Lehman legacy and the predator state
It has been 365 days since Lehman Brothers collapsed, triggering a global economic crisis whose effects are only now being truly felt. The events set off an unprecedented set of actions by the US government, but these actions have still yet to see any new regulations for Wall St. Reports indicate that banks are back to major profits, but economist James K. Galbraith points out that this is not the same kind of profits as banks were making before the crisis. With the collapse of the inflated home market, banks are now reaping profits through public money that is being offered to them at little to no interest through the Federal Reserve, money that they turn around and invest in government bonds, creating a public money machine for the banking sector. Despite all this public funding, says Galbraith, banks are continuing to avoid lending in the public’s interest.
JESSE FREESTON, PRODUCER, TRNN: Welcome to The Real News Network. I’m Jesse Freeston, coming to you from our Washington, DC, studio. We’re coming to you exactly one year after the collapse of Lehman Brothers, the United States’ fourth-largest investment bank. And since then we’ve seen a number of things develop. And here to talk to us about what we’ve seen over the past year, and a bit about his book that was released just previously to the crash, is James K. Galbraith. Welcome, James.
JAMES K. GALBRAITH, ECONOMIST AND AUTHOR: Thank you.
FREESTON: So, James, tell us a little bit about that day when Lehman Brothers crashed, exactly a year ago today, and what’s going to be the legacy of that day.
GALBRAITH: Well, that day precipitated a panic that practically brought the financial system of the entire world into chaos, and created a policy environment of massive and chaotic action, giving us, first, the exercise in bailing out the large financial institutions, known as TARP; secondly, the election of President Obama, which was very closely tied, you know, to these events and the collapse of confidence in the Republican Party and the previous administration; and then, finally, the Recovery Act, the stimulus package in January. All of it flowed from the events of a year ago. The question before us now is: how are we going to rebuild the system so that we get a sustained and effective recovery from this disaster? And, secondly, under what rules and structures should the financial sector be operating going forward?
FREESTON: Alright. And using the terms "rebuild", "recover"—we see a lot of these "re-" terms around. But your book was written in an August 2008. It’s very critical of the situation that we were living in at that time. And so is that what we’re advocating? Has really the legacy of the past year been a lowering of people’s expectations of what an economy should provide them?
GALBRAITH: It’s an extremely important point, and I’m generally more careful about using this term "recover" or "reconstruction". I have a piece that was published a few weeks ago under the headline "Construction, Not Reconstruction". We need to be conscious that not only we cannot go back to the previous system—the history of the last year is a permanent feature of the landscape now, and it will change the way in which financial firms operate, mainly because the targets of the early predatory behavior—namely, the capital wealth of the American middle class in their housing, which is what got destroyed in the mortgage bust—isn’t there now, so that we cannot, practically speaking, go back to an economy based upon this same kind of credit expansion that occurred in the middle part of the last decade. And, secondly, even if we could do that, we shouldn’t want to. We need to design a pattern and program of economic growth which is based upon meeting the actual needs of the society and providing the employment opportunities that the population as a whole has a right to expect.
FREESTON: But how do we get there?
GALBRAITH: Well, that’s a good question. A major flaw in the stimulus package, which I generally supported because I thought it was about the best thing you could get through the Congress in, you know, this emergency period of—in a week or in three weeks or a month or so into the new Congress. The major flaw was the idea that you could put together a one- to two-year expansion program, and then it would be over with and you would be back to normal. I think we’re going to find out. We are going to see a bounce. We’re going to see a very definite bounce in the growth numbers in the next two quarters, I think. In fact, you’re already seeing it in some of these very high productivity growth numbers that have just been released. But the question going forward is: how long will that be sustained? And I think in six months or a year it will be quite clear that further effort is going to be required from the public sector.
FREESTON: Let’s go back to that period a year ago. This number comes out of nowhere: $700 billion. And previously to that, the only time we ever saw numbers that high were military budgets, which aren’t talked about. So all of a sudden $700 billion comes out. What happened to that $700 billion? Has it been repaid? And what is the legacy of the fact that when the banks crashed, they went to the United States Treasury, they went to the government, and got everything they asked for?
GALBRAITH: I asked a senior member of the Senate staff where are the $700 billion came from, where that number came from. And he said, well, it’s more than $500 billion but less than $1 trillion. In other words, it was a number that was picked out of the air by the Treasury Department in late September of 2008 in order to make a public-relations impact. It was not based on any analysis of what was required, and it was very clear that if you put that $700 billion to work along the lines that they were first laid out—which was to say, buying back the toxic assets, securitized mortgages—you would never get close. Someone said to me this is like trying to fill the Pacific Ocean with basketballs. It just wasn’t close to the scale of the problem. The Treasury rather quickly realized that, and what they basically did with the part of the money that they used up immediately in the period before President Obama took office was that they—most of it was purchases of preferred equity in the banking system. That’s a way of essentially relaxing the capital requirements on banks. It’s the same thing as if they’d said, "You don’t have to hold as much qualified capital as you previously did." They were saying, essentially, the government is going to give you the capital, and then, therefore, you’ll meet your capital adequacy standards. And then what they did was to basically say to the world and to the banks, we are going to create a system in which even though the largest banks are not really doing any aggressive, socially productive, economically reproductive lending, they will be able to make money and they won’t fail. And that is what basically stabilized the institutions. It prevented Citigroup and others from having to be taken over by the FDIC.
FREESTON: So when they went to get more money from the government, the government said no, essentially, or there wasn’t the will, the political will, for another TARP program. But you’re saying that somebody else came in and [inaudible]
GALBRAITH: Yeah. Congress was clearly unwilling to go through this exercise again, and they quite rightly did not see what had been achieved in the major reforms that members of Congress were hoping to see in that initial process when it didn’t materialize. So what happened was the problem was turned over to the Federal Reserve, which, from the bank’s point of view, resolved it by creating a situation in which banks could get funds from the central bank, essentially for free, and then effectively lend them back to the federal government at a very—you know, at a 3 or 4 percent interest rate on Treasury bonds or to other high-quality borrowers where the risk was very low. So the banks have a money machine, which—this is not the first time that policy has basically done this. It was also done this way in the late 1980s through 1994. And the result is that while the banks themselves recover financially and they gradually are able to pay back the capital that they’d taken from the government, they are not an engine of economic expansion, and they will not become an engine of economic expansion, in my view, for a long time, if at all, because the previous wave of bank lending was based upon the fact that people had equity in their homes against which they could borrow, and the collapse of asset prices, nothing has been done about that, the collapse of housing values, the oversupply of housing. The foreclosure crisis, which is engulfing millions of people, is still going on, and so long as that is not dealt with, then it’s very hard to see what the substantial basis for a new wave of credit expansion would be. And I think, you know, ultimately, at this stage we have to recognize that the country is run down. It’s decrepit. It has been depriving itself of public capital investment for a generation, since the late 1970s, and that needs to be restored. So you could generate economic activity in new construction of common infrastructure and of environmental resources.
FREESTON: Alright. Well, let’s talk a little bit about that in part two.
FREESTON: Alright. Join us for part two on The Real News Network and our interview with James Galbraith.
Please note that TRNN transcripts are typed from a recording of the program; The Real News Network cannot guarantee their complete accuracy.