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Epstein: Obama plan won’t reduce size of institutions so if they fail, they don’t threaten system

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington, and joining us again is Gerald Epstein. He’s the codirector of the PERI institute, and he works with a group called SAFER, and he’s an economist. And you are trying to work for, fight for more financial reform.


JAY: So in the first segment of the interview, we talked about President Obama’s announcement and sort of came to the conclusion that it isn’t really getting at the problem of too-big-to-fail and why we had a financial meltdown. So if you were advising President Obama on Thursday, what would you have had him recommend?

EPSTEIN: Well, I think there are some clear policies that need to be implemented. The attack on proprietary trading that Obama announced yesterday is important, but it has to be—.

JAY: Okay. Let me quickly, for our audience who haven’t watched—you should have watched our other financial pieces, and you would know what proprietary trading is, if you don’t. But let me recap, as I understand it. This is where Goldman Sachs or a bank—Goldman Sachs is a good example—where they’re supposed to be making money for their clients, who are pension funds and others, but proprietary trading is where Goldman goes and makes investments themselves for their own direct profit, often even betting against stuff they’re selling to their clients.

EPSTEIN: Absolutely. That’s right.

JAY: Okay.

EPSTEIN: So trying to limit that is very important. But the way that the Obama-Volcker plan is designed to do that isn’t enough. Let’s get down to the basics. There are some basic things that need to be done that we now understand quite well. Number one, too-big-to-fail should be too-big-to-exist. We have to cut down the size of these institutions—Goldman Sachs, the other big investment banks, Citibank, Bank of America—to the point that if they fail, they can’t bring down the whole system. And there are several ways to do that. Number one, put limitations on the size of their assets or the size of their leverage, their borrowing, to some reasonable size relative to, say, the gross national product, the whole size of our economy. A number of different figures have been put out there—the assets of no bank should be greater than 1 percent of GDP or 2 percent or 3 percent. But there should be a size limitation. It’s not enough just to limit the size of these banks; we have to limit the dangerous interconnected nature of the financial institutions with each other, because, after all, what really happened in this crisis and the buildup to it is that banks and other financial institutions made enormous bets on each other. They borrowed enormous amounts of short-term money from each other. And when confidence was lost, there was a run on the banking system by the banking system. It’s not the old 1930s, where you have the widows and orphans lining up outside the bank, trying to get their money; it’s the financial institutions lost confidence with each other because they didn’t know who had taken bets on whom, who had lent money to whom.

JAY: I mean, partly they were all holding these subprime mortgages, and everybody knew the actual value was crap.


JAY: So they don’t trust each other’s books, ’cause they know how phony their own books are.

EPSTEIN: That’s right. So we have to have policies that will, first of all, get actual sunshine onto the books of these banks, so that everybody will understand what kinds of interconnectedness they have. But second of all, we have to have limitations on the kind of counterparty interconnectedness that they have, limit it to a certain percentage of their assets, a certain percentage of their liabilities, and so forth. And the only way that you’re going to do that is to get all of the transactions onto the balance sheets, in the light, in the sunshine, so that everybody knows what they are. And one of the things that led to this crisis is all of these off-balance-sheet places, where they could put the collateralized debt obligations, the credit default swaps, and that nobody knew were there.

JAY: Which includes offshore, like Cayman Islands.

EPSTEIN: Absolutely. This offshore business is very important and quite difficult. That’s where you really need to have international cooperation between the United States and the United Kingdom and the European Union and Asia to write rules that will make these offshore places not places where you can park debt, where you can park tax evasion, and so forth. There has been a lot of progress on this, but there needs to be a lot more. But this is just two things: so you limit the size; you limit the interconnectedness. And there are a number of other things we have to do as well.

JAY: Go on.

EPSTEIN: Another thing that led to the crisis was a system where bankers make huge profits and bonuses on the run-up of the bubble, and then when it crashed, they didn’t have to give it back. So it’s heads we win, tails you lose. We have to end that mechanism. I mean, it’s amazing the amount of bonuses and other kinds of compensation that rainmakers at Goldman Sachs and these other firms made, even as the shareholders lost, you know, billions of dollars. So there are a number of things that you have to do. First of all, you can tax these bonuses, and if necessary you could give them back, some of them, over time, as it’s clear that these were bets that did not crash the system. Number two, you have to give stakeholders in the firm—and that includes shareholders, but also employees of the firm—some say in how the profits are distributed among the firm. And right now it’s just the management that really determines this, and other stakeholders have absolutely no say.

JAY: So the suggestions are all rational, almost obvious, in a sense, and it’s an enormous battle to get any of them through.

EPSTEIN: That’s right.

JAY: I mean, more or less what you’re suggesting are no-brainers. They should just be done. In fact, they should have been done. So this really gets back to the politics of the situation, which is that Wall Street doesn’t want it, and Congress is too associated with Wall Street. I mean, what’s actually happening in terms of [Barney] Frank’s committee and the committees that are supposed to be coming up with these kinds of regulations?

EPSTEIN: Well, as some Congress—Dick Durbin and others have said, you know, Wall Street owns Congress. And that’s become completely clear. And the details are frightening. Even the Democrats have been trying to play into this and profit from it. A lot of evidence has come out—and we heard this when we were on Capitol Hill—. I work with this group called SAFER, Economists’ Committee for Stable and Accountable, Fair and Efficient Financial Reform.

JAY: I think it’s an achievement you can remember that. But go on.

EPSTEIN: Quite a mouthful. And when we were up on Capitol Hill talking to staffers about this, they said, “Look, what the Democrats did, Rahm Emanuel, and maybe with the blessing of Nancy Pelosi, is they put freshmen Democrats on the banking committee so that they could get a lot of money from the banks, so that they could then have a war chest for their next election. And that’s about as cynical as you can get. But of course it’s not just the Democrats. The Republicans have been operating in lockstep to oppose any serious financial reform. And now what their plan is, apparently, is to turn around and say, “See? It’s the Democrats who have been supporting Wall Street, who are supporting Ben Bernanke, who are supporting the Federal Reserve. We’re the ones who wanted to change the system, and now it’s the Democrats who are really for Wall Street, and we’re for the little guy.” So this whole strategy of getting money from Wall Street, of trying to win back the confidence of Wall Street that [Timothy] Geithner and [Lawrence] Summers have been promoting, is backfiring. And that’s one of the things, I think, that accounted for the election in Massachusetts.

JAY: Well, it’s totally unbelievable, frankly, that the previous eight years of the administration was a free-for-all for various corporations, including the financial sector—of course, the military sector even more, perhaps—but a total free-for-all. But President Obama, by not taking more radical measures himself, kind of just continued the policy. So now he can’t really attack those policies of Bush. And then add to that he puts Bush on this Haiti commission. So how do you critique the Bush administration at all now? The whole thing is really strange.

EPSTEIN: So I think Obama may finally be getting the message. And this gets back to his announcement yesterday. But he needs to take some more serious measures. I think he needs to stand up and say, “Well, given what’s happening, I’m not going to reappoint Bernanke. We need a change of leadership at the Fed. Given what’s happening, we need a change of leadership at the Treasury. I’m appointing Paul Volcker. I’m appointing Joseph Stiglitz or Paul Krugman to be Treasury secretary,” somebody else, and he needs to shift gears.

JAY: Well, in the next segment of our interview, let’s talk about a more significant shift in gears: is there a more radical approach that would be more effective? And so please join us for the next segment of our interview with Gerald Epstein.

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Gerald Epstein is co-director of the Political Economy Research Institute and Professor of Economics at UMass Amherst.