expansion.

As the financial industry achieved the permissive latitude that it had sought for decades, investment banking expanded rapidly into a shadow banking system in a number of countries led by the U.S. The seven large investment banks that dominated (Goldman Sachs, Morgan Stanley, Bear Stearns, Merrill Lynch, Lehman Brothers, J P Morgan, and Citigroup) pressed the U.S. government to further dilute the SEC's regulatory regime.

Further demonstrating the weak and easily penetrated American state, the SEC agreed in 2004 to replace its enforcement of the remaining regulatory responsibility over investment firms with industry self-policing based on a new voluntary code for the large investment banks, entitled the Consolidated Supervised Entity (CSE) program. This scheme resulted in periodic audits of the affected institutions in place of having regulators on site. It was voluntary and enabled investment banks to opt in or out of the scheme. The SEC also created a process to exempt firms from government rules on leveraging; the application by broker dealers to become part of the CSE program entitled them to exemptions from the SEC's standard net capital to debt rule.

In short, industry lobbying combined with weak administrative capacity for sophisticated risk assessment and a presumption in favor of free markets created a flawed process of oversight and protection against investments that would deliver enormous profits in the short run but expose the financial system in the U.S. and other countries to great risk. The SEC's Office of Inspector General concluded in its report in September 2008 that the CSE regulatory regime was “fundamentally flawed” and that SEC had not effectively regulated the investment firms (Securities and Exchange Commission 2008).

The American State Trips into the TARP Trap: Americans and U.S. businesses as well as governments and markets around the globe have been unnerved by the Bush administration's stumbling search for a solution. Press reports have tended to blame the personal failings of key policymakers—the short-sightedness and other flaws of President Bush, Treasury secretaries Henry Paulson and Thomas Geithner, and congressional officials. Although some blame may lie with these figures, a more probing explanation for the oscillating and uneven quality of the U.S. response would acknowledge the changing contours of the financial markets as the subprime meltdown broadened out to threaten financial institutions and freeze the credit market (effected by permitting Lehman Brothers to collapse suddenly without assessing the likely consequences).

The Bush administration's most substantial initiative to deal with the financial crisis—the Troubled Asset Relief Program (TARP)—offers a case study of the changing and incoherent U.S. government response. Designed and marketed as a means to buy up bad debts TARP in an extraordinary admission of its incoherent initial mission, flipped into a plan to recapitalize banks in exchange for granting the government equity.

The explanation that focuses on personality misses two critical and revealing features of the financial crisis. First, it assumes that there is a solution that an all-knowing smart state could design and impose to restore financial health. The truth is that policy responses by economically developed representative states face fundamental contradictions within the global economy that have prevented any from developing a full-fix solution.

Second, and of particular interest to us, the cross-national variations in the response to the financial crisis and the distinction of the U.S. in originating the financial meltdown result to an important extent from the American state's comparatively uneven administrative capacity related to the skill and sophistication of its financial analysis and its crosscutting and divided lines of authority. The American state's weak administrative capacity not only opened the door to financial crisis but it also hobbled the efficacy of its attempts to rescue and to reconstitute the financial sector moving into the future.

Two underlying factors help to account for TARP's incoherent approach and ineffectiveness (and for early assessments see U.S. Government Accountability Office [2009], Warren et al. [Reference Warren, Hensarling, Neiman and Silvers2008; Reference Warren, Hensarling, Neiman, Silvers and Sununu2009], and U.S. Treasury Department [2008]). First, the personnel in the Treasury Department, SEC, and other frontline administrative bodies were uneven and, in key respects, inadequate to the challenge of monitoring the financial sector and then managing the ensuring crisis. (This incompetence is perhaps most dramatically conveyed in the ill-thought-out decision to permit Lehman Brothers to collapse suddenly, a decision that severely undermined confidence in the financial system around the globe.) The breakdown in oversight at the SEC resulted from too few and insufficiently trained personnel (Labaton Reference Labaton2008). In a revealing acknowledgement of its weak staff, the Treasury Department scrambled to hire new personnel to run TARP and ended up outsourcing critical tasks to professional asset managers. But even this new staff evaded the core problem presented by the logic of TARP—the assumption that asset prices could be assigned to securities with no or unclear value (an ongoing challenge for the Obama administration).

Second, the response by the U.S. government was confounded by divided lines of authority not only between the legislative and executive branches but also within the administration's plethora of competing entities—Treasury Department, Federal Reserve Bank, the Federal Deposit Insurance Corp (FDIC), SEC, and others. For instance, the Treasury Department's approach during the Bush administration of bolstering large financial institutions was challenged by FDIC chairman Sheila Bair. Bair openly campaigned, against the Bush administration line, for using federal funds to modify troubled mortgages that would help homeowners. Uneven staffing and internal conflict contributed to the Bush administration's lack of preparation for a rescue plan. Although the financial crisis had been building for months, the collapse of major financial institutions in the early fall of 2008 caught the U.S. Treasury Department utterly unprepared. The initial three-page proposal, which asked for $700 billion and wide discretion for its disbursement, was developed in a matter of days and without congressional consultation. The result was bipartisan outrage, which contributed to an initial rejection by Congress.

The administration's initial approach (buying up toxic bad-debt assets) was poorly conceived. Indeed, the rescue plan rested on a false or overstated set of expectations. For instance, the critical question of how best to measure the real value of the toxic assets was not spelled out in the legislation and remained elusive, forcing the Treasury Department to later shift strategies. This problem led to the eventual redesignation of TARP into a recapitalization program, a unilateral reformulation of such a large legislative initiative. (The lack of a plan about how to value bad or toxic assets remains a failure in Treasury secretary Geithner's financial plans announced on February 10, 2009, despite his making this step a pillar of the proposals.)

Thus, a major hurdle in implementing TARP was how to accurately measure the balance sheets of banks without mark-to-market inventory (i.e., the process of setting value based on the demand for financial instruments in market trades). With banks and other investors too worried to purchase assets, there is little or no trading in the underlying mortgage-backed assets and therefore there is no or incomplete information about whether such securitized assets have any value. In the absence of robust market activity, it is difficult to set a value. In contrast, for instance, the Savings and Loan cleanup was simpler because the government's rescue body (the Resolution Trust Corporation) was able to engage in some reasonable mark-to-market accounting (as did Swedish banks in that country's early 1990s banking crisis) (Allen and Gale Reference Allen and Gale2007; White Reference White1991).

The Treasury Department's poor preparation and hurried assumption about a process to set value failed to understand that banks are too worried about the weakness of their balance sheets to engage in trading, thereby creating an impasse (only deepened by the sudden collapse of Lehman Brothers). The original idea of conducting “reverse auctions” turned out to be more daunting than first appreciated and was speedily dropped.

The immense scale of the TARP task was underestimated in part because the Bush administration was blinkered by an unwavering devotion to the notion of free markets but also because it lacked the sophistication to fully understand what it was proposing to accomplish. The result of poor design was a shifting set of approaches that careened from the planned objective of acquiring bad debt to providing capital to banks in exchange for granting the government equity when the initial effort failed. Less than two weeks after TARP was enacted, the Treasury decided to invest much of the $700 billion in banks; $115 billion was invested in eight of the largest financial institutions including Bank of America Corp., Citigroup, and JPMorgan Chase with another $155 billion distributed to 77 smaller banks. In contrast to other governments such as Britain, the Treasury approach to recapitalization lacked targeted conditions to spur investment and has produced disappointing results, according to the Government Accountability Office (2009) and an oversight body created by Congress (Warren et al. Reference Warren, Hensarling, Neiman and Silvers2008; Reference Warren, Hensarling, Neiman, Silvers and Sununu2009). Indeed, senior Bush officials initially rejected Britain's approach as “nationalization [and a] … punitive [approach]” (Andrews and Landler Reference Andrews and Landler2008); it was the failure of the Bush administration's policies that compelled policy change, though ideology and weak analytic capacity continued to hinder its diagnosis of the problem and the development of an appropriate remedy.Footnote ¹

2. Government as Instrument

The Bush administration's response to the financial meltdown in the fall of 2008 deepened the crisis by its double action of first expanding the reach of the state and then ceding this new authority back to the groups and individuals with ties to the banks, investment firms, and manufacturers that became the beneficiaries of the new programs. In the first move, Republican leaders, including President Bush, joined with Democrats to discard their earlier principles of anti-statism to rally behind authorizing $700 billion and over $7 trillion more in loan guarantees for what was presented as serving the common good of the nation.

The second move relinquished back to certain financial and manufacturing firms substantial influence over the government's newly expanded authority and resources. This double move—expanded government and wider sectional influence—compromised internal government deliberations and decision making. The ostensible aim of advancing the national interest became a tool to serve and privilege particular industries.

Particularistic interests have penetrated government decisions through three avenues. First and most obviously, industry moles permeate government. Senior officials from the financial industry and other sectors hold senior positions charged with doling out money and authority. In one of the clearest cases, Treasury Secretary Paulson is a former head of Goldman Sachs, a firm receiving new status as a holding bank, making it eligible for Federal Reserve funds and guarantees. The giant insurance firm AIG was rescued in a huge bailout (initially $85 billion, then supplemented with $38 billion and perhaps additional investments) (Sorkin and Walsh Reference Sorkin and Walsh2008); Goldman Sachs was a very large AIG trading partner and stood to lose $20 billion if it collapsed (Morgenson Reference Morgenson2008a).Footnote ² Paulson has multiplied the presence of industry personnel by hiring a number of present and former Goldman Sachs employees to administer TARP (Creswell and White Reference Creswell and White2008).

Having former industry heads deciding how to dole out government funds not only helped certain firms, it also hurt others. Goldman Sachs's rival, Lehman Brothers, was denied support in a decision that has been widely criticized as undercutting confidence in the credit market and accelerating the fall 2008 credit crunch (globally as well as in the U.S.).Footnote ³ In addition to omitting certain firms, the Bush administration's response chose not to offer direct support for another group without a strong proponent sitting at the table of decision makers—namely, homeowners struggling to avoid foreclosure.

A second, more shadowy avenue to shape the government's financial rescue policy has been lobbying, now a veritable financial sector in its own right in Washington (Kaiser Reference Kaiser2009). Such lobbying has occurred throughout the 1990s and 2000s, with mortgage banks and brokers contributing $847,000 to the Bush reelection campaign in 2004 (Becker, Stolberg, and Labaton Reference Becker, Stolberg and Labaton2008). The lax regulation and oversight by SEC and the huge performance-based expansion in Fannie Mae and Freddie Mae were responses to the intense and prolonged lobbying by the finance industry.

The third avenue for molding government policy is the most difficult to discern. There is a form of structural constraint that operates through the anticipated fear among government officials of losing the jobs and tax revenues that would result if massive holders of U.S. debt (such as the Saudis or Chinese) decided to withdraw their investment or to stop using the dollar as a reserve currency (Lindblom Reference Lindblom1979). In October 2008, the U.S. Treasury securities amounted to 3,041.7 billion dollars, of which 652.7 was held by China, 585.5 by Japan, and 187.7 billion by a group of oil-exporting countries dominated by Saudi Arabia. Since then the amounts have grown considerably as the Federal Reserve has issued Treasury notes, bonds, and securities to fund bailouts and other measures. These states together with other sovereign wealth funds exert a complex influence on American policymakers: given the scale of their investment, they harbor a strong interest in maintaining the U.S. public debt as a viable resource that can be repaid over the long run. Yet this very global integration makes U.S. debt funding vulnerable to sudden collapse.

This structural constraint extends the influence of sectional interests beyond the direct connections between personnel on Wall Street and key government institutions. Bush officials concluded that their top priority was to restore financial markets rather than to directly reinvigorate the manufacturing or service industries. This fear drove the New York Federal Reserve Board's coordinated rescue of the Long Term Capital Management hedge fund in 1998 (a decision that looks unjustifiable in retrospect since it sent a positive signal to high-risk leveraged-based speculation and invited moral hazard); it also explains why the Bush Treasury Department has provided extraordinary capital to the AIG insurance company. Maintaining the confidence of American and foreign investors is imperative for sustaining the U.S. debt load and preventing flight to other investments.

The degree of this dependence is revealed in the myopic and poorly conceived response in fall 2008 by the Treasury and Federal Reserve to the deepening and diffusing crisis. No worked-out and intellectually defensible framework guided the decisions about which firms to rescue and when and how to operationalize such key decisions as the federal guarantee of Freddie Mac and Fannie Mae or the implementation of TARP. The perceived threat of a systemic financial meltdown that would prompt a massive flight of capital appeared literally to spook senior financial policymakers: Federal Reserve chair Benjamin Bernanke alerted members of Congress of collapse and the need for desperate measures, and vice president Richard Cheney pleaded for congressional Republican votes by warning that they could be tarred as “Hoover Republicans.” The resulting haphazard and rushed policy was, in this sense, a response to perceived imperatives of global finance as much as a catering to individual lobbyists or former employees at major financial firms.

1. Uncertain Stability of Public Trust

The general public's sustained belief in the American state has been the subject of significant research, especially in the wake of the Vietnam War and protests, the Watergate crisis, and inflation during the 1970s. Researchers distinguish between “diffuse” support for the political system as a whole and “specific” evaluations of incumbent officeholders (Easton Reference Easton1975, 445). Scholars find dramatically different results: stable majorities of everyday Americans during the 1960s and 1970s continued to support the political system and to express pride in the country's political arrangements even though specific government officials (notably, presidents Lyndon Johnson and Richard Nixon) received strong negative approval ratings (Nie, Verba, and Petrocik Reference Nie, Verba and Petrocik1976, 35–36; Miller Reference Miller1974a; Reference Miller1974b; Reference Miller1979; Citrin Reference Citrin1974; Citrin and Green Reference Citrin and Green1986; Weatherford Reference Weatherford1987).

The initial concern, then, that the widespread sense of powerlessness and cynicism would threaten the established political and social order failed to materialize during the 1970s and 1980s; even individuals with quite strong negative attitudes about the political system were unable to identify specific changes in the system of government that they favored (see, e.g., Sniderman Reference Sniderman1981, 130).

Past research poses two helpful lessons for analyzing the legitimacy of the current political system among everyday Americans. First, strong disapproval of a president can and does coincide with support for the overall political system. It is a mistake, for instance, to conclude that the legitimacy and stability of the existing political order threatened to unravel owing to president George W. Bush's historically low popularity as measured in approval ratings. Indeed, the election of Barack Obama on the promise of change could well reinforce the legitimacy of the political system by demonstrating its responsiveness.

A second lesson is that regime legitimacy is contingent on context. The events of the 1960s and 1970s demonstrably resulted from the discrete policies and actions of specific presidents—President Johnson's highly visible (though misleading) set of decisions to expand troop levels in Vietnam and refusal to withdraw them in the face of military setbacks and domestic protest as well as President Nixon's abuses of power that generated constitutional crises. By contrast, the circumstances of the 2008 financial breakdown may pose quite different dynamics that extend beyond the policies of individual administrations to raise questions about the general operations of the economic and political systems. Rather than assuming that the political order is safely stable based on earlier research, it is critical to track and closely study system legitimacy in the wake of disruptions in the financial and economic system that are unprecedented in the period since World War II.

The uncertain and fraught nature of sustaining legitimacy in today's state are explored adroitly in our edited volume by such scholars as John Ferejohn on the tension between inequality and democracy, Cathy Cohen on the alienation of black youth, and Larry Bartels on the class bias of government responsiveness (Jacobs and King Reference Jacobs and King2009).

2. Contradictory Policy: Helping Business and Hurting Citizens

It is important to widen the analytic lens from a closely cropped study of public attitudes in order to consider the coherence of basic government policy. We would argue that the legitimacy of the American state faces a growing deficit moving into the future as it simultaneously funnels trillions of dollars to businesses to restructure them and seeks to sustain the trust of everyday citizens who bear the consequences of that restructuring. This deficit may receive some short-term relief for the new president but will not dissipate quickly. Indeed, the Congressional Budget Office and others are predicting that measures to revive the economy, subsidize financial markets, and cover the costs of the Iraq and Afghanistan wars will produce colossal annual budget deficits in excess of a trillion dollars and 10% of the gross domestic product, the highest levels since World War II (Stiglitz and Bilmes Reference Stiglitz and Bilmes2008).

The messaging of government officials and allies that helping business helps American families is shrewd but it runs into two problems. First, there is widespread suspicion of favoritism for particular industries (e.g., banking over automotive) or firms (Goldman Sachs over Lehman Brothers) at a time of perceived neglect of the everyday citizen who has yet to receive comparable support. The populist backlash against what is portrayed as venal deal making among well-placed insiders has been fuelled by the government's failure—according to the Government Accountability Office and the press—to ensure that the tens of billions of dollars funneled to banks have been tracked; they may even have been committed to paying bonuses to executives.

The second and more profound hurdle is the cycle of reinforcing contradictions in government policy. The recession damaged two golden birds with one stone—it rapidly reduced tax revenues for state and national government at the same time that it rapidly eliminated many jobs and thereby increased the costs for a host of safety-net provisions for unemployment, food stamps, and other essentials. Government efforts to stabilize the financial system and revive a crumbling economy were imperative, earning extraordinary bipartisan support. And, yet, the intended remedy—rescue packages to help sustain business as they struggled to reconstitute themselves—accepted or actually encouraged these firms to take the necessary steps to survive, namely, laying off employees and taking other steps that diminished the living circumstances of everyday Americans. Loans to the automotive industry, for instance, are tied to reducing the wages and benefits of union members. The hundreds of billions of dollars funneled to financial investment firms are targeted to keeping them afloat as they write off toxic loans, which in practice means evicting families from their homes. Even proposals to streamline health care record keeping, which are geared to reducing “unnecessary” costs and have been heralded by President Obama as a key part of his stimulus package, will require firing thousands of workers who currently process the paperwork.

In short, there is a fundamental incoherence in government policy: government policies that ostensibly help everyday families in practice hurt many. The state's legitimacy as the incarnation of the popular will is undercut by the perception of favoritism and by the reality that government funds and requirements diminish the living conditions of certain families by pushing up unemployment in some areas, cutting wages in others, and generally accepting the decline in the credit and home ownership of many families.

The contradiction of help that hurts registers in a ballooning fiscal deficit, which is on track to top one trillion dollars. The tendency to portray the federal government's budget deficit as the work of undisciplined and corrupt politicians larding legislation with pork misses a more fundamental dynamic. Government help to business to sustain its operation ends up undermining the economic circumstances of everyday families, which the government then seeks to partially offset through spending on unemployment checks, subsidies for food, health care services, and other cash and in-kind benefits.

The legitimacy problem is that the state's imperative to sustain core industries like finance and automotive collides with its requirement to maintain its standing as a government for and by the people. This collision of opposing necessities may eventually show up in surveys of public trust in the political system; it also manifests itself in the incoherence of government policy and the confusion of government officials in the Bush and Obama administrations who find themselves both advocating for policies to sustain business while also approving policies to respond to the natural consequences.