THE FINANCIAL CRISIS, THE US ECONOMY, AND
INTERNATIONAL SECURITY IN THE NEW ADMINISTRATION

New School University
New York City
November 14, 2008

1:45 - 2:30 Luncheon Keynote Address

Teresa Ghilarducci:
            I am the Bernard and Irene L. Schwartz Professor of Economic Policy Analysis, a position I just recently took and one that I’m very honored to have, not only because I can direct the center that David Gordon started at The New School, but also because I can teach at The New School and advance the goal of the center and Mr. Schwartz, which is to bring non-conventional economic thinking, or to challenge conventional economic thinking, in the world of policy.  I would like Jamie Galbraith to talk about what Bernard Schwartz means to him and to his project, Economists for Peace and Security. Thanks, Jamie.

Jamie Galbraith:
            Yesterday I was at a television studio doing a taping for Frontline, as it happened, and it was a contentious session dealing with ideas about budget deficits and debt, and so forth, and the opinions of certain people I happen to disagree with. Forrest Sawyer, who was interviewing me, asked if I thought the United States was in the grip of a class war. . I said no, and the reason that we are not, and have not been, and will not be in the grip of a class war is that we have in this country a tradition of political involvement that transcends economic position.  I mentioned earlier today Jesse Johnson, of the Reconstruction Finance Corporation, and I could mention my father’s mentor, Bernard Baruch, and the other leaders of American business who put themselves at the service of the country in cooperation with that greatest of all class traitors, Franklyn Delano Roosevelt.  I might mention my mother’s dancing partner from those years in World War II in New York, and the black sheep of his family, Corliss Lamont. A tradition of excellence, of dedication, of clarity of thought, and truly of leadership, and Bernard Schwartz is very much in that tradition. Everyone, I think, who is in this room has at one time or another, in one way or another, benefited from his presence and his contributions to this community. He is a business leader of distinction. He knows how to make things that work, and I believe he knows how to make them work in hostile environments and after traveling on very fast-moving vehicles. Beyond that, he has set himself the task of bringing his influence, and the clarity of his positions, and his dedication to the cause of the country to bear on the problems that we face today.  I would just say that it is a tremendous privilege, as the chair of Economists for Peace and Security, as a guest of the Schwartz Center, to stand her and introduce to you Bernard Schwartz.

Bernard Schwartz:
            Thank you, Jamie. It is an extraordinary privilege to mentioned in the same paragraph with Jesse Johnson, Bernard Baruch, Corliss Lamont, your father, and your mother. That’s a very very special introduction, and I thank you for that.
            We’re going to be talking a little bit today about a continuation of what was happening here this morning. I think this morning was pretty grand from the point of view of the quality of the dialogue, the challenge of the ideas that were expressed; and I want to thank everybody who was involved. Theresa, thank you very much.  Jamie, I think this is a real contribution to the debate. I want to thank Thea, who may or may not be in the room, and the moderators, and the speakers who were really extraordinary. I thought it was a pretty good dialogue today.
            When we talk about the present crisis, and there’s been a lot of discussion about that, I think we should recognize that part of the difficulty in assessing the uncertainties leading up to the present crisis is that everything happened at once. There were healthy economic indicators that we were, over the last decade or so, used to. The healthy economic indicators turned out, however, to be misleading. What were they? We had achieved a global economy, one that expanded markets, lowered prices, and spread the risks. We had interest rates that were at historical lows. The emerging economies were creating new demand everywhere. New methods of securitizing debt provided abundant liquidity.
            But all at once the music stopped, the system froze. Many people talked about a systemic failure or a latent defect in capitalism. Some said leave it alone. Market prices will kiss it and make it better. Unfortunately, these explanations don’t work. It was rather a collective breakdown of responsible behavior. We just stopped acting smart and responsibly. It was further confounded, our behavior was further confounded by a willful confusion that obfuscated the obvious facts. It is not that we did not see it coming; we all saw it coming. But our confusion, prompted by our government’s distorted vision, our industry regulators’ incompetence, and corporate greed—this potent brew led to a confusion and to financial disaster.
            In all of the commentary about the 2008 financial crisis, the single most consistent reaction continues to be, and has been, confusion. This is evident in the erratic behavior of our government leaders, of our corporate executives, and the extreme volatility of our stock markets, in the arrogance of an administration who could submit a two-and-a-half-page policy proposal that effectively sidestepped 190 years of our nation’s historic commitment against economic concentration, and particularly concentration in the banking institutions. You saw the confusion in the inane shallowness of the media reportage during this crisis. We saw it in the 40, 50, 100 times multiple capital leverage employed by investment bankers. You see the confusion in the repeated assurances of the president, the treasury secretary, the Fed chairman, leading right up to their sudden admission that the catastrophe can only be measured and managed by an emergency process.
            You remember how endless the discussions were about whether or not we were in a recession? About the calculation of $700 billion as the price of capitulation, when we did not have a clue then, and we don’t have one now, of what the true exposure is based on real data.
            We saw the confusion in saying yes to Bear Sterns and no to Lehman. We saw it in the successive bailouts for AIG, none of which worked, so far. Incredibly, no one even now knows the extent of the securitized debt that remains outstanding. In short, what is the size of the problem? That’s important. If you don’t know the size of the problem, it’s hard to address it. You would have thought that, somewhere in our government and the economic channels, somebody would have been keeping track of this immense new capability that we lauded as being a liquidity provider, that nobody bothered to count how much was outstanding.
            There was plenty of confusion. Perhaps it was nothing more than just professional stupidity. I would argue that the meltdown was not, however, a systemic failure. It was a human failure. After all, conditions of the crisis did not arise suddenly like a tsunami. The warning signs were readily apparent to all. The housing bubble took years to develop to its full height of excess speculation. We talked about that. Everyone did. Congressional leaders boasted of pressuring financial institutions like Freddie Mac and Fannie Mae that they should ignore lending standards. Lenders, bankers, mortgage brokers hid owners’ covenants in small print from unsophisticated home buyers. Homebuilders raffled off applications to purchase track homes that were sold several times—the applications—before the house was even built. Credit card issuers indiscriminately made out credit cards to published mailing lists that they didn’t know anything about. All of this well known. Our collective non-reaction to danger was a behavioral breakdown; but it was small potatoes versus the real perpetrators of the crisis.
            Where were the rating agencies that were compensated for their irresponsible credit ratings? Where were the corporate boards who granted huge bonuses for overstated performances? Where the public accountants who certified reports with understated liabilities and inadequate reserves? The regulators, where were they? More to the point, where were we? And where are we now?
            Are we in any better position to evaluate what our leaders in corporate America or in our political leadership—are we in any better position to be able to judge that they’re doing smart things, or dumb things? Are we even skeptical about what they do? I think not.
            The questions that I’m asking now were relevant last year, they were relevant five years ago, maybe a decade ago. While circumstances are more complex, oversight is more lax, economic performance has substantially deteriorated. Further, these adversities are global, compounding the negative impact on all the leading economies. Unfortunately, this is not an historic tale. It describes our current confusion; but it also describes our timidity, our lack of resolve. For there are tried and true remedies that can help if we have the political will to legislate their adoption.
            What could we do? What should we do? We could enforce the regulations. We could limit or eliminate the excess of rewards of corporate greed and incompetence. We could demand more transparency and accountability. We could finally lay to rest the ideology that the free market is self-regulating and does not need governmental intervention. And we could use an energized political leadership to enact good economic policy.
            On the other hand, an example of misdirected policy is the last stimulus package rushed through Congress. As a consumer-based, short-term, tax-generated cash refund, it was [timely?], targeted, and temporary—the three things that they were looking for. Unfortunately, it was the wrong medicine, and the patient died—not quite died.
            A much better stimulus package would have been the proposed infrastructure investment bank that can leverage its capital four to five times, create jobs, create wealth at the middle-class levels that need it most, and improve competitiveness, and improve national security, and improve productivity and the quality of life. Such a government investment plan is not novel or experimental; it’s been well used throughout our national history. However, it is now, gaining some consensus; but its enactment, even now, is politically problematic.
            I was in Washington yesterday speaking to some of our legislators, and the plan of beginning the session next Monday, the special session, they agreed to postpone to Wednesday. They’ll probably be in session, if at all next week, one day. They probably will not even be able to address this package at all. So once again, we see a breakdown in the commitment to do something about it, even when there’s a consensus as to what’s to be done.
            There are other policy issues to be addressed and resolved. In the current predicament, do we adopt inflationary or dis-inflationary counter-measures? Can we enact now fiscal reform that eliminates unfair and inappropriate tax measures? How do we reverse the trend towards deteriorating middle-class incomes? Can we initiate needed economic regulations as required short of overregulation?
            We also must address the pain inflicted on our citizens because of this crisis. We should extend unemployment insurance. We should renegotiate troubled mortgages with principle amortization changes and interest adjustments. We should force the banks and financial institutions to put the bailout money into the economy, not into stock repurchase programs or dividends. We should force the banks to open credit to small and large businesses. We should make sure that these resources reach not only the giant lenders, but also channel them into lenders who serve directly small businesses.
            It is against this background of a deeply wounded economy—and I use the word “deeply wounded economy”; not the more politically acceptable and weaker term, “market adjustment.” Market adjustments happen very quickly and are corrected very quickly. We heard a lot of evidence today that that’s not going to happen here; so I call it, it’s a deeply wounded economy. It’s against that background that we must renew and redouble our efforts for a national investment program, a $60 billion-dollar national infrastructure bank, one that has represented one piece of legislation, the Dodd-Hegel Bill in the Senate, which is now languishing in committee. It will provide for a combination of private and federal financing. It would provide up to $300 billion of fresh capital to refresh and rebuild out nation’s house, the house that we live in. Further, it would combine an accountable partnership between government, local and regional municipalities, the private sector, and the financial markets; and the bank would be able to access markets that are not available to municipal bonds today. It would create millions of skilled jobs, starting now, when they are most needed. It would bring higher productivity and efficiencies, introduce new technologies, enhance national security, and begin to build back our economy.
            Contemplate our situation today if we would have passed such a program five years ago. This reflects on our societal failure, our political ineptitude. Our leaders lacked the vision and the will to sidestep doctrinaire politics. The idea that the market would self-adjust has infected our economics and our political consciousness, and it is the worst kind of doctrinaire ideology. Thus, it is human, not systemic, failure that has brought us to this failure, and one we have to address. That confusion brings the economic confusion and political constipation that are the two enemies of progress and growth.
            Another example is the automobile industry dilemma that we were talking about earlier today. The idea that our leaders will be defeated from bringing financial resources to save our nation’s premier industrial manufacturing resource is ludicrous.  I use the word “resource” advisedly. We’re talking about one of our nation’s great assets when we talk about the automobile industry. To find ourselves in a straightjacket because of the market discipline of the extreme budget balances of this country is bizarre. Certainly our leaders could be expected to step forward to formulate a plan that preserves balance and control.
            I have a suggestion in this regard with respect to the automobile industry: I would prefer as an alternate strategy to manage the United States automobile industry an alternate approach to energy; that is, take away the development costs and activities from the three automobile industries and make it a government program. That would be an alternative to a bailout; that would be an alternative to a bankruptcy. The federal government would assume the long-term R&D effort to find a [groomed?] solution for car and fuels. In return, at the end of that development, it will turn, for nothing, that technology back to the automobile industries and all other companies that wanted to participate in it.
            The benefits of that program are self-evident: One is that we would have one program instead of three programs for that R&D effort. The economies of scale would be tremendous. Secondly, we would initiate a new program that would be driven by national objectives, not narrow corporate self-interest. Thirdly, it would add multi-billions in cash and cost elimination for the auto companies. This important job would get done. The government has proven it can do the job when motivated to do so. It’s done that way in the Defense Department all the time. It was done that way during the atomic project. Governments can do large, very large scale—but maybe they’re inefficient, but they get it done. Industry, on the other hand, has demonstrated abundantly that it does not have the skills, motivation, and organization to find an energy alternative.
            I’d like to say this is a good idea, and it’s mine. It is a good idea, but it’s not mine. I was talking to a business associate of mine, Stan Warshawski, yesterday, and he said, “Why don’t we do something like this?” and together we wrote down on the back of a napkin how this would work. There are good ideas. It’s just that we’re locked down into an approach, or a couple of approaches, that makes it impossible to think outside the box.
These are some of the political changes that I would consider; and if they’re addressed now, it would mitigate the pain of our present crisis and deflect the prospects for future managements.
            The current crisis and confusion present an opportunity for this new administration. A new vision with vigorous leadership can lead to social equality, and most of all, to a balanced and growing global economy. The very large questions are: Do we have the economic clarity to do this and do we have the political will? Thank you.

Q:
            Your plan for the auto industry was already done for the semiconductor industry. It’s called [Semitec?]. You probably ought to put together a proposal with the former head of Semitec, who’s in Washington and is fairly active. I could put you in touch with him. In that case, all of the semiconductor companies were facing a real challenge to develop the next generation of chips in the early ‘90s. If you remember, there was a president’s commission, which I worked with, and they basically came up with a number of plans, and that was the main thing: to essentially send all the R&D people; and they didn’t even think they’d get the best ones, but they ended up getting the best ones.

BLS:
            I remember that, thank you. That’s a good suggestion.
            Good. I answered all the questions.
            I wanted to express my appreciation particularly to The New School, and to the people who are involved with The New School who continue to extend this speakers’ series. I think it’s really adding an important dimension to the debate, and we should continue to support it.