america's political crisis: the unsustainable state in a time of unraveling

Article: “America’s Political Crisis: The Unsustainable State in a Time of Unraveling” Author: Lawrence Jacobs and Desmond King Issue: April 2009 Journal: PS: Political Science & Politics This journal is published by the American Political Science Association. All rights reserved. APSA is posting this article for public view on its website. APSA journals are fully accessible to APSA members and institutional subscribers. To view the table of contents or abstracts from this or any of APSA’s journals, please go to the website of our publisher Cambridge University Press (http://journals.cambridge.org). This article may only be used for personal, non-commercial, or limited classroom use. For permissions for all other uses of this article should be directed to Cambridge University Press at [email protected].

America’s Political Crisis:The Unsustainable State ina Time of UnravelingLawrence Jacobs, University of Minnesota

DesmondKing,Nuffield College, Oxford

TheAmerican economy and financial system is expe-riencing upheaval on a scale not seen since theGreatDepression of the 1930s. A number of the largestand most established banks and investment firmshave declared bankruptcy (including Bear Stearns

and Lehman Brothers) or been taken over at fire-sale rates (aswas the case, for example, withMerrill Lynch). In the fall of 2008,Congress and the U.S. Treasury along with the Federal ReserveBank committed more than eight trillion dollars in payments,loans, and guarantees of various sorts to prop up financial insti-tutions (including the semi-governmentalmortgage entities, Fan-nieMae and FreddieMac) as well as the country’s largest insurer,American International Group (AIG). The speed, number, andscope of these interventions lack historical precedent.

The immediate cause was the collapse of a new and largelyunregulated “shadow” financial system consisting of over-the-counter derivatives, credit-debt swaps, and a little recognized (andunder regulated) sector of the housing mortgage market—loansto so-called subprime borrowerswho failed standard creditworthi-ness tests based on stable income or employment. The devastat-ing impact of defaults in this financial system was magnified bythe loosening of capital requirements for investments. (Govern-ment agencies acquiesced in the drive by financial firms to heav-ily leverage their assets until they accumulated $33 of debt forevery dollar in equity.)

Despite the overwhelming focus on themistakes byWall Streetand key industries, the economic and financial unraveling is funda-mentally a political crisis of the American state. The collapse ofprivate markets both reflects and propels an unsustainable con-stellation of government administrative practices and claims tolegitimacy.

The systematic failure of government agencies such as theSecu-rities and Exchange Commission (SEC) and members of Con-gress to identify the risks of the new financial system and toregulate them aremanifestations of the American state’s compar-atively weak administrative capacity and easy penetration by thefinancial sector and other related societal interests. Although theGeorge W. Bush administration has been the principal target ofcriticism, the truth is that the failure to monitor and constrainsubprime loans, credit swaps, derivatives, and over-leveragedinvestments represents a philosophical deference to private mar-kets and a pattern of administrative practices that crosses partylines (Brown and Jacobs 2008). Indeed, the roots of the policiespursued by the Bush administration extend to previous adminis-trations of both parties including the Clinton administration,which terminated the Glass-Steagall Banking Act that had beenenacted in the 1930s to stabilize the banking system. Put simply,the immediatemedia focus on assigning blame to a party and to asmall circle of individuals misses the institutional and adminis-trative sources of the economic turmoil, which themselves haveresulted from uniquely American political developments.

Themeltdownof theAmerican economynot only reflects com-paratively porous and underdeveloped administrative capacitiesbut unsettles the legitimacy of the American state as a represen-tative democracy.Themassive direct and explicit government “res-cues” of private businesses have starkly revealed chummypersonalrelations among government officials and business and the depen-dence of government onprivatemarkets. It is telling that theharsh-est initial criticism of the Bush administration’s first proposal fora $700 billion infusion of money into the financial sector was forits poor messaging; its use of the language of “bailout” ratherthan “rescue” stripped bare the purpose of government.

More than creating opportunities for personal favoritism, theAmerican state’s policies themselves (including loans to automo-tive companies that required further reductions in wage and non-wage benefits for workers) worsened the circumstances of someAmerican families while failing to directly respond to those ofothers (including those who experienced home foreclosures bybanks that the government propped up). Government “help” tobusiness turned out to hurt or fail to do much for everyday fami-lies. The resulting backlash has taken aim at the government’sfocus on Wall Street rather than Main Street. Implicit in theseattacks are challenges to the government’s creedal foundation—popular sovereignty and the idea of government by and for thepeople.

The economic and financial crisis that culminated in the fall of2008 was a political crisis. It both reveals the unsustainability ofthe currentAmerican state and poseswarnings for the newObama

Lawrence Jacobs isWalterF. and JoanMondaleChair forPolitical Studies anddirector oftheCenter for theStudyofPolitics andGovernance in theHubertH.Humphrey Insti-tute anddepartment of political science at theUniversity ofMinnesota.Hismost recentbooks includeTheUnsustainableAmericanState (coeditedwithDesmondKing,OxfordUniversity Press, 2009);ClassWar?WhatAmericansReallyThink aboutEconomicInequality (withBenjaminPage,University ofChicagoPress, 2009); ThePrivateAbuseof thePublic Interest (withLawrenceBrown,University ofChicagoPress, 2008); andTalking Together: Public Deliberation in America and the Search for Community(with Fay Lomax Cook andMichael Delli Carpini,University of Chicago Press, 2009).DesmondKing is AndrewWMellon Professor of AmericanGovernment atNuffield Col-lege, Oxford University. His research is in American political development and compar-ative political economy. Among his books are Actively SeekingWork: The PoliticsofWork andWelfare in theUSandBritain (University ofChicago, 1995),MakingAmer-icans: Immigration, Race, and the Origins of the Diverse Democracy (Harvard Uni-versity Press, 2000),Separate andUnequal: AfricanAmericans and theUSFederalGovernment (2nd ed. Oxford University Press, 2007) and The Unsustainable Ameri-can State (coedited with Lawrence Jacobs, Oxford University Press, 2009).

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administration, which is pursuing a mix of fresh but also recycledpolicies in the face of daunting obstacles to stabilizing the U.S.economy and democracy. In this essay and in an edited volumewith a lineup of leading scholars (Jacobs and King 2009), we crit-ically examine the unsustainability of the American state and thenature and degree of the crises it faces.

I. THE NATURE OF UNSUSTAINABILITY

The nature of the crisis facing the American state has beenobscured and clouded by a preoccupation with the missteps ofindividual government officials, such as presidentGeorgeW.Bushor president Barack Obama, or individual government entities,whether Congress or particular agencies such as the U.S. Depart-ment of Treasury. Identifying the fundamental sources of the cur-rent economic and political breakdown requires a wider analysisof the tensions and contradictions embedded in the Americanstate.The broader organizational principles of theAmerican state’sadministrative capacity and legitimacy help to explain the break-down of the financial system and the zigzagging character of howit is has been handled.

Our approach to understanding the current financial and eco-nomic turmoil rests on a notion of the state as an interconnectedset of institutions that monopolize force within its territory, relyon administrative capacity to conduct basic economic and politi-cal functions, and maintain its legitimacy by inducing the con-sent of its citizens (Weber 1978; Skocpol 1979; 1985; Shils 1965;1958; Block 1977).

A. Administration: How the American State Is Increasingly anInstrument of Special InterestsThe current economic and financial crises are portrayed as caus-ing the breakup of the Republican hold on government and thegeneral disruption of established philosophical commitments andinterests. In truth, the financial breakdown and ensuing eco-nomic downturn were as much consequence as cause. In particu-lar, they resulted from severe and deeply embedded administrativepathologies. The longstanding weakness of the American state’sadministrative capacity loaded the dice in ways that amplifiedboth the mistakes of a string of administrations in managing thefinancial sector and the anti-government disposition of the Bushadministration, which in turn increased the probability that banksand investmentfirmswould over-leverage, embrace excessive risks,and engage in fraud.

Stephen Skowronek (1982) aptly describes the American stateas a “hapless giant” to capture its distinct amalgam of enormous(and growing) size and institutional incoherence. Decades ofresearch confirm this characterization of American institutionsas consistently lacking (though with notable exceptions) theadministrative capacity of its western European counterparts(Skocpol 1985). This perspective provides an important elementof thehistorical context inwhich thefinancial and economic unrav-eling occurred.

In particular, two administrative pathologies stand out. First,the American bureaucracy and agencies are hobbled by multipleand crosscutting lines of authority that trammel efforts to estab-lish an organizational chain of command to implement policies(Lowi 1979) and by personnel who lack the appropriate skill andtraining and who lag behind the preparation of their Europeancounterparts (Aberbach 2003; Aberbach and Rockman 2000; Moe

1985); deficiencies include but are not confined to the operationof key regulatory agencies. Second, the internal deliberations andindependent decisions of civil servants and authoritative policy-makers are persistently compromised by the interference of out-side interests (see, e.g., Keohane and Milner 1996; Snyder 1991;Jacobs and Page 2005).

1. The Administrative Liability of Under-Qualified Staff andInternal Disagreements Missing the EarlyWarning Alarm: In hind-sight, the inept response of the Bush administration to the dev-astation and destruction wrought by Hurricane Katrina in NewOrleans was a warning siren about the broader threat posed bythe administrative turmoil of the national American state. Thepresident’s public praise of his FEMA director Michael Brown—“Brownie, you’re doing a heck of a job”—jarred with media imagesof a devastated city and shocking hardship for refugees forced toflee the city (Lee 2006). The tragically inept response to NewOrleans resulted from America’s deadly combination of admin-istrative weakness and racial ordering that historically pervertedits rhetorical homage to equality (King 2007; King and Smith2005).

The broader implications and foreboding threat suggested byFEMA’s incompetence were lost in the onslaught of criticisms ofPresident Bush and his administration. What was missed werethe larger risks of persistently failing to recruit and retain civilservants who graduated from the premier colleges and universi-ties (as is the case in Europe) and instead relying on politicalcronies (a problem identified as long ago as 1988 by the PaulVolcker-chaired National Commission on the Public Service andrestated in a 2004 Brookings study thatVolcker also helped chair).The blinking alarm that was missed after Katrina should haveread: “The danger of relying on political loyalty instead of com-petence.” Indeed, the message coming out of political sciencewas the rationality of political loyalty over competence (Moe1985).

The Bipartisan Embrace of StateWeakness as Smart Policy: Theweak capacity of the American state to identify risk combinedwith a bipartisan philosophy that embraced an uncritical commit-ment to markets invited and produced a series of regulatory deci-sions over the past three decades that opened the door for thefinancial and economic meltdown in 2008—events that wereextraordinary in scope but not uncommon in practice (Brown andJacobs 2008).

The most recent iteration of this pattern of bipartisan policy-making were the decisions of the Clinton and Bush administra-tions to reduce the limits on speculative and heavily leveragedrisk taking; the incentives to pursue those risks grew as regula-tory controlswere eased.The implosion of subprime loans to homepurchaserswho lacked the financial capacity to reliably repay theirmortgages was the match that ignited the house of cards. But thehouse itself was built on an unsound administrative foundation,which permitted and, indeed, invited the packaging of debt assecurities that were sold to investors around the world who pur-chased them on the assumption of competent oversight by theAmerican state. In a sense, the 2008 financial meltdown illus-trates the globalization of administrative incompetence or at leastthe global consequences of ineptitude.

The financial implosion of 2008 resulted from decided policychoices during the Clinton administration to repeal the Glass-Steagall Banking Act as well as the Bush administration’s deci-sionswith regard to oversight.The conditions that fuelled passage

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of Glass-Steagall in 1933 were remarkably similar to the circum-stances leading to the present financial crisis. In the first third ofthe twentieth century, hundreds of mainly small retail banksthroughout the United States set up investment operations thathighly leveraged deposits to float bonds and underwrite corpo-rate securities. These investment strategies generated enormousprofits until the sharp drop in the stock market in 1929 promptedbank depositors to request withdrawal of funds that had beeninvested and lost. By thewinter of 1933, over 4,000 banks declaredbankruptcy. President Franklin Roosevelt recast the financial sys-tem by short-term steps (such as closing banks temporarily andsoothing Americans into returning their savings to banks) and bya major new legislation landmark—the Glass-Steagall BankingAct in June 1933. (Congress concurrently enacted federal insur-ance of bank deposits, creating the still-existing Federal DepositInsurance Corporation.)

Glass-Steagall erected a firewall between commercial retailbanking, designed to protect the savings of depositors, and invest-ment wholesale banking, which was permitted greater leeway forrisk taking. As intended, Glass-Steagall restricted banks andinvestment firms from leveraging the enormous capital held bybank depositors to finance buy-out deals, mergers, equity invest-ments, and other activities that would entail risk but would alsohold out the promise of significant profit. Large banks and invest-ment firms chaffed at these restrictions, which were portrayed asexcessive government interference that stifledmarket innovationand growth; however, corporate lobbying efforts to repeal Glass-Steagall from the 1960s to the late 1990s were defeated. Memoryof the financial implosion of the 1930s remained a steady bulwarkagainst 11 initiatives introduced in Congress between 1980 and1998 to end Glass-Steagall.

Even though Glass-Steagall’s firewall between risky invest-ment and protection of deposits remained into the late 1990s,restrictions on the financial institutions were loosened. In 1979,President Carter approved theU.S. Department of Labor’s recom-mendation to permit pension funds to invest their assets in lessestablished firms and corporations than the traditional blue-chipstock assets to which they had been restricted. This modificationhelped spur the explosion in venture capital between 1980 and2002. In 1994, a Democratic president and Congress overturnedthe 1927 ban on retail banks opening new branches across statelines, a reform that encouraged takeovers and the development ofsupersized consolidated banks.

Although these reforms were relatively incremental, the Clin-ton administration at the urging of then Treasury secretary Law-renceSummerspromotedandsignedinto lawlegislationthatmadetwo dramatic changes. First, the Gramm-Leach-Bliley Act of 1999dismantled Glass-Steagall. Second, the new law divided govern-ment regulatory authority over commercial banking: responsibil-ityof the investmentfirms’ securitiesandbrokerageoperationswastransferred from the Federal Reserve System to the SECwhile theholding companies of these firms continued to be regulated by theFederal Reserve System. The 1999 legislation not only breachedthe firewall between commercial and investment banking but thetwo operations came under separate regulatory authorities, whichdidnotnecessarily communicate regularlyor systematically abouttheir respective spheres nor have the capacity or sense of missionto exercise similar levels of attentive oversight.

With the Gramm-Leach-Bliley Act of 1999 opening the floodgates for increasingly unconstrained financial activity, President

Clinton signed legislation in 2000 that removed another brickfrom the regulatory infrastructure by granting more leeway forderivatives and credit-swap deals. Specifically, the new lawremoved these financial instruments from the purviewof theCom-modity Exchange Act, which propelled their expansion.

As the financial industry achieved the permissive latitude thatit had sought for decades, investment banking expanded rapidlyinto a shadow banking system in a number of countries led by theU.S. The seven large investment banks that dominated (Gold-man Sachs, Morgan Stanley, Bear Stearns, Merrill Lynch, Leh-man 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 Amer-ican state, the SEC agreed in 2004 to replace its enforcement ofthe remaining regulatory responsibility over investment firmswithindustry self-policing based on a new voluntary code for the largeinvestment banks, entitled the Consolidated Supervised Entity(CSE) program. This scheme resulted in periodic audits of theaffected institutions in place of having regulators on site. It wasvoluntary and enabled investment banks to opt in or out of thescheme. The SEC also created a process to exempt firms fromgovernment rules on leveraging; the application by broker deal-ers to become part of the CSE program entitled them to exemp-tions from the SEC’s standard net capital to debt rule.

In short, industry lobbying combined with weak administra-tive capacity for sophisticated risk assessment and a presumptionin favor of free markets created a flawed process of oversight andprotection against investments thatwould deliver enormous prof-its in the short run but expose the financial system in theU.S. andother countries to great risk. The SEC’s Office of Inspector Gen-eral concluded in its report in September 2008 that the CSE reg-ulatory regimewas “fundamentally flawed” and that SEC had noteffectively regulated the investmentfirms (Securities andExchangeCommission 2008).

The American State Trips into the TARP Trap: Americans andU.S. businesses as well as governments and markets around theglobe have been unnerved by the Bush administration’s stum-bling search for a solution. Press reports have tended to blame thepersonal failings of key policymakers—the short-sightedness andother flaws of President Bush, Treasury secretaries Henry Paul-son and Thomas Geithner, and congressional officials. Althoughsome blame may lie with these figures, a more probing explana-tion for the oscillating and uneven quality of the U.S. responsewould acknowledge the changing contours of the financial mar-kets as the subprime meltdown broadened out to threaten finan-cial institutions and freeze the credit market (effected bypermitting LehmanBrothers to collapse suddenlywithout assess-ing the likely consequences).

The Bush administration’s most substantial initiative to dealwith 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 buyup bad debts TARP in an extraordinary admission of its incoher-ent initial mission, flipped into a plan to recapitalize banks inexchange for granting the government equity.

The explanation that focuses on personality misses two criti-cal and revealing features of the financial crisis. First, it assumesthat there is a solution that an all-knowing smart state could designand impose to restore financial health. The truth is that policyresponses by economically developed representative states face

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fundamental contradictions within the global economy that haveprevented any from developing a full-fix solution.

Second, and of particular interest to us, the cross-national vari-ations in the response to the financial crisis and the distinction ofthe U.S. in originating the financial meltdown result to an impor-tant extent from the American state’s comparatively unevenadministrative capacity related to the skill and sophistication ofits financial analysis and its crosscutting and divided lines ofauthority. The American state’s weak administrative capacity notonly opened the door to financial crisis but it also hobbled theefficacy of its attempts to rescue and to reconstitute the financialsector moving into the future.

Two underlying factors help to account for TARP’s incoherentapproach and ineffectiveness (and for early assessments see U.S.Government Accountability Office [2009], Warren et al. [2008;2009], and U.S. Treasury Department [2008]). First, the person-nel in the Treasury Department, SEC, and other frontline admin-istrative bodies were uneven and, in key respects, inadequate tothe challenge of monitoring the financial sector and thenmanag-ing the ensuring crisis. (This incompetence is perhaps most dra-matically conveyed in the ill-thought-out decision to permitLehman Brothers to collapse suddenly, a decision that severelyundermined confidence in the financial system around the globe.)The breakdown in oversight at the SEC resulted from too few andinsufficiently trained personnel (Labaton 2008). In a revealingacknowledgement of its weak staff, the Treasury Departmentscrambled to hire new personnel to run TARP and ended up out-sourcing critical tasks to professional asset managers. But eventhis new staff evaded the core problem presented by the logic ofTARP—the assumption that asset prices could be assigned to secu-ritieswithnoor unclear value (anongoing challenge for theObamaadministration).

Second, the response by the U.S. government was con-founded by divided lines of authority not only between thelegislative and executive branches but also within the admin-istration’s plethora of competing entities—Treasury Department,Federal Reserve Bank, the Federal Deposit Insurance Corp (FDIC),SEC, and others. For instance, the Treasury Department’sapproach during the Bush administration of bolstering largefinancial institutions was challenged by FDIC chairman SheilaBair. Bair openly campaigned, against the Bush administrationline, for using federal funds to modify troubled mortgages thatwould help homeowners. Uneven staffing and internal conflictcontributed to the Bush administration’s lack of preparation fora rescue plan. Although the financial crisis had been building formonths, the collapse of major financial institutions in the earlyfall of 2008 caught the U.S. Treasury Department utterly unpre-pared. The initial three-page proposal, which asked for $700 bil-lion and wide discretion for its disbursement, was developed in amatter of days and without congressional consultation. The resultwas bipartisan outrage, which contributed to an initial rejectionby Congress.

The administration’s initial approach (buying up toxic bad-debt assets) was poorly conceived. Indeed, the rescue plan restedon a false or overstated set of expectations. For instance, the crit-ical question of how best to measure the real value of the toxicassets was not spelled out in the legislation and remained elusive,forcing theTreasuryDepartment to later shift strategies.This prob-lem led to the eventual redesignation ofTARP into a recapitaliza-tion program, a unilateral reformulation of such a large legislative

initiative. (The lack of a plan about how to value bad or toxicassets remains a failure in Treasury secretary Geithner’s financialplans announced on February 10, 2009, despite his making thisstep a pillar of the proposals.)

Thus, amajor hurdle in implementingTARPwas how to accu-rately measure the balance sheets of banks without mark-to-market inventory (i.e., the process of setting value based on thedemand for financial instruments in market trades). With banksand other investors too worried to purchase assets, there is littleor no trading in the underlyingmortgage-backed assets and there-fore there is no or incomplete information about whether suchsecuritized assets have any value. In the absence of robust marketactivity, it is difficult to set a value. In contrast, for instance, theSavings and Loan cleanup was simpler because the government’srescue body (theResolutionTrustCorporation)was able to engagein some reasonable mark-to-market accounting (as did Swedishbanks in that country’s early 1990s banking crisis) (Allen andGale2007;White 1991).

The Treasury Department’s poor preparation and hurriedassumption about a process to set value failed to understand thatbanks are too worried about the weakness of their balance sheetsto engage in trading, thereby creating an impasse (only deepenedby the sudden collapse of Lehman Brothers). The original idea ofconducting “reverse auctions” turned out to be more dauntingthan first appreciated and was speedily dropped.

The immense scale of the TARP task was underestimated inpart because the Bush administration was blinkered by an unwa-vering devotion to the notion of free markets but also because itlacked the sophistication to fully understand what it was propos-ing to accomplish. The result of poor design was a shifting set ofapproaches that careened from the planned objective of acquiringbad debt to providing capital to banks in exchange for grantingthe government equity when the initial effort failed. Less thantwoweeks afterTARPwas enacted, theTreasury decided to investmuch of the $700 billion in banks; $115 billion was invested ineight of the largest financial institutions including Bank of Amer-ica Corp., Citigroup, and JPMorgan Chase with another $155 bil-lion distributed to 77 smaller banks. In contrast to othergovernments such asBritain, theTreasury approach to recapitaliza-tion lacked targeted conditions to spur investment and has pro-duced disappointing results, according to the GovernmentAccountability Office (2009) and an oversight body created byCongress (Warren et al. 2008; 2009). Indeed, senior Bush officialsinitially rejected Britain’s approach as “nationalization [and a]. . . punitive [approach]” (Andrews and Landler 2008); it was thefailure of the Bush administration’s policies that compelled pol-icy change, though ideology and weak analytic capacity contin-ued to hinder its diagnosis of the problem and the developmentof an appropriate remedy.1

2. Government as Instrument The Bush administration’sresponse to the financial meltdown in the fall of 2008 deepenedthe crisis by its double action of first expanding the reach of thestate and then ceding this new authority back to the groups andindividuals with ties to the banks, investment firms, and manu-facturers that became the beneficiaries of the new programs. Inthe 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 tril-lion more in loan guarantees for what was presented as servingthe common good of the nation.


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The second move relinquished back to certain financial andmanufacturing firms substantial influence over the govern-ment’s newly expanded authority and resources. This doublemove—expanded government and wider sectional influence—compromised internal government deliberations and decisionmaking. The ostensible aim of advancing the national interestbecame a tool to serve and privilege particular industries.

Particularistic interests have penetrated government deci-sions through three avenues. First and most obviously, industrymoles permeate government. Senior officials from the financialindustry and other sectors hold senior positions charged withdoling 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 eligiblefor Federal Reserve funds and guarantees. The giant insurancefirm AIG was rescued in a huge bailout (initially $85 billion,then supplemented with $38 billion and perhaps additional invest-ments) (Sorkin and Walsh 2008); Goldman Sachs was a verylarge AIG trading partner and stood to lose $20 billion if it col-lapsed (Morgenson 2008a).2 Paulson has multiplied the pres-ence of industry personnel by hiring a number of present andformer Goldman Sachs employees to administer TARP (Cres-well andWhite 2008).

Having former industry heads deciding how to dole out gov-ernment funds not only helped certain firms, it also hurt others.Goldman Sachs’s rival, Lehman Brothers, was denied support ina decision that has been widely criticized as undercutting confi-dence in the credit market and accelerating the fall 2008 creditcrunch (globally as well as in the U.S.).3 In addition to omittingcertain firms, the Bush administration’s response chose not tooffer direct support for another group without a strong propo-nent sitting at the table of decision makers—namely, homeown-ers struggling to avoid foreclosure.

A second, more shadowy avenue to shape the government’sfinancial rescue policy has been lobbying, now a veritable finan-cial sector in its own right in Washington (Kaiser 2009). Suchlobbying has occurred throughout the 1990s and 2000s, withmort-gage banks and brokers contributing $847,000 to the Bush reelec-tion campaign in 2004 (Becker, Stolberg, and Labaton 2008). Thelax regulation and oversight by SEC and the huge performance-based expansion in Fannie Mae and Freddie Mae were responsesto the intense and prolonged lobbying by the finance industry.

The third avenue for molding government policy is the mostdifficult to discern. There is a form of structural constraint thatoperates through the anticipated fear among government offi-cials of losing the jobs and tax revenues that would result if mas-sive holders of U.S. debt (such as the Saudis or Chinese) decidedtowithdraw their investment or to stopusing the dollar as a reservecurrency (Lindblom1979). InOctober 2008, theU.S.Treasury secu-rities amounted to 3,041.7 billion dollars, of which 652.7 was heldby China, 585.5 by Japan, and 187.7 billion by a group of oil-exporting countries dominated by Saudi Arabia. Since then theamounts have grown considerably as the Federal Reserve hasissued Treasury notes, bonds, and securities to fund bailouts andothermeasures.These states togetherwith other sovereignwealthfunds exert a complex influence onAmerican policymakers: giventhe scale of their investment, they harbor a strong interest inmain-taining the U.S. public debt as a viable resource that can be repaidover the long run.Yet this very global integrationmakesU.S. debtfunding vulnerable to sudden collapse.

This structural constraint extends the influence of sectionalinterests beyond the direct connections betweenpersonnel onWallStreet and key government institutions. Bush officials concludedthat their top priority was to restore financialmarkets rather thanto directly reinvigorate the manufacturing or service industries.This fear drove the New York Federal Reserve Board’s coordi-nated rescue of the Long Term Capital Management hedge fundin 1998 (a decision that looks unjustifiable in retrospect since itsent a positive signal to high-risk leveraged-based speculation andinvited moral hazard); it also explains why the Bush TreasuryDepartment has provided extraordinary capital to the AIG insur-ance company. Maintaining the confidence of American and for-eign investors is imperative for sustaining the U.S. debt load andpreventing flight to other investments.

The degree of this dependence is revealed in the myopic andpoorly conceived response in fall 2008 by the Treasury and Fed-eral Reserve to the deepening and diffusing crisis. No worked-outand intellectually defensible framework guided the decisions aboutwhich firms to rescue and when and how to operationalize suchkey decisions as the federal guarantee of FreddieMac and FannieMae or the implementation of TARP. The perceived threat of asystemic financial meltdown that would prompt a massive flightof capital appeared literally to spook senior financial policymak-ers: Federal Reserve chair Benjamin Bernanke alerted membersof Congress of collapse and the need for desperate measures, andvice president Richard Cheney pleaded for congressional Repub-lican votes bywarning that they could be tarred as “HooverRepub-licans.” The resulting haphazard and rushed policy was, in thissense, a response to perceived imperatives of global finance asmuch as a catering to individual lobbyists or former employees atmajor financial firms.

B. Legitimacy DeficitThe legitimacy of the American state as representative and asdevoted to the national interest has been strained by the target-ing of public money to business at a time of significant and grow-ing economic pain for American families. The sustainability ofthe American state’s legitimacy rests in important respects on theperceptions and trust of citizens as well as on the coherence of thestate’s organizing principles among governing elites.

1. Uncertain Stability of Public Trust The general public’s sus-tained belief in the American state has been the subject of signif-icant research, especially in the wake of the Vietnam War andprotests, the Watergate crisis, and inflation during the 1970s.Researchers distinguish between “diffuse” support for the politi-cal system as a whole and “specific” evaluations of incumbentofficeholders (Easton 1975, 445). Scholars find dramatically dif-ferent results: stable majorities of everyday Americans during the1960s and 1970s continued to support the political system and toexpress pride in the country’s political arrangements even thoughspecific government officials (notably, presidents Lyndon John-son and Richard Nixon) received strong negative approval rat-ings (Nie, Verba, and Petrocik 1976, 35–36; Miller 1974a; 1974b;1979; Citrin 1974; Citrin and Green 1986;Weatherford 1987).

The initial concern, then, that the widespread sense of power-lessness and cynicismwould threaten the established political andsocial order failed tomaterialize during the 1970s and 1980s; evenindividuals with quite strong negative attitudes about the politi-cal system were unable to identify specific changes in the systemof government that they favored (see, e.g., Sniderman 1981, 130).

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Past research poses two helpful lessons for analyzing the legit-imacy of the current political system among everyday Americans.First, strong disapproval of a president can and does coincidewithsupport for the overall political system. It is amistake, for instance,to conclude that the legitimacy and stability of the existing polit-ical order threatened to unravel owing to president George W.Bush’s historically low popularity as measured in approval rat-ings. Indeed, the election of Barack Obama on the promise ofchange could well reinforce the legitimacy of the political systemby demonstrating its responsiveness.

A second lesson is that regime legitimacy is contingent on con-text. The events of the 1960s and 1970s demonstrably resultedfrom the discrete policies and actions of specific presidents—President Johnson’s highly visible (thoughmisleading) set of deci-sions to expand troop levels in Vietnam and refusal to withdrawthem in the face of military setbacks and domestic protest as wellas President Nixon’s abuses of power that generated constitu-tional crises. By contrast, the circumstances of the 2008 financialbreakdownmay pose quite different dynamics that extend beyondthe policies of individual administrations to raise questions aboutthe general operations of the economic and political systems.Rather than assuming that the political order is safely stable basedon earlier research, it is critical to track and closely study systemlegitimacy in the wake of disruptions in the financial and eco-nomic system that are unprecedented in the period since WorldWar II.

The uncertain and fraught nature of sustaining legitimacy intoday’s state are explored adroitly in our edited volume by suchscholars as John Ferejohn on the tension between inequality anddemocracy, Cathy Cohen on the alienation of black youth, andLarry Bartels on the class bias of government responsiveness(Jacobs and King 2009).

2. Contradictory Policy: Helping Business andHurting CitizensIt is important to widen the analytic lens from a closely croppedstudy of public attitudes in order to consider the coherence ofbasic government policy. We would argue that the legitimacy ofthe American state faces a growing deficit moving into the futureas it simultaneously funnels trillions of dollars to businessesto restructure them and seeks to sustain the trust of everydaycitizens who bear the consequences of that restructuring. Thisdeficit may receive some short-term relief for the new presidentbut will not dissipate quickly. Indeed, the Congressional BudgetOffice and others are predicting that measures to revive the econ-omy, subsidize financial markets, and cover the costs of the Iraqand Afghanistan wars will produce colossal annual budget defi-cits in excess of a trillion dollars and 10% of the gross domesticproduct, the highest levels sinceWorldWar II (Stiglitz and Bilmes2008).

The messaging of government officials and allies that helpingbusiness helps American families is shrewd but it runs into twoproblems. First, there is widespread suspicion of favoritism forparticular industries (e.g., banking over automotive) or firms(Goldman Sachs over Lehman Brothers) at a time of perceivedneglect of the everyday citizen who has yet to receive comparablesupport. The populist backlash against what is portrayed as venaldeal making among well-placed insiders has been fuelled by thegovernment’s failure—according to theGovernment Accountabil-ity Office and the press—to ensure that the tens of billions of dol-lars funneled to banks have been tracked; they may even havebeen committed to paying bonuses to executives.

The second and more profound hurdle is the cycle of reinforc-ing contradictions in government policy. The recession damagedtwo golden birds with one stone—it rapidly reduced tax revenuesfor state and national government at the same time that itrapidly eliminated many jobs and thereby increased the costsfor a host of safety-net provisions for unemployment, foodstamps, and other essentials. Government efforts to stabilize thefinancial system and revive a crumbling economy were impera-tive, earning extraordinary bipartisan support. And, yet, theintended remedy—rescue packages to help sustain business asthey struggled to reconstitute themselves—accepted or actuallyencouraged these firms to take the necessary steps to survive,namely, laying off employees and taking other steps that dimin-ished the living circumstances of everyday Americans. Loansto the automotive industry, for instance, are tied to reducingthe wages and benefits of union members. The hundreds ofbillions of dollars funneled to financial investment firms aretargeted to keeping them afloat as they write off toxic loans,which in practice means evicting families from their homes. Evenproposals to streamline health care record keeping, which aregeared to reducing “unnecessary” costs and have been heraldedby President Obama as a key part of his stimulus package, willrequire firing thousands of workers who currently process thepaperwork.

In short, there is a fundamental incoherence in governmentpolicy: government policies that ostensibly help everyday fami-lies in practice hurt many. The state’s legitimacy as the incarna-tion of the popular will is undercut by the perception of favoritismand by the reality that government funds and requirements dimin-ish the living conditions of certain families by pushing upunemployment in some areas, cutting wages in others, and gen-erally accepting the decline in the credit and home ownership ofmany families.

The contradiction of help that hurts registers in a ballooningfiscal deficit, which is on track to top one trillion dollars. Thetendency to portray the federal government’s budget deficit asthe work of undisciplined and corrupt politicians larding legisla-tion with porkmisses amore fundamental dynamic. Governmenthelp to business to sustain its operation ends up undermining theeconomic circumstances of everyday families, which the govern-ment then seeks to partially offset through spending onunemploy-ment checks, subsidies for food, health care services, and othercash and in-kind benefits.

The legitimacy problem is that the state’s imperative to sus-tain core industries like finance and automotive collides with itsrequirement to maintain its standing as a government for and bythe people. This collision of opposing necessities may eventuallyshow up in surveys of public trust in the political system; it alsomanifests itself in the incoherence of government policy and theconfusion of government officials in the Bush andObama admin-istrationswhofind themselves both advocating for policies to sus-tain business while also approving policies to respond to thenatural consequences.

II. CHANGE AND CONTINUITY

The current economicmaelstromhas given rise to breathlessmediareports of the utter destruction of American business. Phraseslike “collapse” and “free fall” are rampant.

Analyses of American political development and economic his-torymake clear, though, that even unusual economic turmoil spurs


282 PS • April 2009

not only significant and salient changes, including the bank-ruptcy of longstanding businesses and enormous governmentinterventions in the private sector, but also the continuation ofalready established norms and patterns of behavior and practice.The administrative incompetence that set the trap for the currentfinancial breakdown and the looming legitimacy deficit that mayprecipitate increased alienation anddeclining support for the polit-ical system were structured into American political developmentand are likely to be reconstituted in the new business and govern-ment institutions that emerge. The exceptional expectations forPresident Obama to deliver the transformative change he prom-ised during the campaign will be complicated by a mix of signifi-cant change along with substantial compromises necessitated bythe existing institutional reality.

Unfortunately, few scholarly models of political systems arewell positioned to analyze this duality of change and continuityin current political economic developments. The general orienta-tion of many models is toward studying stability and the for-mation and longstanding maintenance of equilibrium. Forinstance, the varieties-of-capitalism approach to political econ-omy is essentially about stability and equilibrium, with a focuson identifying the self-reinforcing logic of economic and politi-cal development within distinct countries or regime types (Hall

andSoskice2001).Analysisof “pathdependence”similarlyempha-sizes thepositive feedbacks that load thedice toward the reproduc-tion of established institutional dynamics owing to the politicalequivalent of economic investment in fixed costs (Pierson 2000).Path-dependent arguments imply incremental, not dramatic,change in policy trajectories and offer little for the task of under-standing the duality of substantial but embedded change.

Students of economic and political institutions have similarlytended to focus on equilibrium, with debate focused on its insti-tutional conditions (Shepsle 1979). Longstanding analyses ofincrementalism (Lindblom 1959) and, for instance, the develop-ment of budgets (Wildavsky 1964) and social welfare programs(Derthick 1979), point to gradual adjustments in institutionaland policy frameworks that stand out for their remarkable sta-bility and stasis.

While analyses of institutions andpolicy regimes focus ondura-bility and stability, the study of political change (especially whenprecipitated by severe economic demands or downturns) tends tofocus on the propensity for crisis and collapse. The longstandingcrisis school warned of the real or imminent collapse of market-based democracies owing to citizens overloading governmentwiththeir demands for more and more (Huntington 1975), decliningprofitability (Mandel 1975), growing demands to prop up mar-kets and reassure citizens (O’Connor 1973), and other factors. Thecommon theme is that the state faces a persistent threat of col-lapse due to exogenous shocks that trigger systemic breakdowns,political regime reordering, or collapse.

In short, existing scholarly analyses are not well positioned toanalyze a political economic regime that is undergoing signifi-cant change (as illustrated by the recent financial market tur-moil) but avoiding collapse. Enduring political systems experiencestress and significant change without collapse.We need to under-stand this process.

Although critical aspects of America’s twenty-first century sys-tem of political and economic operations, norms, and relation-ships remain entrenched, the generation of mutual (if notproportionate) benefits and legitimacy to citizens and the busi-ness world faces critical future tensions for several reasons. First,the current political and economic systems are not satisfying theexpectations of Americans for a high standard of living and busi-ness for strong profitability. Even prominent business leaders andconservative economists question whether today’s political andeconomic systems can continue as they have without significantreformof the regulatory frameworkwithwhich theAmerican stateoversees financial markets.

Second, the commitment of trillions of dollars to resuscitatingbusinesses and the financial sector significantly limits the publicand private sectors’ future capacity. It burdens government withmassive debt and saps the government of its legitimacy as theembodiment of the popular will. The twin concerns are that the

current interventions are not renewable andwill inflict future gen-erations with deep and damaging consequences.

Models of punctuated equilibrium do helpfully account forlong periods of stability that are on occasion broken by sig-nificant electoral shifts that bring to power a new party,changes in public opinion, or “changes in society” (Baumgartnerand Jones 1993; Givel 2006; Gersick 1991). The unsustainabilityof the American state, however, stems from a more fundamentalbreak in the interconnection of the economy and political sys-tem as well as a more thoroughgoing interconnection of societyand politics.

CONCLUSION: SITUATED FUNCTIONALISM

The Obama administration came to office committed to enhanc-ing the state’s administrative capacity to restore the functioningof private markets. In a long-established but often misunder-stood paradox, state capacity creates and sustains privatemarkets(Brown and Jacobs 2008; Polanyi 1944). Obama’s efforts to restoreregulation over financial markets are geared toward reestablish-ing confidence in the economic system and propping up criticalindustries—like finance and automotive—to allow them to restruc-ture by, in part, reducing their workforces. His administration hasalso taken aim at reversing the kind of shoddy or incomplete over-sight by the SEC and other regulators that permitted BernardMadoff’s $50 billion Ponzi scheme and aWildWest financial sec-tor. Questions are also being raised about overseeing or takingover the job of supposedly independent ratings agencies whose

In short, existing scholarly analyses are not well positioned to analyze a political economicregime that is undergoing significant change (as illustrated by the recent financial marketturmoil) but avoiding collapse. Enduring political systems experience stress and significantchange without collapse.

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dependence on earning fees from the firms whose securities theyrated compromised their judgment (Morgenson 2008b). Increasedregulation will likely (as earlier critics warned) introduce restric-tions and impede future growth, though also reduce the probabil-ity of industry-wide instability.

The Obama administration is also committed to using thestate’s administrative capacity to expand collective social welfareprovisions and health care. Taking steps to improve the livingcircumstances of everydayAmericans hurt by the economic down-turn may well strengthen state legitimacy. Taking steps to halt orslow down the massive wave of home foreclosures and extendhealth coverage to more Americans may counterbalance thegovernment’s persistent responsiveness to the affluent and pow-erful as exemplified by the Wall Street bailouts (Bartels 2008;Hacker and Pierson 2005; Piketty and Saez 2007).

Whether Obama succeeds in restoring private markets andrenewing the state’s legitimacy are open questions. America’semerging fiscal crisis of successive trillion dollar deficits expressesthe contradictions of the American state and complicates its sus-tainability. Tens of billions have been and will continue to bepumped into thefinancial, automotive, insurance, and other indus-tries to keep them afloat and, yet, these lifesaving measures alsoerode the credible notion of a private sector. The more govern-ment intervention, the greater the public review and influence onmanagement prerogatives. Further demonstrating that govern-ment intervention is redefining rather than merely providing anuncomplicated rescue is the impact on credit markets: gargan-tuan government expenditures to rescue businesses necessitate acorresponding ballooning of public debt, which in turn will even-tually drive up interest rates and constrain business efforts tosecure loans on attractive terms.An additional contradiction exists:businesses benefiting from government largesse are basing theirrevival on cutting employees, benefits, and pay, which in turndiminishes the living circumstances of everyday Americans—producing the very outcome that theObamaadministration soughtto avoid and even reverse. In this sense, “the solution” (govern-ment intervention) intensifies the problems—from further layoffsto soaring budget deficits to pay for business bailouts and forunemployment and other benefits to assist those tossed out ofwork.

Understanding the nature and contradictions of the Obamaadministration and the course of economic and political develop-ments during this period requires analyses of both micro-institutional dynamics as well as larger systemic developments. Areconstructed form of functionalismmay prove valuable as a com-plement to fine-grained institutional analyses.

Reconsidering functionalism and political systems must bebased on a candid and careful assessment of its limitations. It fellout of favor after the 1970s because its preoccupation with themechanistic performance of predetermined imperatives pre-cluded due attention to political conflict, empirical attention tocausality, and the potential for system-level strain thatmight arisefrom policies that were detrimental to the political and economicorder. Despite its limitations, the crisis of our times may justify areconsideration of functionalist approaches that incorporate con-flict and empirically grounded analyses of institutional and soci-etal situations. For instance, the critical functionalist tradition ofthe 1970s (see, e.g., Gans 1972; Piven and Cloward 1993) includedsome of the mechanistic limitations of functionalism more gen-erally, but it offers an important platform for combining function-

alist analysis of broader system dynamics with the groundedanalyses of institutions and political conflict.

Situated functionalism could prove useful in studying statesustainability. State operations that sustain private markets andthe legitimacy of the existing political and social systems are fun-damental anchors for the sustainability of society and govern-ment. Whether and how the state maintains market operationsand legitimacy are open questions that require close and criticalinspection. �

NOTES

1. In the Stamp Lecture at the London School of Economics on January 13, 2009,Federal Reserve chairman Ben Bernanke revived the idea of the Treasury usingTARP money to buy up banks’ so-called toxic assets but did not detail howvalues for those assets would be reached.

2. The head of Goldman Sachs who organized the federal bailout participated inthe group that gathered urgently in the Federal Reserve Bank of NewYork; hewas the onlyWall Street chief executive present.

3. For Treasury Secretary Paulson’s response to criticisms about the LehmanBrother decision see the interview with him in the FinancialTimes (Guha 2008).

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