Is There Another Financial Crisis in the Works?
In this regulatory environment banks borrow more and make riskier loans and “no one is watching them,” says professor Gerald Epstein
SHARMINI PERIES: It’s The Real News Network. I’m Sharmini Peries, coming to you from Baltimore.
In a recent interview conducted by C.J. Polychroniou titled “Goodbye Regulations, Hello Impending Global Financial Crisis,” Professor Jerry Epstein argues that the deregulatory environment in the U.S. financial sector lends itself to another financial crisis of the kind we saw in 2007-2008. In late May, Congress had repealed parts of the Dodd-Frank Act, and they said that this would allow financial institutions more flexibility to manage their capital. This was presented to the public as a way to promote competition and economic growth, and to open the way for small financial institutions to compete with the giant financial corporations. Is that in fact its goals? And does the deregulatory environment lend itself to another crisis?
Let’s find out by speaking with Gerald Epstein. He is co-director of The Political Economy Research Institute, and professor of economics at UMass Amherst. I thank you so much for joining us, Jerry.
GERALD EPSTEIN: Thanks for having me, Sharmini.
SHARMINI PERIES: Jerry, in the interview you did with C.J. Polychroniou, you said in this deregulatory environment another financial crisis is almost inevitable. Why do you come to that conclusion?
GERALD EPSTEIN: Well, first of all, capitalism has financial crises every seven or eight years, as Charles Kindleberger, the great economic historian, pointed out. So it’s riddled with financial crises quite often. The reason is that banking is inherently extremely risky. Banks borrow short term and went long term, and neither they nor anybody else can predict the future. And usually banks, as things get going pretty well for a while, they take on more and more risks. They borrow even more, and make riskier and riskier loans. So this happens periodically throughout the course of history.
Marx talked about this, as well as did Keynes. But the real issue is how severe the crisis is; how much does it spread throughout the country and across the globe? And that depends a lot on the interconnections of the different financial institutions, how much risk they’ve been allowed to take on, how speculative and crazy the bets are that they’re making. And the kind of crisis that we had in 2007-2008 isn’t your garden variety financial crisis. It was a really severe one. And what I’m worried about is in this financial deregulatory environment, where the banks are not- nobody’s watching the banks. There’s nobody really looking over them very strictly, and they’re going to be doing so less as time goes on. And so they’re going to start taking on more and more risk, as they usually do. And nobody is going to be trying to stop it. And I’m afraid that over time this is likely to lead to another severe crisis.
It’s not going to be exactly like the one we saw before. It’s going to be different, because each time it is somewhat different, with new technologies, new innovations. But the impacts can be very severe.
SHARMINI PERIES: All right, Jerry. Now, if you read the financial press these days, you’ll see a lot of good news. That the economy is growing, that unemployment has been lowered, even wages are growing, to some extent. So then what are some of the indicators that lead you to believe that a crisis is pending that is, of course, pegged to the deregulation?
GERALD EPSTEIN: Well, for one thing, borrowing and debt is going up at a fairly rapid pace, for a number of reasons. First of all, while there are some good signs in the economy, wages and incomes of most people in the United States and in other parts of the globe is still quite stagnant. Yet people think that the future is looking better; there’s easy access to credit without anybody really looking carefully about whether people can afford to borrow. We see that credit, loans are going up, and that’s happening for consumer borrowing in the U.S. A lot of consumers are borrowing, yet their incomes really aren’t going up very much. So that’s a problem. Student loans are still extremely high.
And while there’s more employment prospects, as I said, wages aren’t going up. So students who are borrowing a lot and are buried under $1.4 trillion dollars of debt, they’re a problem. Banks are start starting to use the same kinds of shenanigans with auto loans and other consumer loans, slicing and dicing them, securitizing them, borrowing and speculating on them. And that means that this loan market is subject to the same kinds of speculation that we had in the housing market before. And this is all just happening in the U.S. If we look at on the global level, European banks are still very weak. They don’t have much capital. And they are starting to engage again in a lot of risky adventures like mergers and acquisitions, and other kinds of activities like that.
So as these problems build up, then, if there is some kind of significant shock to the world economy, like might happen from a serious trade war, or a war breaking out someplace, or a rapid increase in interest rates by the Federal Reserve, or something like that, then these kinds of debts and leverage and speculation can unravel quite quickly. So these are all the things that one looks at that suggests there might be some serious problems ahead.
SHARMINI PERIES: All right, Jerry, let’s talk about this idea of deregulating for the purpose of growth. Because in fact, what they said in Congress to us is actually working. If they deregulate, there is growth in the economy. People feel more confident about the economy. Then they can speculate more and take more risks on Wall Street, and make more money. And hopefully they will hire more people and increase their wages. What’s wrong with that idea?
GERALD EPSTEIN: Well, the basic problem with that idea is that financial regulation doesn’t necessarily lead to more jobs or more investment. We have to think about the economy as having these kind of two circuits that are not usually all that well connected. One circuit is a circuit of employment, production, investment in new factories, technology for, for more productivity. That generates jobs and income and wealth for everybody, or for many people.
Another circuit, though, is this kind of financial circuit, or speculative circuit. And in that circuit, Wall Street and other financial institutions create assets, lend to each other, not to the real economy, not to the factories, and speculate and take out more debt and create asset bubbles like the housing bubble or stock market bubble. And that generates a lot of wealth among the bankers and on Wall Street, but only if some of that trickles down to the rest of the economy does it generate wealth anyplace else.
And so what we see in these big financial centers, like London or New York or elsewhere, you can really see see this. Rental properties, housing properties prices go up, gentrification grows. People are crowded out. That’s all resulting from this financial cycle. But it’s not mostly trickling down to the people in the communities, to more jobs and more investment in the real economy.
SHARMINI PERIES: All right. So let’s, let’s address that, Jerry. So investment in the real economy can be achieved through regulation. And it could, of course, strengthen the economy rather than focus on growth. And strengthening the economy will have greater impact on all of us rather than just Wall Street. How do you make that happen?
GERALD EPSTEIN: Well, there are a couple of ways. First of all, you do have to regulate the financial markets so that the rates of return that they get, the profit and interest they get from the speculation, isn’t so high. I mean, after all, when Wall Street gets really high profits from the speculation, they’re taking on a lot more risk. What happened last time is they made this high profit, they took on more risk. And when the system crashed, we the taxpayers and the people who lost their jobs are the ones that paid for it.
So what you don’t want is Wall Street investing all this money, getting all this income on our backs. Instead you want to channel those resources for jobs and employment and higher wages. So you need to really regulate and prevent this kind of excessive risk taking that in the end we’re going to end up paying for when they have to bail out Wall Street.
So right now what they’re doing is dismantling Dodd-Frank, which was not a perfect law, by any means. But it did prevent some of the riskiest kinds of behavior. They’re dismantling this, the lobbyists and the politicians. And so we need to protect that and strengthen regulation. But that’s not really sufficient. We need other kinds of financial institutions, what I call banks without bankers, or finance without financiers, like community banks, public banks, state banks, worker co-op banks that channel resources to communities and to workers, and to people who really can use these resources to build their communities, and build new and better jobs and standard of living for themselves. And profitmaking private banks aren’t going to do this.
So how are you going to get those kinds of banks up to scale, and will it make a difference? Well, you need institutions like the Treasury Department, the Federal Reserve, other institutions to underwrite these cooperative banks, these public banks, and so forth. And the only way you’re going to do any of this is that the people have to take back the government. Which is, of course, something that’s coming up, and the possibility for the next election. Progressives were running for elected office have to be supported. We have to get more progressives into office so that we can really make financial institutions more public and less private.
SHARMINI PERIES: All right, Jerry, so one good example of this that I have noticed traveling through the U.S. and then traveling in other parts of the world is that when you go to smaller towns in the United States, you see a lot of box stores, or chain grocery stores, and a lot of chain food stores in these strip malls and so on. And in comparison, if you travel to similar towns in Canada or in Europe, you see a lot of small businesses. Small bakeries, small restaurants, mom and pop kind of grocery stores, and so on. Which speaks to how some of the smaller financial institutions in smaller towns can help develop and strengthen the economy of communities. Now tell us if that’s what you’re thinking, and then, of course, that shouldn’t be the only strategy. There are other ways of strengthening economies and ensuring that economies are working in the best interest of people.
GERALD EPSTEIN: Right. So we need to bring back more opportunities for these kinds of institutions. And there are a lot of ideas out there for community banks. Creating a postal savings bank system like we used to have to fund small business cooperatives, community development, and so forth. And so I think taking a leaf out of a lot of these ideas is a great idea. But we can’t stop there. Because while these kinds of things might or might not be going on, the major banks, the global banks, are engaging in enormously risky behavior that threaten to bring down the economy again. And if you if you only operate trying to build the smaller community banks and you forget about controlling these mega-banks and what they’re doing, we’re going to get caught in another big crisis. So you have to walk on two feet at once.
SHARMINI PERIES: All right. Jerry, I thank you so much for joining us today.
GERALD EPSTEIN: Thank you. Thanks a lot, Sharmini.
SHARMINI PERIES: And thank you for joining us here on The Real News Network.