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2009-02-10

Economist James Galbraith: Bailed-Out Banks Should Be Declared Insolvent

Guests

James Galbraith, economist and professor of public affairs and government at the University of Texas. His most recent book is The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.

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With estimates of the cost of addressing the financial crisis exceeding $9.7 trillion, we speak with economist and University of Texas professor James Galbraith, author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too. Galbraith says rather than pouring billions into propping up troubled giant banks, the government should declare them insolvent. [includes rush transcript]

Transcript

This is a rush transcript. Copy may not be in its final form.

AMY GOODMAN: As the Senate prepares to vote on the $800 billion stimulus and recovery package today, President Obama urged Congress to pass the bill Monday, first at a town hall meeting in Elkhart, Indiana and later at the first news conference of his presidency. He warned that not acting immediately to rescue the economy could lead to a “catastrophe” and emphasized only the government could bail out the economy at this moment.

    PRESIDENT BARACK OBAMA: And if there’s anyone out there who still doesn’t believe this constitutes a full-blown crisis, I suggest speaking to one of the millions of Americans whose lives have been turned upside down because they don’t know where their next paycheck is coming from. That is why the single most important part of this Economic Recovery and Reinvestment Plan is the fact that it will save or create up to four million jobs, because that’s what America needs most right now.

    It is absolutely true that we can’t depend on government alone to create jobs or economic growth. That is and must be the role of the private sector. But at this particular moment, with the private sector so weakened by this recession, the federal government is the only entity left with the resources to jolt our economy back into life.

AMY GOODMAN: President Obama’s news conference came just hours after the stimulus bill advanced in the Senate by a vote of 61-to-36. Three Republicans and two Independents joined fifty-six Democrats to move the legislation forward, with a vote on final passage expected later today. The Senate bill differs substantially from its counterpart in the House, and the two versions will have to be reconciled before Obama can sign the legislation into law.

With his stimulus package receiving little Republican support, Obama repeatedly brought up his concerns around partisanship and "ideological" opposition to a federal spending plan.

    PRESIDENT BARACK OBAMA: Some of the criticisms really are with the basic idea that government should intervene at all in this moment of crisis. Now, you have some people, very sincere, who philosophically just think the government has no business interfering in the marketplace. And in fact there are several who’ve suggested that FDR was wrong to intervene back in the New Deal. They’re fighting battles that I thought were resolved a pretty long time ago.[...]

    What I’ve been concerned about is some of the language that’s been used suggesting that this is full of pork and this is wasteful government spending, so on and so forth. First of all, when I hear that from folks who presided over a doubling of the national debt, then I just want them to not engage in some revisionist history. I inherited the deficit that we have right now and the economic crisis that we have right now. [...]

    The question I think the American people are asking is, do you just want government to do nothing, or do you want it to do something? If you want it to do something, then we can have a conversation. But doing nothing, that’s not an option from my perspective. [...]

    Although there are some politicians who are arguing that we don’t need a stimulus, there are very few economists who are making that argument. I mean, you’ve got economists who were advising John McCain, economists who were advisers to George Bush, one and two, all suggesting that we actually needed a serious recovery package. And so, when I hear people just say, “We don’t need to do anything; this is a spending bill, not a stimulus bill,” without acknowledging that, by definition, part of any stimulus package would include spending — that’s the point — then what I get a sense of is that there’s some ideological blockage there that needs to be cleared up.

AMY GOODMAN: Highlights of President Obama’s discussion of the economy at his first news conference last night.

I’m joined now from Austin, Texas by economist James Galbraith. He’s a professor of public affairs and government at the University of Texas, Austin. His most recent book is The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.

Professor Galbraith, welcome to Democracy Now! First, your assessment of the stimulus package that will be voted on today.

JAMES GALBRAITH: Well, the one that’s being voted on in the Senate is distinctly inferior to the bill that was passed by the House a few days ago. It will pass the Senate, and we will now go to conference, and one hopes that the compromise package will be an improvement over the Senate bill.

There are things like school construction funds and particularly flexible aid to states, which are in a terrific fiscal crisis right now, that were taken out of the Senate bill to placate the small group of Republicans who came across, the two senators from Maine and Senator Specter, and it’s hard to understand why they wanted, for example, school construction funds to be out of this bill. Senator Nelson gave an explanation of it last night, which was, I think, very, very weak.

But there will be a chance in the conference committee to improve the legislation that will come out stronger. It will pass, it will be signed, and it will do some good. So that’s — progress is being made.

AMY GOODMAN: I’ve heard Senator Collins saying if it changes much, she simply won’t vote for it the next time.

JAMES GALBRAITH: Well, you know, it’s in this nature of the Senate that a small group of people can — and particularly with this division of power in the Senate, that a small group of senators can hold the entire package to ransom, if they choose, and that’s a reality, I suppose, that we have to live with.

But it’s very hard to see what their argument is for taking the particular tack that they are taking, to say — it’s extremely clear that school construction, for example, creates jobs in the United States, jobs that cannot be outsourced, jobs that immediately generate incomes in their community and leave valuable assets behind for generations of schoolchildren to take advantage of.

AMY GOODMAN: And —-

JAMES GALBRAITH: The flexible aid to -— yes, go ahead.

AMY GOODMAN: Professor Galbraith, what do you make of the new RNC chair, Michael Steele, saying these aren’t jobs, they’re simply work?

JAMES GALBRAITH: Well, it’s interesting that this semantic philosopher has taken over the Republican National Committee. It’s going to lead to some exceptionally — historians will have fun with the logic chopping and sentence parsing that we’re going to get from Mr. Steele, obviously, during his tenure. But otherwise, it’s unimportant.

AMY GOODMAN: I think the argument they’re using about schools, well, because they want to make the stimulus package smaller, is this could go to the states.

JAMES GALBRAITH: Well, they have actually taken out the funds that would support state spending. And the collapse of revenues for state and local government is one of the most serious aspects of this crisis. It is what is causing the state of California to put its employees on furlough as we speak.

So we’re looking here at something which, if not dealt with, will materially worsen the entire economic picture in the United States. And I think what we’re seeing — I can’t speak to the motives of the senators from Maine and Nebraska and so on, but I don’t think that they are as sensitive as they should be to the very dire economic conditions facing the population in large states like California and New York.

AMY GOODMAN: Professor Galbraith, do you think the stimulus package is large enough?

JAMES GALBRAITH: The stimulus package is a very good bill, and it should pass. It will not, by itself, deal with the economic crisis that we’re in. I think we should be very clear about that. Expectations for an early turnaround should not be — you know, should not be very high. A clear — a major problem that we face is that the stimulus package is sized so that it will work only if the revival of credit, which is part of the plan that the Treasury is announcing today, also works. And the problem is that that plan is still, I think, not well designed and is not likely to succeed. I think it actually, in many ways, misconceives the nature of the credit problem that we have, and therefore is very unlikely to succeed at bringing about an early revival of credit markets, of housing markets, of consumer credit markets, automobile loans, and the rest. Now, we could talk about that, but I think it’s very important to understand that this spending package is really geared to the success of this other piece, and this other piece is much more problematic than the spending package is.

AMY GOODMAN: We have to go to break, but we’re going to come back to Professor James Galbraith, economist, professor of public affairs and government at University of Texas. His most recent book, The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too. Stay with us.

[break]

AMY GOODMAN: Obama’s Treasury Secretary, Timothy Geithner, is set to introduce the next $350 billion installment of the financial rescue plan later today. At last night’s news conference, Obama spoke in broad terms about some of the features of the plan.

    PRESIDENT BARACK OBAMA: That means having some transparency and oversight in the system. It means that we correct some of the mistakes with TARP that were made earlier, the lack of consistency, the lack of clarity in terms of how the program was going to move forward. It means that we condition taxpayer dollars that are being provided to banks on them showing some restraint when it comes to executive compensation, not using the money to charter corporate jets when they’re not necessary. It means that we focus on housing and how are we going to help homeowners that are suffering foreclosure or homeowners who are still making their mortgage payments, but are seeing their property values decline. So there are going to be a whole range of approaches that we have to take for dealing with the economy.

AMY GOODMAN: President Obama in his first news conference last night. Professor James Galbraith is still with us, economist, University of Texas. His book, The Predator State. Explain the bailout and what you think should happen today.

JAMES GALBRAITH: Well, the crucial question is, on what terms does the Treasury plan to guarantee or to repurchase or to otherwise deal with the bad assets that the banks have? These assets are mortgage-backed securities. They are securities derived from subprime loans that were made in an atmosphere of regulatory laxness and complicity and fraud, basically, during the Bush administration, which came to take over the system of housing finance and to infect it with assets which nobody trusts, which nobody can value. And nobody really knows what’s in the files, what’s on the loan tapes of those — that underlie those securities. So the question that I think we need to ask is, before we issue a public guarantee, does the Treasury of the United States plan to conduct a meticulous audit of the assets that underlie the securities that they’re expecting to take off the banks’ books, so that we, the taxpayer, can have an idea of what, if anything, these securities are worth?

And the problem is that when you — the little bit of checking that has been done appears to reveal that a very large fraction of these securities contain, on the face of it, misrepresentation or fraud in the files. And so, we are looking at an asset which nobody, no outside investor doing due diligence on behalf of a client for whom they have some responsibility, would touch. And that is the issue. That’s the problem.

If that is indeed the case, then I think it’s fair to conclude that the large banks, which the Treasury is trying very hard to protect, cannot in fact be protected, that they are in fact insolvent, and that the proper approach for dealing with them is for the Federal Deposit Insurance Corporation to move in and take the steps that the FDIC normally takes when dealing with insolvent banks.

And the sooner that you get to that and the sooner that you take these steps, which every administration, including the Bush administration, actually took in certain cases — replacing the management, making the risk capital take the first loss, reorganizing the institution, guaranteeing the deposits so that there isn’t a run, reopening the bank under new management so that it can begin to function again as it should have all along as a normal bank — the sooner you get to that, the more quickly you’ll work through the crisis.

The more you delay and the more you try to essentially prop up an institution whose books have already been poisoned, in effect, by this — the practices of the past few years, the longer it will take before the credit markets begin to function again. And as I said before, the functioning of the credit markets is absolutely essential to the success of the larger package, of the stimulus package and everything else, in beginning to revive the economy.

AMY GOODMAN: Professor Galbraith, I wanted to read to you a little from today’s New York Times, which said, “The Obama administration’s new plan to bail out the nation’s banks was fashioned after a spirited internal debate that pitted the Treasury secretary, Timothy [F.] Geithner, against some of the president’s top political hands.

“In the end, [Mr.] Geithner largely prevailed in opposing tougher conditions on financial institutions that were sought by presidential aides, including David Axelrod, [a] senior adviser to the president.” [...]

“[Mr.] Geithner, [who] will announce the broad outlines [of the plan on Tuesday], successfully fought against more severe limits on executive pay for companies receiving government aid.

“He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid.”

JAMES GALBRAITH: Well, I think David Axelrod’s instincts in this matter were correct, but it really is not a political issue. This is an issue which should be determined after you have had — made an evaluation of the solvency of the institution, of whether its assets are sufficient to cover its liabilities. That’s a technical determination.

The proper authority for making that is neither Timothy Geithner nor David Axelrod; it’s Sheila Bair, the chairman — the chairwoman of the Federal Deposit Insurance Corporation. She has the authority, and she should be the one who’s making that determination, again, not on political grounds, not on whether the public is angry, as it justifiably is, over the compensation packages these banks have been paying to themselves, but whether the banks themselves are viable as — whether they’re meeting their capital requirements, whether they in fact have assets on their books sufficient, as I say, to keep them solvent. And if that’s not the case, there’s a clear chain of responsibility, and it’s not a political decision. It’s a technical decision. It’s a banking regulation decision that needs to be taken.

AMY GOODMAN: But what about Geithner’s plan, again reading from the Times, saying, “The $500,000 pay cap for executives at companies receiving assistance, for instance, applies only to very senior executives.” [...]

“Abandoning any pretense about limiting the moral hazards at companies that made foolhardy investments, the plan also will not require shareholders of companies receiving significant assistance to lose most or all of their investment. Some officials had suggested [that] the next bailout phase not protect existing shareholders.” [...]

“Nor will the government announce any plans to replace the management of virtually any of the troubled institutions, despite arguments by some to oust current management at the most troubled banks.

“Finally, while the administration will urge banks to increase their lending, and possibly provide some incentives, it will not dictate to the banks how they should spend the billions of dollars in new government money.”

Professor Galbraith?

JAMES GALBRAITH: Well, when you’re dealing with a bank which is essentially solvent, then you can make these judgments. But as I said, when you’re dealing with a bank which has already basically rendered itself insolvent by virtue of its complicity — it’s basically seeking for easy money, for big profits, out of mortgage originations and underwriting fees in the last part of this decade — then you’re dealing with a bank which is already underwater. The risk capital is already worth nothing. It’s being held up only by the expectation of a federal bailout.

The management is — the problem with leaving the management in place is that you cannot rely on the existing management to give you a full and fair accounting of what is in the books of the bank and what the practices of the bank are. That is why you need to bring in a new team. You need to bring in a team which is nominated by the FDIC, which has as its first objective coming clean, going through the books of the bank and separating the good assets from the bad assets, the assets which are — which have a reasonable chance of continuing to earn income from the assets which need to be written down or written off. Then you can make an assessment of just how big the losses are and what has to be done, whether the bank itself should be closed, which is sometimes the case; whether it can find a merger partner, which is sometimes the case; or whether what you do is reorganize it, isolate the bad assets from the good assets and relaunch the good assets as part of a new bank. One thing or another has to be done. And when it’s done, you can begin to basically grow the economy on the basis of these new newly reconstructed credit institutions.

But so long as you’re dealing with the old management and so long as you’re dealing with the old practices and so long as you don’t have a clean audit of the books, the chances are that the bank is going to behave in ways which are not constructive, which do not contribute to the growth of the economy, and which leave all kinds of suspicions present in the system about the integrity of the institution and of the regulatory process. And that’s the problem the Treasury Department seems to be determined not to face.

And so long as it doesn’t face it, we’re not going to get out of this, and the Treasury Department is not contributing constructively to the success of the recovery plan, which the Congress is about to enact. And that will mean that the recovery plan itself will be, sort of after the fact, too small to deal the problem of unemployment, which is just growing at the rate of a half a million jobs a month. So we are — and that’s the dilemma that we’re in.

And I think that this point — the Times story is extremely important, because it does tell you exactly where the Treasury Department is. But at this point, that’s the impasse that has to be solved, and I’m afraid it’s going to be some time, since this plan is going to be announced today, before we come again to the realization that the hard choices in the financial system cannot be avoided.

AMY GOODMAN: Professor Galbraith, are you for nationalizing banks?

JAMES GALBRAITH: You know, I think the term is a political misleading term. I learned a few months ago that in 1982, at the time of the Latin American debt crisis, the Reagan administration’s FDIC had a contingency plan to nationalize the major banks in the case that a major Latin American country — let’s say Mexico or Argentina or Brazil — had defaulted outright on its debt. This was not something that administration would have wanted to do. In the end, they didn’t have to do it. But they had a plan to do it, if it was necessary because the banks were rendered insolvent by the running to ruin of a major class of assets.

Well, we have a major class of assets — that is to say, all of these subprime mortgage-backed securities — which have run to ruin. They should never have been issued in the first place. They are very, very highly likely to default. They were issued on terms which makes them basically unmarketable, because there is not adequate loan documentation. And when there is loan documentation, that documentation evidently indicates that the loans are likely to go bad, so that nobody outside will buy them. That’s a problem that exists in the banking system, and the regulators simply have to deal with it.

And I don’t think — you know, it’s not — we’re not in 1945 in Attlee’s Britain, where we are taking the commanding heights of their economy or anything like that. We are doing what regulators always have to do, in conservative and liberal administrations, when faced with major intractable insolvencies in the financial system. If you don’t deal with that, the problem of fraud and loss just gets worse. And the losses that are incurred after insolvency are losses that fall on the taxpayer, because they come against deposits that are insured. So, one way or another, until we deal with this, the taxpayers’ liability just gets bigger and bigger.

AMY GOODMAN: Professor James Galbraith, something I’ve noticed over these last weeks is this whole debate, sort of re-debating the New Deal and FDR and what it accomplished, and conservatives continually saying that it was not the New Deal that ended the Depression, it was World War II.

JAMES GALBRAITH: Well, first of all, there is a grave understatement in those arguments about what the New Deal actually did. And that understatement is typically because the unemployment figures that many people are accustomed to using for the 1930s don’t count people who actually worked for the New Deal. This is Michael Steele’s distinction between jobs and work. But people who were building the Lincoln Tunnel or the Triborough Bridge or the aircraft carrier Yorktown are counted as work relief and not as employed, and there were many millions of those. And when you put them into the figures, you find that the New Deal actually reduced unemployment from 25 percent in 1933 to about — to less than ten percent in 1936. It went up again in ’37 and then came back down again to about ten percent before the war. So, a major, major improvement in unemployment did occur under the New Deal.

It is true that the war made a major transformation in the economy. It drove unemployment to zero. But it also did something else. It gave the American family, the American household, a financial cushion, which was the war bonds that people accumulated during the war that formed the basis for the financial prosperity of the 1950s and 1960s. And that is what made the — made it possible for the private financial system, which collapsed in 1929, to recover in the 1950s and ’60s. And I think that point is very important, because what it shows you is that when the financial system goes down, as it seems to have gone down in the last couple of years, recovery requires a long time. And the precondition for recovery is not fixing the banks; it’s fixing the balance sheets of the households, the creditworthiness of the American family.

And the problem that we have here is the fall in housing prices, people who have mortgages that are worth much more than their houses, which is rendering the entire borrowing base of the American economy basically insolvent. And it will lead to make it extremely difficult for the mechanisms of credit to work again, until you’ve done enough basically to stabilize housing, to stabilize jobs and incomes, and then make it possible for banks — for any reasonable bank, even a solvent bank — to look at its borrowers and say, “Gee, this is a good credit risk,” and for that matter, for the borrowers themselves to feel, “Gee, this is a good time to come in and borrow and get that new car.” That’s the issue that they’re going to face. It’s going to take a long time and major change. And that’s why I say the whole package here is probably not adequate, but it’s a good — that said, what Roosevelt did in ’33 wasn’t adequate either. It was simply a start. And that’s where we are.

AMY GOODMAN: Professor Galbraith, I hate to ask you this last question with just about thirty seconds to go, but it’s about the title of your book and what it means, The Predator State.

JAMES GALBRAITH: Well, the Predator State refers to the takeover of state power by private interests masquerading behind conservative principle and basically acting for private clients and private profit. That was the Bush administration in a nutshell. The title goes back to Veblen and a bit to my father’s New Industrial State, and it’s an attempt to capture in two words a phenomenon that I think really has transformed our economy, much for the worse in the last several decades.

AMY GOODMAN: James Galbraith, I want to thank you very much for being with us. And yes, if you were wondering if his father was John Kenneth Galbraith, he is. Professor James Galbraith is economist, a professor of public affairs and government at the University of Texas, Austin. His most recent book, The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.

This is Democracy Now! When we come back from our break, we’re going to look at another part of the news conference last night, and that’s the question that President Obama was asked about Afghanistan: what is his plan? We’ll speak with the former UN human rights investigator who was fired in 2005, forced out after he released a report critical of US soldiers’ human rights abuses in Afghanistan. We’ll be speaking with the attorney, the international law expert, Cherif Bassiouni in Chicago.

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