James K. Galbraith’s contribution to the Progressive Governance Conference’s handbook.
This article appears in the 2009 Progressive Governance Conference policy handbook
In 1930, John Maynard Keynes wrote, “The world has been slow to realise that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.” Today, as then, we are in the shadow of catastrophe. Today, as then, our thinking is slow. We need to come to grips with the crisis itself.
Two ingrained habits are leading to failure. The first is to assume that eventually economies will return to normal on their own. In London in January, chairman Bernanke said, “the global economy will recover.” He did not say how he knows. The fact that for months the news has been consistently worse than expected shows that the forecasts are wrong. Their basic failure is that they do not take account of the massive pay-down of household debt, everywhere underway, as a result of the collapse of the banks.
The second bad habit is to believe that recovery runs through the banks rather than around them. This idea holds that credit is “blocked;” it must be made “to flow.” The metaphor is fallacious. Credit cannot flow when there are no creditworthy borrowers, no profitable projects. Banks have failed, and the failure to recognise this is a recipe for wild speculations and control fraud, compounding taxpayer losses. Thus the following measures, though far from exclusive, are needed now:
Make economic forecasts realistic
Economic forecasts should be consistent and realistic, with their point of departure being the consequences of debt deflation. Fiscal expansion programmes should therefore be geared to the actual scale of the crisis, not limited by the arbitrary thought that it will be shallow and short.
Audit banks more honestly
Competent regulators should take charge of troubled banks, install new management, and obtain an honest audit. A review of US loan files will show that fraud and misrepresentation were pervasive, that the market for bad assets cannot be recreated. Therefore, the condition of many major banks (US and foreign) holding sub-prime securities in quantity cannot be repaired without a pass-through receivership, reorganisation and recapitalisation. In Europe, the same conclusion will be drawn from fair examination of foreign-currency linked residential loans in central Europe, whether the individual credits were fraudulent or not. Audits will force action and restore confidence in the remaining healthy banks – nothing else can.
Introduce effective financial regulation
Financial regulation going forward should abolish tax havens, eliminate shell corporations and other forms of regulation-evasion, and restrict the carry trades and foreign-currency-linked debt instruments that fatally infected Iceland and central Europe in recent years.
Keep people in their homes
As this is a housing crisis, a critical need is for measures to forestall evictions and keep people in their homes, limiting chronic oversupply and collapsing values. This means measures to stop foreclosures or to permit foreclosed homeowners to convert to rentals under public management, with options to repurchase their homes when conditions improve. Measures adopted in the US may be adapted to meet conditions in other affected countries.
Increase public retirement benefits
Finally, an overlooked arena is a major opportunity. The crisis is dealing a major blow to the elderly in every aspect of their private wealth. Home values, stock market values, and interest income are all being hit hard. This is surely the moment to increase public retirement benefits. In the US and in developing countries, a strong increase in social security benefits is called for. The European Union should start a European Pension Union, leveling up pensions payments in the poorer member states until a common minimum standard for Europe as a whole has been reached. This would have good effects on employment, and help to ease the mortgage crisis.
Some of these issues are long term but the time to start work on them is now. We are not in a temporary economic lull, an ordinary recession, from which we will emerge to return to business-as-usual. We are at the beginning of a long, profound, painful and irreversible process of change. We need to start thinking and acting accordingly.
James K. Galbraith holds the Lloyd M. Bentsen, jr. Chair in Government/Business relations at the Lyndon B. Johnson School of Public Affairs, The University of Texas at Austin