Worst week ever on world markets

October 11, 2008

Timothy Canova says its time to nationalize the big banks

Timothy Canova says its time to nationalize the big banks



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Story Transcript

Worst week ever on world markets

Producer: Carlo Basilone

CARLO BASILONE, TRNN: US President George Bush called for an emergency meeting of the G7 finance ministers to help find solutions to the global economic meltdown. Finance ministers and central bankers from the US, Japan, Germany, the UK, France, Italy, and Canada are in Washington, DC, for the weekend meeting. The week saw financial markets get trashed around the world. The Dow Jones had its largest-ever weekly drop, losing almost 18 percent on the week and more than 40 percent since its record all-time high one year ago. In Japan, the Nikkei index lost 24 percent on the week, and European markets didn’t fare much better. Another bad sign of the times is General Motors. Once the linchpin of the US economy, its stocks are trading at 1950s levels. The automaker had to deny speculation that it’s heading for bankruptcy. There’s also talk that US Treasury Secretary Henry Paulson is considering the radical step of taking ownership stakes in banks.

PROF. TIMOTHY CANOVA, INTERNAT’L ECONOMIC LAW, CHAPMAN UNIV.: Many people with money, smart investors, have to know that $700 billion is not going to solve the problem. Part of the problem right now is that nobody knows what the size of the problem itself is. The banks, the financial institutions, are holding an enormous amount of bad assets, of mortgage-backed securities and other non-performing assets. They’ve managed to hide an awful lot of it off balance sheet, thanks to decisions that were made in 2003 and 2004 by the Financial Accounting Standards Board and the Securities and Exchange Commission. So our accounting system is so far from transparent that nobody knows for sure the size of the mess. There are estimates that it could be two or three trillion dollars in these mortgage-backed securities that are being held by our financial institutions, along with the very real, legitimate concerns that the credit markets have remained frozen and that the banks are not lending—they’re not lending to each other, they’re not lending further down to businesses, to Main Street, to individuals.

BASILONE: Is what’s going on in the last couple of weeks equivalent to the fall of the Berlin Wall in any way?

CANOVA: It’s an interesting question. Dr. Michael Intriligator at UCLA’s Public Policy School had made the very similar comparison, had said it was very similar to what happened to the Soviet Union when it collapsed and that the Soviet Union was under a lot of external pressure to convert its economy right away from a communist system to a very free market capitalist system, and it discovered it did not have the institutional structure, it did not have the commercial and investment banking structure to have an effective free market system. And, lo and behold, here we are today with the realization dawning on people that our institutional structure is not sound, that functionally speaking much of our commercial banks and investment banks are functionally insolvent today. Right now the market conditions resemble to some degree what was happening during the banking crisis of 1932-1933. The money supply was much more constrained then than now. Right now the central bank is flooding the street with liquidity. But what’s similar is in the days and weeks prior to Franklyn Roosevelt assuming the presidency in March of 1932 was that there was an awful lot of hoarding in the economy then, and there is hoarding now. Doesn’t matter what the central bank does: Federal Reserve can lower interest rates to zero; it can raise interest rates; it is not going to induce people to part with their money because of the mass psychosis, the mass psychology of fear. When monetary policy becomes completely ineffective, there are very few tools that are left. Now, as far as a macroeconomic tool, the main other tool other than monetary policy is fiscal policy. Fiscal policy is divided between tax cuts to stimulate an economy or major spending increases to stimulate activity. The problem with tax cuts in this environment is that they too will be hoarded. They will not be saved, invested, lent. It won’t reignite the credit system. So it’s gotten to the point where perhaps the only tool left is going to be fiscal policy of a major public works, infrastructure-building, spending, New Deal variety. However, that could take many weeks, many months, and I think this is why people are talking about partial nationalizations of these banks at this point. The Treasury Department, that bailout plan, we’re talking about $700 billion to take bad assets off the hands of banks. But it doesn’t get the banks to start lending again. And a New Deal will take months—that won’t help in the here and now while the system is melting down. And that’s why, well, you saw Britain turn to partial nationalization. People are talking about what Sweden did in the early 1990s when it nationalized its banks in the middle of a crisis like this. And it’s not just to give the taxpayer an equity interest in the bank; it also means that the state, the federal government in this case, would have more influence, and maybe control, over decisions that are made within the bank to really mandate that more lending occurs. This is very disturbing that a free-market system has gotten to the point where very serious people are talking about partially nationalizing or fully nationalizing the banking system. But it’s not all that surprising, maybe, on another level, because when you look at the central bank, the Federal Reserve, that is a private bank. The Federal Reserve system is 12 regional Federal Reserve banks that are all owned by the private commercial banks in those districts. And for many years we’ve acted as if the only sensible way to conduct central banking policy is by having a privatized central bank, and this is what it’s brought us. It’s brought us a central bank that has become captured by the financial interests it’s supposed to regulate, and therefore there’s no regulation that’s done. When you look back in history—and this is what gives me some hope—there have been periods of time when the Federal Reserve itself was functionally not independent. From 1941 to 1951 the Federal Reserve was functionally directed and controlled by the White House and Treasury, and that was the decade in which the United States accomplished incredible things. World War II was fought and financed and won in only three and a half years. The Marshall Plan rebuilt Western Europe and Japan. It was a four-year program. It was a massive building program. And the GI Bill, which educated and housed and integrated 16 million veterans returning from World War II. All those major public works programs took place in one decade, 1941 to 1951, when the Federal Reserve was really directed by public officials who were accountable to the electorate.

BASILONE: Do you think that the people of the United States are ready for that? Are they willing to the point that they think that the free market is the only way, and government intervention—I mean, you know, going back to a famous Ronald Reagan line of the government isn’t the solution but the government is the problem? Are people now realizing that that’s not the case, do you think?

CANOVA: Yes, I do think so. For the last 25 years, regulation was a dirty word. And that has changed so dramatically in the past month now, where you see it in the presidential campaign—everyone’s talking about re-regulating. So far it’s just rhetoric; it’s not translated into action. But I’d say with election day just a few weeks away, it’s maybe hard to expect politicians to move much faster than they are right now. And I think this is what’s really become quite frightening about this crisis is the feeling that there’s no one really responsible at the helm right now, that we’re in this transition moment where we’re waiting for an election, we’re waiting for new leadership to come to power. And this administration certainly does seem to be mostly wedded to that mindset of deregulation and free markets. And what’s perhaps needed at this time—and I would argue it is needed at this time—is an administration in Washington, a president who’s ready and willing to take firmer control over the commanding heights of the economy, the financial system, to make sure that the financial system is working for ordinary Americans, and we might have to wait a little while for that to happen.

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