The Crisis and How to Deal with It

From The New York Review of Books:

By Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, Robin Wells et al.

Following are excerpts from a symposium on the economic crisis presented by The New York Review of Books and PEN World Voices at the Metropolitan Museum of Art on April 30. The participants were former senator Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, and Robin Wells, with Jeff Madrick as moderator.

—The Editors

Jeff Madrick: It was six months ago now that the Lehman debacle occurred, that AIG was rescued, that Bank of America bought Merrill Lynch; it was about six months ago that the TARP funds started being distributed. The economy was doing fairly poorly in much of 2008, and then fell off a cliff in the last quarter of 2008 and into 2009, shrinking at a 6 percent annual rate—an extraordinary drop in our national income. It is now by some very important measures the worst economic recession in the post–World War II era. Employment has dropped faster than ever before in this space of time.

We have a three-front problem: a housing market that went crazy as the housing bubble burst; a credit crisis, the most severe we've known since the early 1930s; and now a sharp drop in demand for goods and services and capital investment, leading to a severe recession. What gives us the jitters is that all of these are related. We have seen some deceleration in the rate of economic decline, and many people are saying that "green shoots" are showing. What is the actual state of the economy, and do we need a serious mid-course correction on the part of the Obama administration?

Bill Bradley: How far are we along in a recovery? When the market price of Citicorp drops from 60 to 1, and then comes back to 3, I don't think that's a recovery. Warren Buffett buys Goldman Sachs, and after he buys, the price drops 45 to 50 percent, and if he's going to break even on the investment he's got to earn 9 percent for the next twelve years, I don't think that's a recovery. The administration has put in place measures that, if they were to work, could offer some hope.

What I'd like to suggest is that if they don't work, there's an alternative. The national government has now made about $12.7 trillion in guarantees and commitments to the US financial sector, and we've already spent a little over $4 trillion in this crisis. Some institutions such as Citicorp, for example, received about $60 billion in direct assistance, and $340 billion in guarantees. So US taxpayers are into Citicorp for around $400 billion. If we look out to June, July, and if we see that the PPIP [Public-Private Investment Program, created by Treasury Secretary Timothy Geithner] is not succeeding, that the bank assets aren't being bought at levels that they should be bought from the books of banks, then there is an alternative.

Think back to Citicorp. I looked at the ticker today: the market capitalization of Citicorp is $17 billion. So the government could buy Citicorp for a fraction of what we've already obligated the taxpayer for. And in buying Citicorp, as an example—there could be one or two others—the government would announce in four to six months that it is going to sell the good assets of the bank back to the public. If the government bought Citicorp for, let's say, $20 billion, what would it be worth if the government sold the good assets back to the public? Surely, several times what it paid for it.

I don't mean selling these assets to hedge funds, although they can participate; but I would propose offering them to any American who wants to invest in this good bank the opportunity to do so.

The prospect of that happening would bring very strong, positive influence on the development of the whole economy. And what would the government then be left with? The bad bank—that is, the bad assets that we're going through hoops now to try to get off the bank books. Instead the government would have those assets and it could take fifteen to twenty years to clean them up. So I say I would like to see the existing program work. But if it doesn't work, there is an alternative, and it's an alternative in the long run in which the average guy in America could participate.

Niall Ferguson: This is the end of the age of leverage, which began, I guess, in the late 1970s, and saw an explosive rise in the ratio of debt to gross domestic product, not only in this country, but in many, many other countries. Once you end up with public and private debts in excess of three and a half times the size of your annual output, you are Argentina. You know, it's funny that people refer all the time back to the collapse of Lehman last September. Let's remember that this crisis actually began in June 2007. It fully became clear in August of 2007 that major financial institutions were almost certainly on the brink of insolvency to anybody who bothered to think about the impact of subprime mortgage defaults on their balance sheets.

But we were in denial. And we stayed in denial until September, more than a year later, of last year. Then we had the breakdown. Notice how psychological terms are very helpful when economics fails as a discipline. After the breakdown, we came out of denial and we realized that probably more than one major bank was insolvent. Then in September and October the world went into shock. It was deeply traumatic.

Now we're in the therapy phase. And what therapy are we using? Well, it's very interesting because we're using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman—Milton Friedman, that is —which is being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the early 1930s. I'm fine with that. That's the right thing to do. But there is another course of therapy that is simultaneously being administered, which is the therapy prescribed by Dr. Keynes—John Maynard Keynes—and that therapy involves the running of massive fiscal deficits in excess of 12 percent of gross domestic product this year, and the issuance therefore of vast quantities of freshly minted bonds.

There is a clear contradiction between these two policies, and we're trying to have it both ways. You can't be a monetarist and a Keynesian simultaneously—at least I can't see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.

After all, $1.75 trillion is an awful lot of freshly minted treasuries to land on the bond market at a time of recession, and I still don't quite know who is going to buy them. It's certainly not going to be the Chinese. That worked fine in the good times, but what I call "Chimerica," the marriage between China and America, is coming to an end. Maybe it's going to end in a messy divorce.

No, the problem is that only the Fed can buy these freshly minted treasuries, and there is going to be, I predict, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be absorbed by the financial system this year. That will tend to drive the price of the bonds down, and drive up interest rates, which will also have an effect on mortgage rates—the precise opposite of what Ben Bernanke is trying to achieve at the Fed.

One final thought: Let's not think of this as a purely American phenomenon. This is a crisis of the global economy. I'd go so far as to say it's a crisis of globalization itself. The US economy is not going to contract the most this year, even if the worst projections at the International Monetary Fund turn out to be right; a 2.6 percent contraction is far, far less than the shock already being inflicted on Japan, on South Korea, on Taiwan, to say nothing of the shock being inflicted on Europe. Germany is contracting at something close to 5 or 6 percent. So we are faced not just with a problem to be dealt with by American policy, we are faced with a crisis of global proportions, and it's far from clear to me that the prescriptions of Dr. Friedman and Dr. Keynes together can solve that massive global crisis.

Paul Krugman: Let me respond to that a bit. Let's think about what is actually happening to the global economy right now. On the one side there has been an abrupt realization by many people that they have too much debt, that they are not as rich as they thought. US households have seen their net worth decline abruptly by $13 trillion, and there are similar blows occurring around the world. So the people, individual households, want to save again. The United States has gone from approximately a zero savings rate two years ago up to about 4 percent right now, which is still below historical norms; but suddenly saving is occurring.

That saving ought to be translated into investment, but the investment demand is not there. Housing is flat on its back because it was overbuilt; housing bubbles collapsed not only in the United States, but across much of Europe. Many businesses cannot get access to capital because of the breakdown of the financial system. But even those that do have access to capital don't want to invest because consumer demand is not there. Between the housing bust and the sudden decision of consumers to save, after all, we have a world with lots of excess capacity. The GDP report that just came out says that business-fixed investment, non-residential fixed investment, essentially business investment, is falling at a 40 percent annual rate.

This causes a problem. There are lots of people who want to save, creating a vast increase in savings, not only in the US but around the world, combined with a sharp decline in the amount that the private sector is willing to invest, even at a zero interest rate, or rather even at a zero interest rate for US government debt, which is what the Federal Reserve has the most direct impact on.

One way to think about the global crisis is a vast excess of desired savings over willing investment. We have a global savings glut. Another way to say it is we have a global shortage of demand. Those are equivalent ways of saying the same thing. So we have this global savings glut, which is why there is, in fact, no upward pressure on interest rates. There are more savings than we know what to do with. If we ask the question "Where will the savings come from to finance the large US government deficits?," the answer is "From ourselves." The Chinese are not contributing at all.

Those extra savings are, in effect, the savings that America has wanted to make anyway, but that US business is not willing to invest under current conditions. That is the way Keynesian policy works in the short run. It takes excess desired savings and translates them into some kind of spending. If the private sector won't do it, the government will. There is actually no contradiction between the Federal Reserve's actions and the actions of the US government with a fiscal stimulus. It's very much necessary to do both. By buying a lot of private securities, the Federal Reserve is essentially going out there and playing the role that the private banking system is no longer playing properly; by engaging in investment, the federal government is playing the role that businesses are not now willing to play. All that debt-financed spending on infrastructure by the Obama administration is basically filling the hole left by the collapse in business investment in the United States. There is not an excess demand for savings that is going to drive up interest rates. The only thing that might drive up interest rates—and this is a real concern—is that people may grow dubious about the financial solvency of governments.

Now, the great concern I have is that although we understand these things fairly well, there are thirty-eight Republican senators who say that the answer for the crisis is another round of Bush-style tax cuts that will reduce revenues by $3 trillion over the next decade.

This crisis has been so large and the political process has been so sluggish that the difficulties have been greater than expected. And yes, there are some green shoots. Things are getting worse more slowly, but we have not managed to head off a crisis that could turn out to be self-reinforcing, and leave us in this trap for many, many years.

Nouriel Roubini: It's pretty clear by now that this is the worst financial crisis, economic crisis and recession since the Great Depression. A number of us were worrying about it a while ago. At this point it's becoming conventional wisdom.