Point Austin: Under Water
James K. Galbraith on the prospects of an economic meltdown
That was the most reassuring word I received from professor James Galbraith, the Lyndon B. Johnson School of Public Affairs economist and author, most recently of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too. That subtitle sounds almost redundant this week, as Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have gone to Congress, hats in hand, pleading for $700 billion or so in public money to bail out Wall Street investment firms overloaded with debt and without further recourse in the "free market." Despite Hank & Ben's desperation, Galbraith said that Congress, whatever it does, can take the time to try to get it right. "They may want to get something rolling, but it doesn't have to get done this week. The stock market is holding up today; the world is not seized by panic. So we'll see."
Amid the general alarm and ubiquitous comparisons to 1929, I had called Galbraith to ask if the U.S. economic roof is indeed collapsing. "The roof has fallen in on a certain type of [financial] activity, that's for sure; it's been falling for a year. The roof was propped up by the unlimited liquidity that the Fed was giving to the banks, and that just proved to be inadequate, at the end of the day. So I'm not wildly surprised. What we have is the top tier of the financial sector, which is ... certainly bankrupt. The question is whether one avoids dealing with this, because the scale of the system is too large to do so [or whether] the unraveling is too disorderly to permit it to collapse."
Galbraith conceded that Congress needs to make the attempt but said the outcome is far from certain. "The question that I have is whether there is anything effectively that can be done to prevent that collapse. And if the answer to that question is no, there is nothing – that $700 billion won't do it ... then the question becomes ... what do you do after the collapse. That may be where we're heading. As far as I can tell right now, whether or not Congress acts, it's entirely unclear what the prospects for success actually are."
One Step at a Time
Galbraith has never been shy about criticizing the Bush administration. He has written: "Under Bush and Cheney, oil and gas, drug companies and defense contractors, insurers and usurers control the government of the United States, and it does what they want. This is the predator state." But he doesn't automatically echo widespread charges that the brief draft bailout bill, with its provision that actions of the Treasury secretary would be "unreviewable," is an administration attempt at a coup d'etat. ("After reading this proposal," said Sen. Christopher Dodd, "I can only conclude that it is not just our economy that is at risk but our Constitution as well.") Although Galbraith admits the administration reflexively overreaches, he said: "I saw [the draft] as a group of staffers in one hell of a hurry, putting a page or two in front of the Congress, with absolutely no expectation that the Congress would enact such a bill. ... The chance that this Congress would hand this administration an unreviewable writ to spend this money anyway they like has got to be nil."
Galbraith has served as a congressional adviser and has proposed some initial improvements for the bailout bill: provisions enforcing disclosure, preventing fraud and conflicts of interest, establishing pricing for transferred assets, providing transparency, and so on. (See "Trust but Verify" with William K. Black, posted online at TheNation.com.) He said he has also recommended not surrendering to the demands for undue haste. "What they should do is give them $200 billion to work out a pricing mechanism" for the assets, he says, "and give them the rest of whatever else is needed if they succeed in the first two or three months with the 200. You limit your exposure, you've left the thing up in the air for a while, and you can argue out and watch how they're doing it. If they manage to pull off something effective and manage to buy back securities with something that isn't a rake-off from the taxpayer and begin to establish market prices for this stuff, then you go ahead and give them more. But I don't see any reason why you need to give them $700 billion tomorrow."
In this instance, Galbraith is less concerned about the shape of the eventual legislation than about the likelihood of its ultimate success. "At the end of the day, you just don't get away from two problems. One is that these firms are basically bankrupt. It would take extraordinary sums of money to change that reality. Seven hundred billion might change it for a small number of key firms ... but it's not going to change it for very, very large numbers of highly leveraged institutions. ... A lot of stuff is going to go down, and a lot of assets are going to get unloaded. The process of debt deflation is one in which asset values will fall – that's just sitting out there as a very likely thing.
"The other is that no matter what happens – it's not as though this is a beaver dam on the creek of flowing credit, which is the sort of metaphor that's being used here, and all you have to do is get a sledgehammer and bust the dam, and the river will start to flow. That's not the case. The borrower here is the American household, and the American household is under water, because their house values don't support the credit burden they already have. So there's no way that fixing this problem, and preventing an implosion on Wall Street, is going to restore the flow of credit. So that metaphor is completely misleading. It's a much longer process to fix that."
So, presuming this $700 billion Band-Aid manages to stem the bleeding, where will it leave us? "It leaves us with this creaky structure still standing," Galbraith says, "without having a panicked collapse of asset values. That's what they're striving for, and that I'm uncertain they can achieve. It does not leave us with a solution to the underlying economic problem, by any stretch of the imagination."