A New Age Of Global Capitalism Starts Now

And there was plenty being spread, particularly after 2004, when another legal shift further increased the stakes of the game. The SEC, in order to gain more regulatory jurisdiction over the parent holding companies of investment banks (which it regulated), bartered away the traditional 12 to 1 cap on leverage in a Faustian bargain, allowing banks to take bets as big as they liked. On one level, the move made sense, since the holding companies were typically the entities taking the hazy credit-derivative bets that were making people increasingly nervous. Yet the result was a situation in which SEC regulators no longer had clear-cut capital guidelines to review when judging the solvency of banks; instead, they had to pour over incredibly complex models comparing the value of one group of assets with another at different points in time (it was perhaps apropos that these models were known as "Monte Carlo simulations"). It's not too difficult to imagine SEC staffers being paid five figures having a hard time keeping up with such high finance. "There are a lot of things that the SEC is good at, but that wasn't one of them," says Professor John Coffee, a securities-law expert at Columbia University. "The market for complex securities was growing too fast for them to keep up." (Coffee believes that regulation of such complex models is ultimately better left to the bankers at the Federal Reserve, which will be in charge of regulating banks such as Goldman Sachs and Morgan Stanley going forward.)

House prices, which had shot up between 2001 and 2005, plummeted, exposing poor credit standards (it didn't help that the credit agencies were paid by the companies they were supposed to rank). The bubble burst. The dominoes fell. And now Americans are left wringing their hands about the cost of a bailout package that would seem to reward the greed that created the mess to begin with. "Much of the anger over the past week has not been about the fact that the government has produced this massive safety net, but that the people who will receive it are the Wall Streeters who've made out like bandits in the past few years," notes Robert Reich. Meanwhile, average Joes are scared (a point worked to effect by both presidential candidates in the U.S.), and basic dreams like homeownership seem to be slipping away for many. Experts like Coffee predict that with the demise of securitized mortgages, the overall mortgage market in the U.S. will contract to one tenth its current size. The sort of Depression-era scenario of a one-lender town painted in movies like "It's a Wonderful Life" no longer seems so far away.

While it's unclear yet how much help average Americans will get from the government's bailout package once details are finalized, what is clear is that the extremely free-wheeling capitalism of the past two decades is changing—if not into an entirely new ideology, then into a more moderate version of itself. For starters, old-school investment banks as we knew them are finished. Policed by the Fed, their ability to leverage themselves into big deals will shrink massively. "I think it's going to be back to basics," says Morgan Stanley's Roach. "More advice giving and less highly leveraged trading. Deals will be driven by the strategic needs of the clients—not the intermediaries—and we'll see deals themselves that are more strategic rather than financial."

Bankers' pay may even be capped (in the U.S., Reich and many others are calling for pay pegged to five-year rolling performance targets to help curb undue short-term risk-taking, in Europe there are plans to legislate delays in the vetting of options). Meanwhile, the complex derivative markets that made the bankers so rich are also liable to be constrained. In the U.S., there are calls for a clearinghouse that would make trades more transparent. In Europe, plans to regulate derivatives are already moving forward: last week, the EC drafted a proposal that would ban or limit CDOs and other banking magic tricks that turned risky debt into triple A securities.

German Finance Minister Steinbrück has even launched an official campaign to "civilize" financial markets. "Unrestrained capitalism like the kind we're experiencing right now with all its greed will in the end devour itself," he proclaimed, referencing Marx in a speech in an interview with a German weekly. Steinbrück is gunning for higher cash reserves for banks, prohibitions on short selling, bonus caps, and no more off-balance-sheet vehicles, among other things. "It must be clear that returns of 25 percent can't be attained without unreasonable risk or intentionally damaging other market participants," Steinbrück told the Bundestag last week.

Of course, it's worth remembering that some of the most highly leveraged deals in recent memory were done by state-regulated German banks rather than Wall Street giants. More government oversight itself is no guarantee that all will turn out well—regulations must be well crafted, well enforced, and to some extent, flexible. George Soros, for example, a strong critic of Wall Street excesses, advocates not lowering leverage ratios to a set rate, but giving the Fed the flexibility to raise and lower the rates as market conditions dictate.