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Taking an Economic ‘Wrong Turn’:
How Our Chance to Build a Sustainable Economy Is Being Undermined

Hendrik van den Berg
UNL Professor of Economics

In my last article (“We’re Never Getting Back to ‘Normal,’” April 2009 Nebraska Report) I explained that — even if the current financial crisis ends — things cannot return to what they were because the economic practices of the past quarter of a century were simply unsustainable. For an entire generation, we were living beyond our (and the earth’s) means and the bubble has finally burst.

Instead, I proposed that we use the opportunity this crisis affords to move toward a more economically, socially and ecologically sustainable future. Already the global recession is bringing consumption down to a more sustainable level, and Americans are actually beginning to save more of their income. The stimulus packages contain ‘green’ projects, and Congress is once again giving consideration to increasing funding for education and providing healthcare coverage for everyone.

That hoped-for outcome may not necessarily come to pass, however. There is a very real possibility that, in a few years, we will find ourselves in much worse shape than we are already.

Some Americans are clearly angry about what the Wall Street banks and other firms did. The various ‘Tea Parties’ held around the country in April suggest that some Americans are also angry about the massive bailouts and subsidies for the very same banks and firms that caused the collapse in the first place. But given the intransigence of the financial industry and the complicity of our political leadership, it’s clear that the public has not gotten nearly angry enough. The weak popular outcry has been insufficient to stop our government officials from providing the financial industry repeated bailouts and subsidies on obscenely favorable terms.

Let’s face it, if our political leaders were at all concerned about public reaction, Treasury Secretary Tim Geithner wouldn’t have dared release the new ‘heads I win, tails you lose’ bail-out plan to encourage private investors (mostly financial firms and hedge funds) to acquire the questionable assets those same financial firms created. Under this blatantly obscene plan, the government provides loans to the buyers of the assets — but they can walk away from the loans if the assets fall in value below their purchase prices, thus saddling the taxpayers with the losses. Most Americans reply with a collective “Whatever.”

Americans are clearly no longer politically engaged. Nor do they seem to understand — or want to understand — economics and finance. These are disturbing and destructive tendencies because the financial industry (which is keenly aware of its own interests) has taken advantage of this apathy by effectively dictating U.S. financial and economic policy. The result of letting the financial industry dictate policy for the past four decades is the worst economic recession since the Great Depression — a recession that is touching every corner of the globe.

The Lessons of the Great Depression

Our experience from the Great Depression suggests that governments around the globe should now be instituting real financial and economic reforms to reverse some of the familiar economic problems like growing income inequality, unemployment, and stagnant wages, as well as confronting new problems such as environmental destruction. When the U.S. economy collapsed from the financial crisis that followed the stock market crash of 1929, Congress eventually passed the “Securities Act” and the “Glass-Steagall Act” in 1933 and the “Securities Exchange Act” in 1934. The regulatory structure these laws set up provided for more market transparency and information, prohibited financial institutions from engaging in conflicting and overly-risky activities, and established strict oversight of financial markets. They prevented a recurrence of financial crises for nearly 50 years.

At the same time, the experience from the Great Depression is also sobering. Let’s not forget that it took from 1929 until 1933 before real reform was passed by the Congress and signed into law by President Roosevelt (newly elected after nearly four years of inaction under President Hoover). Unemployment had to rise to nearly 25 percent and a large percentage of the U.S. banking industry had to openly fail and lose a large proportion of Americans’ saving before reform measures were finally taken. We are not yet in such a dire situation today, so there may not yet be the urgency to change economic and financial policies.

Still, one might expect that we learned something from the mistakes of the past and that, this time, another Great Depression will not be necessary before we take measures to prevent excesses in the financial industry from undermining the global economy. Economically and politically, however, we seem to have forgotten the lessons of the Great Depression. In fact, for over 30 years now, we have been dismantling or undermining the Depression-era reforms.

As early as the 1960s, when memories of the Depression were still fresh, the banking industry began actively lobbying for weakening the Glass-Steagall provisions that prohibited banks from engaging in risky, non-banking activities. This lobbying brought results in the 1970s, when banks were given more freedom to set interest rates on loans and deposits. The public seemed to be happy with the higher interest rates on their deposits and not the least bit suspicious of the deeper consequences of bank liberalization.

Then, in the early 1980s, many of the barriers between banks, savings and loan (S&L) banks, and other financial institutions were removed. Of course, it was just a couple of years after the savings and loans were permitted to engage in commercial and investment banking activities that massive abuse, fraud and incompetence caused the so-called “S&L crisis.” Cleaning up the failed S&Ls cost the American taxpayer about $200 billion in 1980s dollars. But during the Reagan era there was no talk of re-regulating anything. If anything, the mess was blamed on previous government regulations, and more deregulation was needed!

Under the watch of Chair Alan Greenspan in the late 1980s, the Federal Reserve Bank unilaterally decided to further undermine the Glass-Steagall Act by permitting banks to engage in non-banking activities such as investment banking. This was justified by alleged concerns that U.S. financial firms would be unable to compete in the global financial industry if they were stifled by 1930s regulations. Again, there was little public outcry. Most Americans were content to believe the frequent claims that our sophisticated and globally competitive financial industry was our greatest economic asset.

Finally, by spending some $300 million in lobbying and campaign contributions, the financial industry pushed Congress to overturn Glass-Steagall altogether in 1999. This new legislation was passed with the active help of the Clinton Administration and its Secretaries of the Treasury, Robert Rubin and Larry Summers. The latter now serves as Obama’s director of the National Economic Council. Again, there was little public reaction. As a result, financial firms can today do pretty much anything they want to do.

We all know what they say about people who forget the lessons of history. According to the script, we again find ourselves with a financial crisis and in a very serious global recession — one that could still become another real depression.

Oh, But Today Things Are Different

Yes, some things are different today. But the differences may lengthen the economic fall. One thing that is different today, compared to 1929, is that the government and most economists have learned something about macroeconomic policy. Even the George W. Bush administration quickly enacted a real fiscal stimulus package at the first signs of recession, and it did not wait years, as the Hoover administration did, to increase aggregate demand by increasing government expenditures financed by borrowing the savings that otherwise would not be spent. The White House is now actively pushing other countries to do the same, and most have. For example, China has increased government spending by an even greater percentage of its GDP than the U.S. has. Hence, we may avoid a world depression as deep as we experienced in the 1930s.

But, from a long-run perspective, the partially successful fiscal stimulus (at best, fiscal stimuli can only soften the fall) may actually make it more difficult to achieve a sustainable global economy. Perversely, the general level of public apathy means that as long as things do not get much worse, there won’t be any political pressure to bring about real economic change. There won’t be enough unemployed people to demand a reversal in the weakening of the social safety net, to improve healthcare or to improve education. Nor will people feel the need to substantially change their lifestyles, save more and stop wasteful consumption. If people’s savings are not totally wiped out, as they were in the Depression, there will be little pressure for new laws to re-regulate how much risk the financial industry takes with our money. And there will be less pressure to reestablish a more just and progressive tax system to fund Social Security, fund universal healthcare, and provide a good education through college for both rich and poor. Of course, the economic slowdown may be just worrisome enough to justify the postponement of serious environmental legislation.

In short, as long as there is enough fiscal stimulus to prevent a massive economic collapse, we will end up muddling through under the present laws and dysfunctional regulation, the broken social policies, and the shortage of funding necessary to create a more progressive society. So much for the ‘change’ we were promised.

The Financial Industry Is More Politically Entrenched Today

The most ominous difference between today and the 1930s is the growing political clout of the financial industry. Note how it has been able to continue fleecing the taxpayer even after it was found to have been found fleecing sub-prime borrowers, credit card users, retirees and just about everyone. Some angry writers and citizens point to the financial industry’s excessive ‘greed’ and ‘arrogance.’ But such words only serve to deflect attention away from the true cause of the financial sector’s behavior: over the past 50 years it has amassed enough political power to effectively dictate economic and financial policy throughout the world.

Here in the U.S., despite a change in administrations and control of both houses of Congress by the president’s party, economic and financial policies are being set by people who were recently bankers themselves. The foxes are still running the henhouse.

Paulson, Summers, Geithner and other high-ranking government economic advisors are all from the financial industry. Geithner worked for Robert Rubin at the Treasury Department, who had the left the helm of Goldman Sachs to become Clinton’s Treasury Secretary, before passing the position over to Larry Summers in 1999. During the past decade, as head of the New York Federal Reserve Bank, Geithner technically oversaw and audited Citibank — the world’s largest bank — which was headed by, you guessed it, Robert Rubin. This is the type of “crony capitalism” for which we criticize developing countries. It should not come as a surprise that President Obama actively resisted calls by several European leaders for increasing international regulation of financial firms during the recent G20 meeting in London, pushing instead for all countries to expand fiscal measures like increased government expenditures. The IMF/World Bank meeting in late April, where the U.S. was represented by Treasury Secretary Geithner and National Economic Council director Summers (Obama’s chief economic advisor), failed to resolve the regulation/fiscal dispute.

The American public has not yet realized that the financial industry is not on their side. It seems to be more than willing to side with Obama against those ‘socialistic’ European governments seeking more regulation. Calls for the nationalization and reorganization of banks — a tactic used by every capitalist government, including ours, to deal with failures of small banks — is labeled as socialistic and, therefore, not an option. We are now also seeing active bank lobbying against letting judges alter the terms of mortgages in order to avoid home foreclosures. “‘Poor borrowers’ own fault,” chime in the conservative pundits.

Meanwhile, regulators have encouraged the largest banks to become even larger by letting them acquire other failed banks. And so the concentration of the financial industry grows even denser. And because the government assistance comes without any strings attached, we now see the bailed-out firms using bailout funds to fund more PR, lobbying and congressional campaign contributions, making it unlikely the financial industry will ever be constrained by the government. You scratch my back, and I’ll scratch yours is the political order of the day.

How Do We End the Dominance of the Financial Industry?

If we are to achieve the good outcome suggested in my last article, it is absolutely mandatory that the financial industry be reduced to carrying out basic functions such as 1) providing a safe place for savers to store their accumulated wealth, 2) channeling those savings to investment and R&D projects in an objective and efficient manner, and 3) providing certain insurance services. More important, we need the financial industry to change how it handles the economy’s savings. We need the financial industry to channel increased savings to the new ‘green’ and social programs that underlie a more fair, just, and livable economy.

The best way to get there is the nationalization of the current bankrupt industry, followed by its reorganization into smaller, better-defined parts of the financial industry. Most of the industry can eventually be resold to private investors, with the government hopefully getting back most of the money paid to restore the individual banks and financial firms to solvency. Unfortunately, we may have already missed the opportunity of using the industry’s financial plight to carry out a nationalization and reorganization.

The generous bailout money thrown at the private mega-firms with few strings attached has now improved the financial firms’ situation to where they can generate seemingly positive results, and nationalization seems to not be necessary any longer. And equally expensive fiscal stimulus plans have prevented the massive economic contraction that could mobilize the public to demand real change. The government’s commitments of hundreds of billions — even trillions — of dollars to “turn the economy around” and more to ‘save the financial industry that is critical to our economy’ almost guarantee that nationalization and reorganization will not be forthcoming. The banks and the obscene incomes of the bankers will survive for a while longer, and real change seems to have been pre-empted.

Where is the public opposition to this scheme to make the public pay to save the very financial institutions that are standing in the way of creating a more just and sustainable world?