Our country is at a rare and dangerous juncture. The old order is crumbling, and virtually all the centers of power that govern us have been discredited by events. The president is irrelevant, weak and unbelievable, even to his own party. The Democratic majority controlling Congress is stalled by its own shortcomings. The treasury secretary, given his arrogant approach to the financial crisis, is not to be trusted as a steward of the public interest. Nor are the conservative Federal Reserve and its chairman. The private power of Wall Street is utterly disgraced and desperate.
This condition of vulnerability is sure to prevail for at least the next three months, until a new president and new Congress take office. In the meantime, the governing elites are clinging to the old order, trying to salvage it by delivering massive amounts of relief from taxpayers to the failing financial institutions. The American people correctly see this approach as a historic swindle that rewards the villains at the expense of the victims. A Nevada real estate broker asked the Washington Post, "Instead of having a bailout, why don't we have indictments?"
Indictments can wait, along with fundamental reforms. Right now the country needs to confront the fire raging through the financial system and engulfing people and productive assets in the real economy. Aroused and angry, the public, for a change, can play a decisive role in the political arena, as it did when the House rejected the bailout package. That shock to the system was valuable therapy. People can drive politicians to begin facing reality and to develop a more forceful strategy for national recovery, an approach that serves the country as a whole and has a far better chance of succeeding. The sooner our leaders recognize that the old order is gone, the sooner Americans can begin reconstructing a more viable and equitable economy.
The calamitous unwinding of financial institutions in recent months has an ominous resemblance to events that unfolded after the stock market crash of 1929, when three years of recurring waves of bank failures and economic contraction led to massive suffering. The government, led by the Federal Reserve, was scandalously derelict during that crisis. This time Washington has reacted more aggressively but still hasn't found a strategy to stabilize finance or reverse the gathering recession.
Another total collapse like the one in the 1930s may still be avoided if politics changes direction. We do have some factors in our favor. First, our living standard is abundant by comparison, despite our indebtedness to foreign nations. Second, the New Deal created economic mechanisms that remain in place as automatic stabilizers, like federal deposit insurance to prevent disastrous runs on banks like the ones that wiped out more than 10,000 back then.
Given the political paralysis, people have to find their own way. Corny as it sounds, the necessary first step is honesty--getting a clear understanding of what we are facing and what can be done, then forcing our views and ideas on the governing circles in both parties. The bitter tragedy of our era is that the hard lessons Americans learned during the crisis of the New Deal years have been tossed aside--either repealed or systematically subverted--by the present generation of governing elites. Democratic partisans who claim an aura of innocence are falsifying the past. For the last generation, Democrats have colluded with conservatives in the destruction of New Deal law and principle. And Democrats do not yet have a clear idea of how to restore those lost lessons and update them for our present predicament.
Understanding the situation begins by recognizing the real crisis--the great wound to the nation that Treasury Secretary Paulson and his supporters have obscured with their alarm-bell rhetoric. The United States has collectively suffered a massive loss of wealth--capital in the financial system as well as savings in the real economy of families and producers. With the collapse of Wall Street's phony valuations, financial capital disappeared like air from a deflating balloon. Banks are endangered because they have lost $1 trillion or maybe twice that. Therefore the banking industry will shrink considerably. We are witnessing that bloody spectacle right now--failing firms and forced mergers, either propped up by government or taken over by private investors like Warren Buffett.
When Japan went through a low-grade depression during the 1990s after its financial bubble burst, something like twenty-one major banks were reduced to four. The US system is shrinking in similar fashion, but much faster. This inspires recurring panic among investors, creditors and shareholders, but a smaller financial system will eventually be good for the country--more focused on the real purpose of banking, which is to channel capital investment into the economy. In recent years financiers have instead amassed speculative fortunes by peddling exotic debt instruments.
Paulson's solution was to relieve bankers of their rotten assets--primarily mortgage securities--and then replenish their lost capital. He did not explain this clearly, because he knows even $700 billion is not enough to save them all. So his extraordinary powers would put him or his successor in the role of savior and Grim Reaper, the titan who picks and chooses which banks will survive and which must die. But even if he chose wisely, it would not solve the basic problem. The financial system is going to shrink no matter what; under Paulson's plan, the public would be stuck with all its costly mistakes.
The other half of the nation's great loss of wealth belongs to the people--ordinary working people, mostly, who have borrowed heavily in order to sustain their faltering standard of living under pressure from flat or falling incomes. Given the bubble of inflated housing prices, people borrowed most easily from their own savings--the equity they had accumulated in their homes. When housing prices collapsed, economist Dean Baker estimates, their loss of wealth was $4 trillion to $5 trillion. Three decades ago, American homeowners held 70 percent equity in their homes. Today it has fallen below 50 percent. Many families have spent their retirement savings and are still working.
Just as the financial system is doomed to become smaller, so must millions undergo a painful fall in their standard of living. Many already have. There is no obvious way around this, but if they face the facts, people can begin to focus on what is possible and then pressure government to undertake remedies to mitigate the pain and avoid the worst. Right now, everyone is scared, hunkering down.
Only government has the leverage to "get the money moving again," as New Dealers used to say. No other sector or interest is equipped to raise the financing. Government can borrow money from people afraid to spend and wealth-holding institutions afraid to lend, then pump it into real economic activity. It can issue cheap loans if the banking system won't. It can forgive debts or relax the terms if that puts people back to work and keeps them in their homes. As economist James Galbraith suggests, it can hand off the money to state and local governments and make sure they spend it. All this is elementary Keynesian economics, the doctrine taught by the New Deal era. I restate it in plain English because even the Democratic Party seems to have forgotten the basics, having become obsessively fearful of large budget deficits (except when powerful interests want the money). Average Americans need to start saving again, and business and banking will not begin to reinvest in the economy until they see that government is leading the way.
Washington must assert its full emergency powers and tackle two things at once: manage the gradual downsizing of the financial system in an orderly fashion that sustains lending, and revive production and employment by force-feeding activities of many kinds. This cannot be a voluntary program that simply invites bankers to participate on their terms. The government must impose emergency regulatory controls to keep finance in step with the nation's overall goals. If bankers resist these terms, they should be cut off, isolated from the public's lifesaving assistance.
These are not idle suggestions. The nation is now in the grip of dynamic political change, and this will not stop with the decision on Paulson's grandiose bailout. Presuming the bailout prevails in Congress, Paulson will be handing out public billions to Wall Street players in the next few months. The political counterforce for genuine public-spirited solutions should be pushing back right away. Activists and intellectuals, public citizens and heavyweight financial players, even some members of Congress, are already at work on the details. If Congress reconvenes for a lame-duck session, you will see some of these measures surface for public debate and popular agitation.
The essence of this action will borrow ideas and models from the New Deal and update them to fit our present circumstances. This not simple nostalgia. It is a clearheaded recognition that the public interest has not been served and the crisis will not recede until it is. Here are five concepts for recovery and reconstruction that are in circulation. If we are lucky, these proposals will redefine the next presidency, whoever wins.
1. Stop the easy-money bailout. Instead of buying rotten assets from Wall Street firms with no strings attached, the government should examine their books and decide which banks can be saved with direct infusions of capital in exchange for public ownership--roughly on the terms Warren Buffett got when he aided Goldman Sachs (preferred shares and guaranteed dividends). The failing institutions should get regulatory euthanasia. This approach gives the government direct control over the survivors and ensures that the public is protected from egregious loss. The model is the Reconstruction Finance Corporation of the 1930s, which recapitalized banks and corporations under stern supervision.
2. Help the folks who are hurting--directly. A homeownership corporation patterned after the New Deal original would have the money and the flexible authority to supervise "workouts" for millions of failing families. This is what bankers do for corporations when they get in over their head. Government can do the same for indebted households: stop the liquidation, stretch out default dates and arrange manageable terms. This is not a bleeding-heart gesture--keeping families in their homes is economic stimulus, and it halts the decay of neighborhoods.
3. Get serious about economic stimulus. We need a recovery program five or six times larger than the pitiful $60 billion proposed by Democratic leaders. These billions should go for the familiar list of neglected priorities--fixing bridges and schools--but should also jump-start the green agenda for alternative fuels and restoration of ruined ecosystems. The government should subsidize the new industries of our age, just as New Deal spending financed the modern development of aircraft, petrochemicals, steelmaking and other key industries in the 1930s.
4. Re-regulate the bad actors and indict the criminals. Start by restoring the law against usury--the predatory lending practices that ruin weak and defenseless borrowers. Government cannot wait for a relaxed debate about restoring regulations. We need newly designed controls over the financiers and well-defined public obligations imposed not only on banking but also on hedge funds and private equity firms. These cannot be discretionary rules. If the money guys don't like them, they should get out of the business. Paulson's Wall Street colleagues are already mobilizing lobbyists for this fight, but they may discover that Washington has been changed by events. The easygoing deference to Big Money seems suddenly out of fashion.
5. Create a new brain for government management of the economy. The crisis and the halting decision-making by the Treasury and the Federal Reserve--not to mention the secrecy and special deal-making on behalf of financial interests--make it clear that deep reform is required. I would start with a special reconstruction and recovery agency, empowered to lead policy and oversee banking regulators and the economic stimulus. The Federal Reserve's so-called independence is an antique concession to the big banks and doesn't make any sense. Monetary policy and fiscal policy must be balanced and decided in the same process. That rational approach might have stopped the Fed from the biases and dereliction that led to this crisis.
These ideas and many others are in gestation. They will reach fruition when politicians and other leaders swallow their bruised egos and rethink their supine posture, arm in arm with Wall Street. That looks improbable at the moment. But voters can help them change their minds.