The Global Finanical Meltdown and What to Do About it Gerald Epstein Department of Economics and Pol

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The Global Finanical Meltdown and What to Do
About it?Gerald EpsteinDepartment of Economics
and Political Economy Research Institute
(PERI)University of Massachusetts, AmherstUSA

• ATTAC, Vienna
• 5 March 2009

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Joint Work with James Crotty
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The Great Depression of the 1930s was a
depression caused by Liberalism. The roots of
this crisis is in the neo-liberalism of the last
30 years.
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Key TO Crisis Inequality of income and wealth in
the U.S. and U.K. is at historic highs in the
U.S. real wages have stagnated for almost four
decades.
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Source G. Palma, from Saez and Piketty
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According to Saez and Piketty, in the
US Average income of the bottom 90 fell
between 1973 and 2006 in real terms. The top 1
increased 3.2 times The top .5 increased 3.8
times The top 0.1 increased 5.4 times The top
.01 increased 7.5 times In real terms
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U.S. Wage-Led Economy

• Excellent Work by Ozlem Oneran
• and Englebert Stockhammer shows U.S. is a
• (Slightly) Wage-Led Economy.

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In this context, DEBT-LED (that is FINANCE-LED)
consumption based economic expansions in the U.S.
has been the main mechanism for economic growth.
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This system of financialization is now
threatening to bring down the entire world
economy.
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In the U.S. and Europe, governments have tried to
hit the Re-start button, hoping to save the
ancien regime.
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Financialized CapitalismLocked in A
Devastating Dynamic of De-regulation, Financial
Innovation, Explosion, and Bail-out
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Longer Term Perspective 1900 -2008
Current Crisis
Source Reinhart and Rogoff, 2008a
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TOTAL FINANCIAL ASSETS AS OF GDP IN US
2007
1945
1981
2007
1981
1945
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Relative Wages in U.S. Financial Industry 1930 -
2007
Source Philippon and Reshef, 2009
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De-Regulation of Finance

• A Key Financial Problem

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In U.S. New Deal Regulation of Finance

• Separation of commercial and investment Banking
  (Glass-Steagall)
• Segmented Asset Classes and Institutions
• Restrictions on Securitization

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New Deal System of financial Regulation Eroded in
the U.S. in the 1970s, and 80s

• Largely due to pressure from large banks and
  their allies in the Fed, Treasury, Congress and
  the White House

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New Report Shows

• U.S. Finanical Institutions spent over 5 billion
  dollars on lobbying and campaign contributions in
  the past 10 years to get Republicans and
  Democrats to reduce regulations on U.S. financial
  Institutions.

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Creation of Shadow Banking System

• Over the Counter (OTC) Derivatives Markets
• Hedge Funds
• Private Equity Funds

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De-Regulation supported by Democrats and
Republicans

• For Example
• 1998 Brooksley Born, Chair of the Commodity
  Futures Trading Commission proposed to regulate
  over-the-counter derivatives.
• President Bill Clintons Treasury Secretary
  Rubin and assistant, Larry Summers, blocked the
  idea.
• 1999 Rubin, Summers and Bill Clinton
  Administration supported the bill to end the 1933
  Glass-Steagall Act that separated Commercial and
  Investment Banking

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Robert Rubin and Larry Summers Reward?

• Rubin becomes Chair of Citigroups Executive
  Board and Larry Summers moves up to become
  Secretary of the U.S. Treasury.

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Look At How The Key Banks and Instruments were
regulated

• OTC derivatives (ABS CREDIT DERIVATIVES not at
  all.)
• Large investment banks eg. Goldman Sachs,
  Morgan Stanley, Merril Lynch, Lehman Brothers and
  Bear Stearns.
• A VOLUNTARY PROGRAM RUN BY THE SEC CALLED THE
  CONSOLIDATED SUPERVISED ENTITIES PROGRAM (CSE)

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AFTER LEHMAN BROTHERS FAILED, in Sept. 2008

• Christopher Cox, head of the SEC, ended the CSE
  program because all the banks had either failed
  or become Bank Holding Companies under the
  regulation of the FED or other authorities.
• Christopher Cox Voluntary Regulation Does Not
  Work, 26 September, 2008.

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What about Credit Default Swaps one of the most
deadly of the toxic instruments.?
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Credit Default Swaps (CDS)
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No One Regulates These!

• Key reason why the Lehman Bankruptcy was so
  disruptive.
• A Key Reason why the U.S. government keeps
  putting more and more money into AIG, the
  insurance company.
• Many European Banks bought CDS. IF these are
  destroyed, many European Banks will have serious
  problems.

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This de-regulation lead to the so-called NEW
FINANCIAL ARCHITECTURE (NFA)which led directly
to the crisis
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But Now

• This is all crashing down.

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Estimates of Financial Losses Keep Getting Higher
Nouriel Roubini Recently Estimated US Financial
Losses

• 3.6 trillion US dollars in the U.S. Alone
• Half of which for U.S. Banks and Brokers

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Impact of the Crisis on People

• Losing wealth people have lost 25 or more of
  their wealth
• Losing their homes foreclosures expected to be 2
  million this year.
• Unemployment, above 8 higher in some places.
  Expected to go to 10
• Hispanics particularly hard hit working in
  construction industries.
• Males also particularly hard hit.

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SOWho Lost Wall Street and Main Street?
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Who Lost Wall Street

• Supported by a social super-structure that
  profited from this system
• The media
• Economists there was a corruption of the
  economics profession in the US

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Well Known Financial and Macroeconomists

• Consulted for or owned substantial shares in
  hedge funds, private equity funds, investment
  banks etc.
• Reluctant to call for regulation of these when
  spoke publicly, they rarely announced that they
  had substantial financial interests in the
  financial businesses.

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Mainstream Economics

• Efficient markets theory which justified all this
  light touch regulation interacted with the
  material interests of these economists, to
  produce a system where criticism of the system
  was very rare among mainstream economists in the
  US.

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Program for Economic Recovery and Financial
Reconstruction,

• an interlocking set of initiatives which include

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Outline of Program for U.S. and Coordination with
Europe and Others

• 1) a massive fiscal stimulus program to promote
  economic recovery
• 2) economic policies to restore the economic
  power, balance and health to labor, communities
  and families and
• 3) Policies to reconstruct, regulate and manage
  financial institutions so they will serve the
  needs of people, business and communities
• 4) Principles for international cooperation and
  coordination to help the world economy recover
  and transition to a healthier, fairer and more
  sustainable trajectory than the one it has been
  on for the last several decades.

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Recovery and Re-construction program (continued)

• Immediate policies to revive the economy by
  focusing on jobs, housing and state and local
  services, green investments, and infrastructure
  investments and supporting monetary policy.
• Policies to reform the financial sector bail-outs
  to be fairer, less costly and more effective
• Policies to reverse extreme inequality and
  increase the prosperity and power of families and
  communities

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Program, continued

• Principles and mechanisms for re-regulation and
  restructuring of the financial sector
• Principles for restructuring international
  economic governance to make the transition to a
  more balanced, prosperous and just global economy
  appropriate to changing global realities

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What is Obama Doing?

• Short Term Stimulus Package
• Housing
• Banks and Financial Bail-outs
• Longer-term budget priorities
• Re-regulation of the financial sector

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What is Obama Doing?

• Short Term Stimulus Package

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What is Obama Doing?

• Short Term Stimulus Package
• Housing

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What is Obama Doing?

• Short Term Stimulus Package
• Housing
• Banks and Financial Bail-outs

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What is Obama Doing?

• Short Term Stimulus Package
• Housing
• Banks and Financial Bail-outs
• Longer-term budget priorities

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What is Obama Doing?

• Short Term Stimulus Package
• Housing
• Banks and Financial Bail-outs
• Longer-term budget priorities
• Re-regulation of the financial sector

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U.S. 16 of Stimulus package is on green spending
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Reform the Banking System What should be done?
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More fundamental Reform of financial system in
the U.S.

• Return to core mission of banking and finance

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Good Bank/Bad Bank Approach

• Bad idea.
• Socialize losses privatize benefits.
• Lets banks continue more or less as before but
  worse Zombie Banks

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Two possible better ideas Public Utility vs.
Nationalization

• Turn banks into highly regulated public utilities
  (privately owned but very highly regulated) to
  perform these functions.
• Or
• Nationalize most of financial sector.

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For innovation

• Perhaps keep a venture capital sector to fund
  highly innovative, risky projects.
• But of course, governments in most countries are
  the main source of credit for these kinds of
  ventures, anyway.

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Finance without financiers

• Can Nationalized banks be efficient and promote
  healthy economic development?
• Many models in history of Europe, including here
  in UK, Italy, France and elsewhere.
• Need transparency, accountability and democratic
  oversight to function well.

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What about reforming the financial sector more
generally?Nine point program
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We will not be able to enact adequate reforms
until two fundamental changes take place.

• First, the mainstream theory of efficient
  financial markets that is the foundation of
  support for the NFA must be replaced by the
  realistic financial market theories associated
  with John Maynard Keynes and Hyman Minsky.

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Second, there must be a broad political mandate
in support of serious financial regulatory
reform.

• For too long the money from financial
  institutions have corrupted the political
  process. Congress and the President have acted in
  recent decades as if they were paid employees of
  financial market interests, which many of them
  were.

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The key is to channel popular anger into pressure
for a new "New Deal" in government regulation of
financial markets and Economic Reconstruction.

• Until we have regulatory institutions empowered
  by law to control financial markets and force
  them to act in the public interest and we
  populate them with well-trained officials who
  believe in serious regulation, we will continue
  down the disastrous path we have been following
  for the past three decades.

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Thank you again for giving me the opportunity to
speak to you today.