5-29-08, 9:32 am

Editor's Note: Doug Henwood publishes Left Business Observer and hosts the weekly radio talk show Behind the News with Doug Henwood on New York's WBAI radio.

PA: How severe is the economic crisis we are facing? How bad could it get?


HENWOOD: It could get very bad. The disaster scenarios are easy to spin out if you want to. They would arise if the current turmoil in the credit markets spreads to real day-to-day business kinds of lending, the so-called commercial industrial loans that banks make, for example, or routine consumer credit – not just mortgages, but credit cards and other kinds of consumer debt. If that were to freeze up, then I think the economy could go into a very serious tailspin.

We are not there yet. Regular consumer and business lending, aside from a couple of specialized sectors, looks like it is continuing, and the real economic indicators so far are consistent with a mild recession, not a severe one – but we are still in the early stages of this, so it’s very hard to say just how bad it’s going to turn out. There is also really no precedent for the kind of financial turmoil we are seeing, so there are no easy historical templates we can apply to this situation. There is the example of Japan in the 1990s, which experienced a very long economic stagnation after the collapse of their speculative mania of the 1980s: that has a lot of parallels with the United States.

Arguing against that would be the fact that the Federal Reserve and other authorities have acted much more quickly to counteract the deflationary effects of the credit crisis, in contrast with Japan, where the authorities took a very long time to intervene. They actually raised consumption taxes in the mid-1990s, which only prolonged the suffering.

But if I had to put it all together and lay out a scenario, I think we are facing years of a very weak and stumbling economy that will feel to many people like an extended recession, even if it is not formally one.

PA: The speedy effort to bail out Bear Stearns indicates to a lot of people that there is a gap in the government’s view of how to handle this particular crisis compared with the problems that ordinary Americans face. Why does there seem to be such a disconnect between Wall Street and Main Street?

HENWOOD: I would say, first of all, that bail out the financial system. Unfortunately, they are kind of holding the rest of us hostage. If the financial system implodes, it will take the rest of us down with it. On the other hand the public suffering you are talking about is just not being paid much attention to.

The actions so far – for example, to protect homeowners on the verge of mortgage foreclosure or who are already in foreclosure – those actions so far are very, very weak, affecting almost no one. Given the scale of the problem – millions of people are either in or at near risk of foreclosure, the scale of the response is just ridiculously small. It is clear that the sufferings of bankers excite more sympathy in Washington and in the canyons of Wall Street than do the pain of regular people.

There is certainly a distinct class bias to everything that has been done so far. We could imagine some sort of very vigorous activity to assist people who are in mortgage trouble. For example, the government could buy up the mortgages that are in trouble at a discount, and the banks could take a loss, with the government having to take up some of the loss, but sparing the folks who are at risk of losing their houses.

PA: The action the British government took in bailing out Northern Rock was to nationalize the bank. Is there a substantive difference between what they did and what the Federal Reserve and J.P. Morgan did here?

HENWOOD: I think it is a little mistaken to take Northern Rock as an example or precedent for anything done here. First of all, Northern Rock was a pretty small institution. It held mainly retail deposits. Bear Stearns was a very large investment bank that was connected to many other players on Wall Street. If they had gone down, it could have taken a lot of other people with them and really created a panic situation. I just don’t think the situation of the two banks is similar. Also, the British government dithered for weeks and weeks and actually rejected a takeover offer from another bank – which could have saved everything and also saved everyone a lot of trouble. Now the British government is on the hook for potentially billions of pounds, so this is not a lossless transaction for the British government.

PA: Other critics I have spoken to about the credit crisis in the US, talk about the lack of regulation and oversight of banking, brokers and Wall Street.

HENWOOD: That is a very, very large part of the problem. We have had five or six – I’ve kind of lost count – of these major financial crises over the last couple of decades, and there has been no reversal of the political trend toward deregulation of finance. Given that the financial sector is so crucial to the economy and that the government will react with a bailout whenever that sector is threatened, this shows that these guys can be just as reckless as they want to in boom times and then have themselves bailed out when it turns to bust times.

This combination of deregulation and lack of governmental supervision, along with the whole bailout culture that has developed, is almost a perfect prescription for financial crisis. After the dot-com and the Enron disaster in the early part of this decade, you might have thought that some lessons had been learned, and that there might have been at least some degree of disclosure requirements imposed on corporations that were building up such large speculative financial positions. We didn’t even see that, much less any kind of regulatory action. So now that people are again talking about this, I hope that it actually comes to something, because in order to prevent this kind of thing from happening again several years down the road – assuming we do not enter some kind of long-term depressive crisis – to pre the authorities do have to take action to vent it happening again, we really need some kind of re-regulation.

The public should get something in return: that means different kinds of financial institutions emerging from this crisis: community, nonprofit organizations – cooperative institutions that would provide basic financial services at low fees to lower and middle-income people, and stay out of speculative markets. This would create a much less speculative and profit-driven financial sector.

It would be interesting to see what effect that would have in competition with the big banks. These new institutions could conceivably offer basic financial services at lower cost than the big guys do. People are paying fees through the nose for basic financial services now. If there were some competition coming from public or cooperative institutions, that would be an interesting use of market competition to promote the public welfare.

PA: Are Wall Street’s financial problems, the credit crunch, the housing crisis – is that the limit of our economic problems, or are we talking about something deeper and more structural?

HENWOOD: When I was talking earlier about spinning out disaster scenarios, that is kind of what I was implying. There are many other things wrong with the American economy: one is that we have basically no domestic savings in this country. Households have been spending all their income and then some in recent years. Part of that is because of weak wage growth, weak job growth, and because people have used the mortgage market to borrow money to compensate. But since we had so small a pool of domestic savings to draw on, this was financed from abroad. So now we have an enormous foreign debt that has grown by trillions of dollars over the last several years, much of it financed by Asian central banks.

We have this very perverse economic model in which we import a lot, send a lot of dollars abroad, and then the people we import things from lend us the money back, so we can buy more stuff. Obviously there is a kind of mutually dependent, but not very healthy, relationship that has developed between the US and Middle Eastern oil exporters, on the one hand, and Asian exporters of manufactured goods on the other. Those entities have been accumulating large piles of dollars and then acquiring US assets with them. That can’t go on forever. We cannot keep accumulating foreign debt at the rate we have been. That now means, according to orthodox economic thinking, that the United States has become a country that needs to go to the IMF and get a structural adjustment program. We’ll need to tighten our belts, grow slowly, squeeze consumption, and have an extended period of a very weak economy in order to put the foreign books back into balance.

There are good ways we could do that sort of thing. We could tax rich people, have an infrastructure development program, improve the quality of our welfare state, and provide income supports for people – or we could do it the ugly, market-based way, which would mean a very deep recession, a possible severe financial crisis, an extended period of high unemployment, and very weak job and income growth.

But something’s got to give. We cannot continue to consume at the rate we have and borrow at the rate we have. Household balance sheets are really in terrible shape. There has been an enormous amount of borrowing to compensate for weak income growth for decades, but it has really accelerated in the last 5-10 years. Something has to change there. We badly need a different kind of economic model.

Also, our corporations, despite having very high profits during this expansion, have re-invested at very low rates and hired at very low rates, so while they have accumulated lots of money, they have mostly shipped that money out to their shareholders. If we are going to see a healthier economy in the future, we need to get that rate of investment up – but Wall Street won’t be very happy about it, and it may take concerted public action to make it happen. Added to that, the physical and social infrastructure in the country is in pretty rough shape, and we need to spend money on that sort of thing.

We also need to do something, if we are going to continue to have life on earth, about climate change, and I think we may have a fortunate case where spending money on R&D and greening our infrastructure would be both good economic policy and good environmental policy. But we need to have more people in public life talking about this sort of thing; some people are talking about it, but in a very weak and mild way, and I think we need much stronger medicine than what is likely to be prescribed by anybody now in public life.