This item is a reprint of an item published at the onset of the 2008
financial crisis. This is what a friend said and the actions of the
Obama presidency can be judged accordingly.
As I spelled out in the early days, the housing situation needs to
be fixed in order to rebuild credit among those destroyed. Some of
this is only now beginning to happen. Iceland has shown us one way
and others also exist. The banks continue to dream that the market
will somehow bail them out while the reality is that they own wasting
assets.
In fact Obama has failed utterly to address the core issue of his
presidency and has instead catered to the banking system rather than
outright dismantling it. I suspect that our too big to fail banking
group is on the road to dismantle itself. The weaknesses are
becoming more apparent and the rising success of the mid sized
successor institutions will naturally drain business away from the
elephants.
These are long cycle changes though and we will barely notice some of
the changes. Recall the rail industry of the sixties when they all
pretty well hit the wall and were forced into contraction and
rationalization. Today the whole industry is lean and mean and
growing nicely and ready for technical innovation.
James K. Galbraith:
We Told You So
Author: Yves Smith ·
May 24th, 2012
James K. Galbraith is
an economics professor at the University of Texas at Austin, where he
holds the Lloyd M. Bentsen Jr. Chair in Government/Business
Relations. He writes about economics for numerous publications. His
latest book, “Inequality and Instability: A Study of the World
Economy Just Before the Great Crisis” (Oxford University Press,
2012), is available here.
Like many Americans, I
was doing everything I could to help elect Barack Obama. It wasn’t
all that much—but as an economist in Texas, I had some authority on
the thinking of former Senator Phil Gramm, John McCain’s chief
economic adviser. I’d made the front page of the Washington Post
describing Gramm as a “sorcerer’s apprentice of financial
instability and disaster.” (Gramm, with a certain sense of humor,
denied it.) For that, and for my experience drafting policy papers, I
was in contact every few days with Obama’s economists.
To economists in my
own circle, it had long been clear that the financial crisis then
unfolding was an epic event. We had watched the subprime mortgage
disaster build up. In August 2007 we knew the meltdown had begun.
Bear Stearns had failed. But for reasons that have to do with the
pace and rhythm of politics, these issues remained on the back
burner, the campaign being dominated by health care and the Iraq war.
For those of us on the outside, it was hard to know whether the
insiders understood what was coming.
And so it seemed a
good idea to raise an alarm. But here you confront the Cassandra
paradox: if you predict disaster, no one believes you. Economics is
rife with alarmists; if the wolf really is at the door, it’s better
to have a whole chorus saying so.
For this I had the
help of the Charles Leopold Mayer Foundation for Human Progress,
which convened a meeting in Paris. When you invite twenty friends to
spend a few days in Paris in June, it’s rarely hard to persuade
them to come. Among the Americans in the group were the editors of
two important journals, a former United Nations financial expert, and
the former federal regulator who had blown the whistle on the savings
and loan fraud. There were also senior specialists from France,
Britain, India, China, and Brazil.
The meeting had no
political connection, but one result was a long memorandum, which I
sent in early July to the Obama team. I do not know whether, or by
whom, my memo was read. Not the slightest word came back.
Yet the memo
disproves the notion that nobody knew. To the group in Paris, three
months before Lehman, what I wrote was obvious. It was our consensus
view. What follows is an excerpt.
* * *
The most important
common ground was over the depth and severity of the financial
crisis. We placed it in a different league from all other financial
events since the early thirties, including the debt crises of the
eighties and the Asian and Russian crises of the late nineties. One
of us called it “epochal” and “history-making.” And so it has
turned out. What distinguishes this crisis from the others are
three facts taken together: (a) it emerges from the United States,
that is, from the center, and not the periphery, of the global
system; (b) it reflects the collapse of a bubble in an economy driven
by repetitive bubbles; and (c) the bubble has been vectored into the
financial structure in a uniquely complex and intractable way, via
securitization.
Bubbles are endemic to
capitalism, but in most of history they are not the major story. In
the nineteenth century, agricultural price deflation was a larger
problem. In the twentieth, industrialization and technology set the
direction. It was only in the information technology bubble of the
late nineties that financial considerations including the rise of
venture capital and the influx of capital to the United States
following the Asian and Russian crises—came to dominate the
direction of the economy as a whole. The result was capricious and
unstable—vast investments in (for instance) dark broadband,
followed by a financial collapse—but it was not without redeeming
social merits. The economy prospered, achieving full employment
without inflation. And much of the broadband survived for later use.
The same will not be
said for the sequential bubbles of the Bush years, in housing and now
commodities. The housing bubble—deliberately fostered by the
authorities that should have been regulating it, including Alan
Greenspan and Ben Bernanke—pushed the long-standing American model
of support for homeownership beyond its breaking point. It
involved a vast victimization of a vulnerable population. The
unraveling will have social effects extending far beyond that
population, to the large class of Americans with good credit and
standard mortgages, whose home values are nevertheless being wiped
out. Meanwhile, abandoned houses quickly become uninhabitable, so
that, unlike broadband, the capital created in the bubble is
actually destroyed, to a considerable degree, in the slump.
Securitization is a
long-standing practice but the question is, at what point does it go
too far? It should be clear by now that nonconforming home loans
cannot be safely securitized, because the credit quality and
therefore the value of the asset cannot be reliably assessed.
Further, in the regulatory climate of recent years (where as William
K. Black pointed out, political appointees brought chainsaws to press
conferences), ordinary prudential lending practices broke down
completely. The housing crisis was infected by appraisal fraud, a
fact overlooked and therefore abetted by the ratings agencies. “No
one looked at the loan package.” Now the integrity of every
part of the system, from loan origination to underwriting to ratings,
is under a cloud.
Fraud is deceit, a
betrayal of trust. And it is trust that underlies valuation in a
market full of specialized debt instruments, off-books financial
entities and over-the-counter transactions. That trust has, as of
now, collapsed. The result, as John Eatwell phrased it, is that
financial crisis takes the form of market gridlock—a systematic
unwillingness of institutions to accept the creditworthiness of their
counterparties. This is, of course, especially grave where a
counterparty has no direct resort to a lender of last resort—and so
the crisis naturally erupts in parts of the system that are outside
the direct purview of central banks. Deregulation is, in other words,
a vector of financial crisis.
The message of all
this for the Obama presidency is fairly clear. No one in the group
expects the financial crisis to have disappeared, or even to be under
stable control, by January of 2009. At that time there will no doubt
be immediate priorities: more fiscal expansion, fast action
against the wave of home losses to foreclosures, plus fast action
against financial speculation in commodities would seem as of now to
head the “to-do” list. But the financial problems will not go
away. And that means that a seemingly benign credit expansion, such
as got underway for Clinton in 1994 and carried him through his
presidency, is not in the cards for Barack Obama.
Given the fact that
vacated and unsold houses (unless destroyed outright) stay in
inventory for a long time, there is little prospect of a housing
recovery, or that a new expansion of loans to the broad population
will be collateralized by home values any time soon. Recovery from
this source should indeed not be expected within the policy horizon
of the next presidential term. Something could happen, for reasons
largely unforeseen, as it eventually did in the 1990s. But to bank on
such a happy development would be an act of faith. More likely, there
won’t be good news on the growth front in 2009, 2010, or 2011.
Achieving economic growth in some other way will therefore be an
overriding policy preoccupation.
The only other known
way is fiscal policy, and this raises two questions: how much fiscal
expansion will be needed, and over what time horizon?
Calls are now being
heard for a “second stimulus package”; these reflect the fact
that the first stimulus package [the Bush package of Spring 2008],
while effective, was necessarily short-lived. But the same will be
true of the second stimulus package. And once the election is over,
will the coalition presently supporting short-term stimulus stay in
place? If not, what then?
If the above analysis
is correct, the political capital of the new presidency risks being
exhausted, quite quickly, in a series of short-term stimulus efforts
that will do little more than buoy the economy for a few months each.
Since they will not lead to a revival of private credit, every
one of those efforts will ultimately be seen as “too little, too
late” and therefore as ending in failure. Meanwhile a policy of
repetitive tax rebates can only undermine the larger reputation of
the country; it is unlikely that the rest of the world will happily
continue to finance a country whose economic policy consists solely
of writing checks to consumers.
What is the
alternative? It is to embark, from the beginning, on a directed,
long-term strategy, based initially on public investment, aimed at
the reconstruction of the physical infrastructure of the United
States, at reform in our patterns of energy use, and at
developing new technologies to deal with climate change and other
pressing issues. It is to support those displaced by the unavoidable
shrinkage of Bush-era bubbles but to do so efficiently—with
unemployment insurance, revenue sharing to support state and local
government public services, job training, adjustment assistance, and
jobs programs. It is to foster, over a time frame stretching from
five years out through the next generation, a shift of private
investment toward activities complementary to the major public
purposes just stated. It is to persuade the rest of the world that
this is an activity worthy of financial support.
As noted, this
strategy will have to be developed in a hostile environment of
unstable oil and food prices. However, it would be a grave mistake to
interpret that unstable price environment as “inflationary,” as
leading toward a sustained or inertial inflation. In particular,
money wages have not changed or caught up; real wages are therefore
falling—and quite sharply—in view of the commodity price
jumps. As Ben Bernanke acknowledged in a recent speech, nothing in
the present movement of price indices can be attributed to wages. In
Bernanke’s choice phrase, “the empirical evidence for this
linkage is less definitive than we would like.”
It is Democratic Party
mantra that Presidents do not comment on the actions of the Federal
Reserve. But in this situation, comment is needed. An appropriate
comment on the larger role of monetary policy does not amount to
interference in routine decision-making, e.g., of the Federal Open
Market Committee. Rather, it should reflect the core reality: the
Federal Reserve and other financial regulatory agencies failed in
their responsibilities in the past decade and now they must take up
those responsibilities again.
The entire point of a
regulatory system is to regulate. It is to subordinate the
activities of an intrinsically unstable and predatory sector to
larger social purposes, and thus to prevent a situation in which
financial interests dictate policy to governments. That is,
however, exactly the situation we have allowed to develop. The job of
the Federal Reserve and of the other competent agencies in the next
administration must be, in part, to reestablish who is boss.
Specifically, there needs to be a very thoroughgoing revamping of the
financial rules of the road, to dampen financial instability, deflate
the commodity bubble, reduce the enormous monopoly rents in the
financial sector, set new terms for credit management, and generate
productive capital investment where it is most required. This is
in large part the Federal Reserve’s job, though it has strong
inter-agency and international dimensions.
These measures cannot
be viewed, or undertaken, in isolation from the international
financial position of the United States. Obviously, a successful
speculative attack on the dollar would severely disrupt the orderly
implementation of this or any other strategy. Equally obviously, a
unilateral defense of the dollar via a campaign of high interest
rates would severely aggravate the problems of the real economy.
The way out of this
dilemma—the only way out—lies in multilateral coordination and
collaboration: a joint effort by the United States and its creditors.
And this means that the next administration must return, rapidly and
with a credible commitment, to the world of collective security and
shared decision-making that the Bush administration has been at pains
to abandon. An orderly disengagement from Iraq would send a major
signal of the intent of the U.S. government to play, in the future,
by a different set of rules.
Collective security,
in short, is not merely a slogan. It is the lynchpin of our future
financial and economic security—security that cannot be assured by
any unilateral means. Only a collective effort will keep America’s
creditors committed to the stability of the dollar-reserve system for
long enough to effect the next round of economic transformation in
the United States. Conversely, continued failure to appreciate the
financial and economic dimensions of unilateral militarism is one
certain route toward the failure of the next administration’s
economic and financial strategies. The two largest issues we face—how
to maintain American economic leadership in much of the world and how
to manage American military power—cannot be separated from each
other.
Collective security
is, however, also more than simply a way of reducing risks and
instabilities. It is the foundation stone for many physical
transformations of the economy to come. It is obvious, in particular,
that the military basis of international power on which the United
States continues to rely is completely out of date, and has been for
decades. As Iraq has demonstrated to everyone including the
professional military, military power alone cannot deliver stability
and security at all—let alone at an acceptable human and social
cost. Yet parts of the military establishment continue to develop,
and to harbor, the technological talent and capacity for problem
solving which every aspect of our energy problem now needs. Shifting
the basis of our security system away from one based on military
equipment is a key step toward making those resources available.
And the same is true
for other countries. China, for example, has long made energy choices
favoring coal partly because the resulting power plants are diffuse
and militarily expendable. In a secure world, that country would be
far more willing to develop its vast hydroelectric potential, as the
then-invulnerable United States did in the 1930s. Hydropower is
carbon-clean, but militarily exposed. A stable reduction of military
fears is a key step toward opening up markets that can potentially
permit resolution of collective problems on the grand scale.
In short conclusion:
from the beginning, the Obama presidency will face acute situations
requiring immediate action, especially in oil and housing. It
should aim for early victories in these areas as the foundation stone
for intermediate- and long-term programs. For the medium term,
institution building and the restoration of competent and effective
regulatory power over the financial system—both national and
international—will be key.
For the long term, the
goal should be nothing less than the transformation of our energy
base and the solution of our environmental challenges—the
rebuilding of America. And that can be done only in an international
financial climate made possible by a return to multilateral
decision-making and a commitment to collective security. The American
people are ready for this. President Obama should be prepared to
explain that leadership in a world community—leadership of
collective action on the grand scale—is America’s true destiny.
It is not in futile warfare, but in great endeavors, that a great
nation finds its future, its purpose, its place in history, and
prosperity, as well as security, for its people.
* * *
This piece first
appeared in Issue 19 of The Baffler — available now! — and is
reprinted with permission. Image from Fey Ilyas (CC BY-SA 2.0)
This post originally
appeared at naked capitalism and is posted with permission.
No comments:
Post a Comment