According to unapologetic Keynesian economist James K. Galbraith, his side has won, but not without massive collateral damage. (Photo: AP)My Interview With Economist James K. GalbraithBy Matt Renner
t r u t h o u t | Interview
Wednesday 06 May 2009
Economists go to work every day at universities, financial institutions, think tanks and government offices prepared for battle. They fight using historical models, statistics, public statements and complex computer algorithms. Their war is the war; they fight to influence world leaders who command the course of history.
This war remains somewhat hidden until catastrophe strikes, collapse is imminent and the economists are wheeled out to explain what happened. This occurred after the stock market crash of 1929 and the subsequent Great Depression and is going on again today as the reality of the so-called Great Recession begins to sink in.
According to unapologetic Keynesian economist James K. Galbraith, his side has won, but not without massive collateral damage.
Galbraith is the Lloyd M. Bentsen Jr. chair in Government/Business Relations and professor of Government at The University of Texas at Austin. He has written numerous books, the most recent of which, "The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too," was published in 2008. It details the peak of a "predatory" governing system under President George W. Bush, which, despite its rhetoric, had long ago abandoned the "free market" principles and began to feed off of the institutions of the state. He demonstrates a unanimous acceptance of government involvement in the economy among policymakers, even before the Obama administration's rise.
In a recent interview, Professor Galbraith and I discussed the efforts of the Obama administration to solidify the economy and begin to put the pieces back together. I asked him about the recent accusations of massive fraud by famed bank regulator William K. Black, the ongoing recession and about his personal strategy for restoring the US economy.
Matt Renner: You have been outspoken in your criticism of economists who have provided economic guidance for past administrations. What is your judgment of the Obama economic team and their actions to date?
James K. Galbraith: I think the administration got off to a strong start with the expansion package
which was about as strong a bill as you could hope to get through Congress in three weeks. I felt that it was probably based on an overly optimistic underlying forecast and probably too small to turn around the economy effectively in a short amount of time. But the political judgment that you couldn't have gotten a bigger bill is probably sound.
On the bank plan, the administration is following a policy that is in some ways a continuation of the Paulson plan under the Bush administration. In some respects, the plan goes back and makes some mistakes that the previous Treasury started to make and then turned away from. This is all very troublesome. The issue is a question that effects the strategic direction of the economy and the stability and soundness of the banking system going forward.
The choices being made in the Geithner program going forward are misguided. This program is based around the assumption that the assets will recover values. But when you look at the stress tests, they seem to have been largely designed as a statistical exercise relating the valuation of different classes of assets, which the banks hold in different proportions, depending on institutions, to the performance of the economy.
The deeper problem with those assets is that they are, in the case of subprime mortgage securities, based upon documentation that is in many cases missing, contains misrepresentation and fraud on the face of the documents. Those are securities which are intrinsically unsafe, which will default at very high rates, which should never have been securitized in the first place and should not be treated as though they were financial assets.
That distinction is an extremely important one and one that the Treasury has not fully taken on board. An economically viable asset that is underwater because of economic conditions is different from one that is based on fraudulent underwriting, which was programmed to default at very high rates, therefore, is permanently impaired.
If I'm right about the underlying quality of a large part of that asset base, then these loans are going to default and go back to the Federal Deposit Insurance Corporation (FDIC) on a nonrecourse basis. That means that this plan is a way of rescuing incumbent management and bondholders of the major banks that were most responsible for the crisis and, in a disguised way, transferring the losses from the books of the banks, where they sit now and have to be recognized, to the FDIC and the taxpayers. It is a way of avoiding the necessity of devaluing those assets now and requiring their present owners - the banks - to take the losses that are appropriate to take.
The strategic reason that the administration is doing this is to preserve the large banks. The result of the decision to do that is that in a financial sector, which is much too big relative to the economy, the shrinkage that will occur will fall elsewhere. It will force smaller banks to the wall and it will force institutions which are more community oriented and more vulnerable to be bought up or suffer from very big increases of insurance charges. We will end up with a banking system which is much more concentrated than it should be and where you have these enormous executions of small banks, which experience shows you really can't prevent.
MR: In an interview with Bill Moyers, bank regulation expert William K. Black did not hedge in describing the Wall Street collapse as a result of massive fraud starting in the board rooms and CEO offices of Wall Street. What is your take on this? Has the American economy fallen victim to a group of confidence men?
JKG: Bill Black is a comprehensive expert on the subject of bank fraud. He is not prone to exaggeration or polemic. He is a lawyer and criminologist who uses words with considerable precision. One of the things that Bill has noted is that as far back as 2004, the FBI warned that there was an epidemic of mortgage fraud on the way. The administration failed to do anything about it and did not give the FBI the direction and the resources required to make dealing with white-collar fraud a priority.
So, you had fraud in the origination of the mortgages, fraud in the underwriting. You also had fraud in the ratings agencies, which were operating according to a business model where they did not get paid unless they issued the favorable ratings, and they issued ratings on assets they could not examine. They examined using statistical methods and did not look at the underlying documents to asses the possibilities that the assets they were rating were rotten to the core.
But of course they were. A subprime mortgage is an intrinsically problematic instrument. It is an loan issued to people who can't document their incomes, whose credit histories are bad, and were issued on assets whose values were systematically inflated.
MR: Do you think this fraud was a plan?
JKG: Sure it was! There was a whole class of lenders out there, many of whom were completely unregulated, the Countrywide Financials of the world, others of whom should have been regulated but were effectively desupervized, the Indymacs and the Washington Mutuals, where the business model was "push those bonuses out the door, get as many of them signed up as possible because if they pay for the first 30 days, we can sell them and pocket the fees. After that, it isn't our responsibility."
Systematically, in this industry, the people who previously specialized in risk management used to say, "show me the documents proving that this will be a safe mortgage," were given instructions by top management, "get out of the way, and get these mortgages issued." There are plenty of records showing that these lenders were told to drop the standards. That was the revenue model for the institution. You have a model which is fraud in origination, fraud in the conveyance and fraud in the rates.
MR: Do you see people going to jail for these crimes?
JKG: In the savings and loan crisis there were 1,000 felony convictions for S&L insiders and about 700 or so went to jail. This is a bigger crisis, so you could easily be talking about a larger number of convictions. It is a question of whether the Justice Department does its job. The records available for sending people to jail are clearly present, so there is nothing mysterious about what needs to be done regarding investigations of the appropriate criminal referrals and prosecutions.
Aside from the Department of Justice, the regulators are highly important. In the case of a troubled bank, the FDIC has the power to install new management. One of the responsibilities of the new management is to cooperate in criminal referrals as appropriate. When the new management comes in, you have people who have not been paid off and who are not a party to the old deals, who are interested in the long-term survival of the bank and are prepared to participate in a clean audit. When they encounter evidence of corruption and fraud, as they inevitably will as they go through the books, they are to make an appropriate criminal referral. That is how the prosecutions happen.
...much more here: http://www.truthout.org/050609J