Let the Mea Culpas Begin, Part 1

Alan Greenspan has already apologized for the damage he wrought, admitting the crisis reveals that his approach to economics is fundamentally flawed.
Apparently it is now time for mea culpas from the rest of the team most responsible for creating this mess: Rubin, Summers, and Bernanke. Rubin and Bernanke just provided theirs (here and here) —albeit somewhat half-heartedly, a bit more Tiger Woods than David Letterman.
Don’t hold your breath for an apology from Summers, who never owns up to his mistakes, ranging from his proposal to use developing nations as toxic waste dumps to his argument that females suffer from congenital handicaps that render them incapable of doing science (here and here).
Still, with three out of the four acknowledging errors, this could indicate a New Year’s trend. Next we can hope that the University of Chicago—the institution most responsible for producing the theories that guided our misguided policymakers—will apologize for its indiscretions. That could set an example for all mainstream economists who, as the Queen pointedly put it, failed to foresee the crisis.
The statements by Rubin and Bernanke are quite interesting—both for what they say and for what they leave out. Rubin claims to have learned that we “need to reform the financial system to better protect against systemic risk and devastating crises in the future.” Nice deduction, Sherlock! But he goes further, admitting he has long had misgivings about the shape of the financial system: “About four years ago, a well-known London investor said to me that the only undervalued asset in the world was risk. I had the same view, as did many others, and often said that markets, including credit, had gone to excess and that would probably be followed by a cyclical downturn—perhaps a sharp one—though the timing, as always, was unpredictable.” Really? Four years ago? Did he try to warn the Bush administration’s regulators? Or his protégé, Timmy Geithner at the NYFed who was busy (by his own admission) NOT regulating banks?
At that time did he feel any guilt, since he was among the most important deregulators who had created the conditions that would ensure undervaluation of risk? Did he push for re-regulation of the financial institution he was running into the ground?
To be fair, Rubin notes other problems with the “free market” approach he used to advocate, indeed, his complaints sound remarkably similar to the arguments long made by progressives (including heterodox economists). For example, the market should not be counted on to determine income distribution:

“Even before the recession hit, our current model had displayed major shortcomings that markets, by their nature, won’t address and that need to be met through public policy. For example, market-based economics, global integration, and the strong growth that has resulted have been accompanied by serious income-distribution problems around the world, though the circumstances differ among countries.”

He even engages in a bit of class warfare:

“For example, market-based economics, global integration, and the strong growth that has resulted have been accompanied by serious income-distribution problems around the world, though the circumstances differ among countries. In the United States, median real wages have lagged behind productivity growth for more than three decades (except for the second half of the 1990s), and income has become more heavily distributed toward the most affluent.”

Hold it a second. The redistribution of income toward the affluent occurred as Wall Street “fat cat bankers” grabbed an ever rising share of corporate profits—the source of the bonuses paid to Rubin and his cronies. In 2006 Rubin received $29.4 million from Citigroup. That was four years ago, when he was supposedly fretting that the whole financial bubble was heading toward collapse (see here).
How about some clawbacks? Compensation caps? Investigations for fraud and significant jail time for fat cat bankers? Ban Goldman Sachs alum from Washington? Unfortunately, Rubin is mum on these issues.
After acknowledging the real suffering generated by Wall Street’s excesses, Rubin concludes:

“…virtually no one involved in the financial system—whether institutions, investors, regulators, analysts, or commentators—recognized the breadth of forces at work or the possibility of a megacrisis, and this included the most experienced among us. More personally, I regret that I, too, didn’t see the potential for such extreme conditions despite my many years involved in financial matters and my concern for market excesses.”

The sentiment is touching, but the attempt to share the blame is factually incorrect. Many financial market participants and commentators saw this coming. Many warned of the consequences of allowing banksters to run wild—but they were mostly ignored or even ridiculed by Rubin and his buddies. There was a very strong will to believe that when the crash came, government would be able to quickly bail-out the financial institutions, as it had so many times before over the course of the postwar period. Of course, that will to believe was bolstered by a strong financial interest in engaging in those practices that would eventually lead to crisis. Perhaps Rubin’s claim that he had not foreseen such a deep crisis is correct, but many others did. He chose not to listen to them.
There are, however, two quite disturbing arguments raised by Rubin in his apology. First, he cites a fundamentally flawed study put out by the Commission on Growth and Development (a task force founded by the World Bank and a collection of “advisors” including Rubin) that purports to prove that market liberalization is a necessary condition for growth and development:

“In the six decades since the end of the Second World War, there has been a broad movement around the world toward a model of market-based economics, public investment, and global integration. With that move came enormous economic progress in industrial countries, including the recovery of war-torn Europe and Japan and, as time went on, in various developing countries.” Further, “The commission also found that no economy anywhere in the world had been successful with largely state-directed activities and high walls against global integration. The evidence, in other words, strongly suggests that a market-based model is still the best way forward.”

Surprisingly, the countries he cites as examples of the success of the Neoliberal market model are South Korea, Singapore, China, and India. While it is true that these nations have relaxed constraints on markets, none is a good candidate for demonstrating the wondrous advantages of market-based economics. Indeed, most analysts recognize that there is a highly successful alternative Asian model of development that opens markets only as development reaches a sufficient level to compete in international markets. Development then continues almost in spite of markets, guided by the very visible hand of government.
And China? Can Rubin actually believe that China’s success is due to reliance on free markets? True, the Chinese government uses international markets when it sees an advantage. And it squelches markets when that is advantageous. Its ability to avoid any of the damages of the “market fall-out” occasioned by the crisis is proof not that markets “work” but that a sovereign government does not have to allow markets to dictate economic outcomes. China grows at an 8% pace in spite of markets. Maybe to spite them—to show off the superiority of its government-led model. And unlike Obama, its premier has no fear of being called a socialist as its government ramps up spending and reigns-in errant entrepreneurs (occasionally sentencing particularly nefarious individuals to death—a practice Rubin might want to adopt here?). It avoids financial crises by avoiding financialization of the sort that Rubin pushed onto the US economy.
The other error is even more serious, as Rubin continues his role as cheerleader for deficit hawks. Clearly he learned nothing from his term as Clinton’s Treasury Secretary, when budget surpluses killed the economy and helped to bring on the NASDAQ-led equities crash. (Memo to Rubin: a decade later, stocks still have not recovered their values.) He still, mistakenly, believes that the Clinton boom was due to budget surpluses, failing to realize that the boom created the surpluses (as tax revenue exploded) and this fiscal drag sucked so much income and wealth out of the private sector that a crash was inevitable. He now wants to prevent recovery or at least kill one should it get underway:

“Putting another major stimulus on top of already huge deficits and rising debt-to-GDP ratios would have risks. And further expansion of the Federal Reserve Board’s balance sheet could create significant problems. Second, while the measures taken were absolutely necessary, unwinding the stimulus, restoring a sound fiscal regime, undoing the expansion of the Federal Reserve Board’s balance sheet, and reducing government’s involvement in the financial system will be very difficult, both substantively and politically.”

So what we have is a former head of the Treasury, and who still plays an outsized role in advising Obama administration policy-makers like Geithner, who does not understand how the Treasury works (or, for that matter, how the Fed works). It spends by crediting bank accounts; it taxes by debiting them; and any net spending by the Treasury (called deficit spending) adds to the nongovernment sector’s net income and wealth. There are no risks that would arise from additional stimulus; but there are huge risks of not doing enough. Rather than focusing on the budget deficit—which provides no information of importance to guide policy-makers—Rubin ought to be recommending policy that could create the 25 million or so jobs we will need to restore the nation’s health.
As to unwinding the Fed’s balance sheet, that will be done simply and following normal Fed operational procedures. That is the topic for the next blog, which will also examine Bernanke’s mea culpa.

3 responses to “Let the Mea Culpas Begin, Part 1

  1. I would debate you here, but I am not sure where to start. First, I don't believe the surplus killed the economy in the 1990's. The stock market was a fraud and if anything, treasury played a part in it being a bubble. There was excessive credit stimulus into the economy in the 1990's. The only reason that the lower end of the workforce prospered in the second half of the 1990's is this was the only time the banking system was capitalized and the Fed had its foot off the neck of the economy. Unfortunately, there was a depression going on in Asia and there was a move made to artificially strenthen the dollar, opening the door for massive credit to the US. I was literally thrown off a board the other day in part for proposing a tax the rich idea. I do believe Michael Hudson has a good part of the right idea. Government probably does need to deficit spend in a fashion where spending is derived out of taxing rents of the rich. I think a 1970's tax rate would do, but I believe the brackets need to be adjusted to reflect the 2000's, not the 1930's or 1940's or whenever those schedules were drawn up. $250,000 isn't rich. Ditto the estate tax, where rates should become punitive over $10 million and maybe peak at $20 million with some light stairstepping to maybe 35% at $10 million. A million dollar exemption with a tax starting at 10% and going up 5% every $2 million would work. The capital gains tax needs to be closer to the earned income rate, but it needs to allow for inflationary adjustments, as inflationary gains are not gains at all. Interest should also have an inflationary adjustment, maybe up to $1 million a year with the rest taxed at high rates. Thus the government shouldn't be allowed to seize property under the table. The question is how to get the cancer of debt out of the system. Hudson and Keen both propose a Jubilee. I think that would be a shock,but it is clear there needs to be haircuts taken or we are looking at potential serfdom and dark ages. This is not a laughable matter. As you might tell, I am kind of conservative in my economics, but I can see a real problem when one arises. This debt problem isn't going to go away on its own and there isn't any real repayment solution other than one where the government acts as lubricant and taxes away the principal over time. The really rich will survive and some of the moderate rich will not be that way when this is done if something is done, but if something isn't done, Katy bar the door. On that site, I mentioned that $30 to $40 trillion in debt needed to be relieved out of the system. The host took it as a joke, but it will happen one way or another. The idea we are going to support the status quo or even that the government itself will survive this mess are the extreme ones. We will get to 100% of debt to GDP or else we will become a feudal/slave economy.

  2. Scum like Rubin, Bernanke, Summers and Geithner need to feel the sting of a peoples' justice. Perhaps detained, interrogated and facing public trial, a maggot like Summers might suddenly find his conscience. Clearly the millions of bankrupt, outsourced, foreclosed upon, unemployed and hungry Americans now suffering think he should. Andrei Vyshinsky

  3. Thanks for comments. Mannfm, I am not sure what your post has to do with my commentary. I have written plenty on debt. Go to http://www.levy.org for briefs, notes and working papers warning as long ago as 1999 that the debt-fueled bubble would collapse into a crisis (as it has done). And you will find papers from 1999 and 2000 that I wrote demonstrating that it was the budget surplus that killed not only our economy but also hit the rest of the world. So you might have a strong will to believe that budget surpluses do not kill the economy, but they ALWAYS HAVE. We have had only 7 periods of federal budget surpluses in US history; the first 6 were followed by depressions, the 7th followed by recession, and then with a lag by this crisis. Finally, taxing the rich is good blood sport (and will help to prevent dynasties from arising) but that has nothing to do with solving our debt problem or the problem of stagnant real wages for most Americans. LRWray