The crucial question is, on what terms does the Treasury plan to guarantee or to repurchase or to otherwise deal with the bad assets that the banks have? These assets are mortgage-backed securities. They are securities derived from subprime loans that were made in an atmosphere of regulatory laxness and complicity and fraud, basically, during the Bush administration, which came to take over the system of housing finance and to infect it with assets which nobody trusts, which nobody can value. And nobody really knows what’s in the files, what’s on the loan tapes of those—that underlie those securities. So the question that need to ask is, before we issue a public guarantee, does the Treasury of the United States plan to conduct a meticulous audit of the assets that underlie the securities that they’re expecting to take off the banks’ books, so that the taxpayer, can have an idea of what, if anything, these securities are worth?
And the problem is that when the little bit of checking that has been done appears to reveal that a very large fraction of these securities contain, on the face of it, misrepresentation or fraud in the files. And so, we are looking at an asset which nobody, no outside investor doing due diligence on behalf of a client for whom they have some responsibility, would touch. And that is the issue. That’s the problem.
If that is indeed the case, then it’s fair to conclude that the large banks, which the Treasury is trying very hard to protect, cannot in fact be protected, that they are in fact insolvent, and that the proper approach for dealing with them is for the Federal Deposit Insurance Corporation to move in and take the steps that the FDIC normally takes when dealing with insolvent banks.
And the sooner that you get to that and the sooner that you take these steps, which every administration, including the Bush administration, actually took in certain cases—replacing the management, making the risk capital take the first loss, reorganizing the institution, guaranteeing the deposits so that there isn’t a run, reopening the bank under new management so that it can begin to function again as it should have all along as a normal bank—the sooner you get to that, the more quickly you’ll work through the crisis.
The more you delay and the more you try to essentially prop up an institution whose books have already been poisoned, in effect, by this—the practices of the past few years, the longer it will take before the credit markets begin to function again. The functioning of the credit markets is absolutely essential to the success of the larger package, of the stimulus package and everything else, in beginning to revive the economy.
This really is not a political issue. This is an issue which should be determined after you have had—made an evaluation of the solvency of the institution, of whether its assets are sufficient to cover its liabilities. That’s a technical determination.
The proper authority for making that is neither Timothy Geithner nor David Axelrod; it’s Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation. She has the authority, and she should be the one who’s making that determination, again, not on political grounds, not on whether the public is angry, as it justifiably is, over the compensation packages these banks have been paying to themselves, but whether the banks themselves are viable as—whether they’re meeting their capital requirements, whether they in fact have assets on their books sufficient, to keep them solvent. And if that’s not the case, there’s a clear chain of responsibility, and it’s not a political decision. It’s a technical decision. It’s a banking regulation decision that needs to be taken.
When you’re dealing with a bank which is essentially solvent, then you can make these judgments. But when you’re dealing with a bank which has already basically rendered itself insolvent by virtue of its complicity—it’s basically seeking for easy money, for big profits, out of mortgage originations and underwriting fees in the last part of this decade—then you’re dealing with a bank which is already underwater. The risk capital is already worth nothing. It’s being held up only by the expectation of a federal bailout.
The problem with leaving the management in place is that you cannot rely on the existing management to give you a full and fair accounting of what is in the books of the bank and what the practices of the bank are. That is why you need to bring in a new team. You need to bring in a team which is nominated by the FDIC, which has as its first objective coming clean, going through the books of the bank and separating the good assets from the bad assets, the assets which are—which have a reasonable chance of continuing to earn income from the assets which need to be written down or written off. Then you can make an assessment of just how big the losses are and what has to be done, whether the bank itself should be closed, which is sometimes the case; whether it can find a merger partner, which is sometimes the case; or whether what you do is reorganize it, isolate the bad assets from the good assets and relaunch the good assets as part of a new bank. One thing or another has to be done. And when it’s done, you can begin to basically grow the economy on the basis of these new newly reconstructed credit institutions.
But so long as you’re dealing with the old management and so long as you’re dealing with the old practices and so long as you don’t have a clean audit of the books, the chances are that the bank is going to behave in ways which are not constructive, which do not contribute to the growth of the economy, and which leave all kinds of suspicions present in the system about the integrity of the institution and of the regulatory process. And that’s the problem the Treasury Department seems to be determined not to face.
And so long as it doesn’t face it, we’re not going to get out of this, and the Treasury Department is not contributing constructively to the success of the recovery plan, which the Congress is about to enact. And that will mean that the recovery plan itself will be, sort of after the fact, too small to deal the problem of unemployment, which is just growing at the rate of a half a million jobs a month. That’s the dilemma that we’re in.
The term “nationalizing banks”, is a political misleading term. I learned a few months ago that in 1982, at the time of the Latin American debt crisis, the Reagan administration’s FDIC had a contingency plan to nationalize the major banks in the case that a major Latin American country—let’s say Mexico or Argentina or Brazil—had defaulted outright on its debt. This was not something that administration would have wanted to do. In the end, they didn’t have to do it. But they had a plan to do it, if it was necessary because the banks were rendered insolvent by the running to ruin of a major class of assets.
We have a major class of assets—that is to say, all of these subprime mortgage-backed securities—which have run to ruin. They should never have been issued in the first place. They are very, very highly likely to default. They were issued on terms which makes them basically unmarketable, because there is not adequate loan documentation. And when there is loan documentation, that documentation evidently indicates that the loans are likely to go bad, so that nobody outside will buy them. That’s a problem that exists in the banking system, and the regulators simply have to deal with it.
We’re not in 1945 in Attlee’s Britain, where we are taking the commanding heights of their economy or anything like that. We are doing what regulators always have to do, in conservative and liberal administrations, when faced with major intractable insolvencies in the financial system. If you don’t deal with that, the problem of fraud and loss just gets worse. And the losses that are incurred after insolvency are losses that fall on the taxpayer, because they come against deposits that are insured. So, one way or another, until we deal with this, the taxpayers’ liability just gets bigger and bigger.
Whether it was the New Deal or World War II that ended the Depression?
First of all, there is a grave understatement in those arguments about what the New Deal actually did. And that understatement is typically because the unemployment figures that many people are accustomed to using for the 1930s don’t count people who actually worked for the New Deal. This is Michael Steele’s distinction between jobs and work. But people who were building the Lincoln Tunnel or the Triborough Bridge or the aircraft carrier Yorktown are counted as work relief and not as employed, and there were many millions of those. And when you put them into the figures, you find that the New Deal actually reduced unemployment from 25 percent in 1933 to about—to less than ten percent in 1936. It went up again in ’37 and then came back down again to about ten percent before the war. So, a major, major improvement in unemployment did occur under the New Deal.
It is true that the war made a major transformation in the economy. It drove unemployment to zero. But it also did something else. It gave the American family, the American household, a financial cushion, which was the war bonds that people accumulated during the war that formed the basis for the financial prosperity of the 1950s and 1960s. And that is what made the—made it possible for the private financial system, which collapsed in 1929, to recover in the 1950s and ’60s. And I think that point is very important, because what it shows you is that when the financial system goes down, as it seems to have gone down in the last couple of years, recovery requires a long time. And the precondition for recovery is not fixing the banks; it’s fixing the balance sheets of the households, the creditworthiness of the American family.
And the problem that we have here is the fall in housing prices, people who have mortgages that are worth much more than their houses, which is rendering the entire borrowing base of the American economy basically insolvent. And it will lead to make it extremely difficult for the mechanisms of credit to work again, until you’ve done enough basically to stabilize housing, to stabilize jobs and incomes, and then make it possible for banks—for any reasonable bank, even a solvent bank—to look at its borrowers and say, “Gee, this is a good credit risk,” and for that matter, for the borrowers themselves to feel, “Gee, this is a good time to come in and borrow and get that new car.” That’s the issue that they’re going to face. It’s going to take a long time and major change. And that’s why I say the whole package here is probably not adequate, but it’s a good—that said, what Roosevelt did in ’33 wasn’t adequate either. It was simply a start. And that’s where we are.
The Predator State refers to the takeover of state power by private interests masquerading behind conservative principle and basically acting for private clients and private profit. That was the Bush administration in a nutshell. The title goes back to Veblen and a bit to my father’s New Industrial State, and it’s an attempt to capture in two words a phenomenon that I think really has transformed our economy, much for the worse in the last several decades.
Professor James Galbraith talking with Amy Goodman.
James Galbraith is economist, a professor of public affairs and government at the University of Texas, Austin. His most recent book, The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.
– from democracynow