PP: Moving on, in the book you make the claim that had the financial system been allowed to melt down we would not actually have ended up in another Great Depression. This is not to say that you don’t recognise that letting the financial system melt down would have caused a lot of problems – for banks, of course, but also for pension funds and the like – but you say that those in charge of the bailouts exaggerated the importance of the financial sector. Could you explain briefly what you mean by this? And what do you think should have been done at the time of the bailouts?
DB: The point here is that we know how to reflate an economy. Massive government spending will do it. It got us out of the Great Depression, although not until World War II created the political consensus for the level of spending that was necessary to actually do the job.
A financial collapse cannot condemn us to a decade of stagnation and high unemployment. That only comes about from a prolonged period of political failure. If we had allowed the banks to collapse in the financial panic of 2008 then we would [still?] have had the opportunity to pick up the pieces and get the economy back on track with a massive stimulus program.
Of course it was best to not let the banks collapse. However the bailout should have come with real conditions that would have ensured the financial system was fundamentally restructured. This would have included breaking up the too big to fail banks (on a clear timetable, not necessarily at that time), serious caps on compensation, a commitment to principal write-downs and other real conditions.
At that time the banks were desperate. Without a big dose of public money they would almost certainly have been insolvent, so they would have had little choice but to accept whatever conditions were imposed. As it was, they almost got President Obama thanking them for taking taxpayer dollars in the bailout.
PP: Any ideas about what could be done with the banks now? Or is the damage already done?
DB: We still need to reform and downsize the financial sector. We don’t have the same leverage over the banks as we did at the peak of the crisis when we could have slapped whatever conditions we wanted on the loans and guarantees they needed to stay alive, but Congress can still pass laws that will rein in the industry.
At the top of the list is a financial speculation tax. A modest tax on financial transactions will do much to reduce the rents in the industry and to eliminate or drastically reduce short-term trading that serves no productive purpose. It will also raise a ton of money.
The second thing is breaking up the too big to fail banks. There is no justification for allowing banks to be able to borrow at below market interest rates because they enjoy an implicit government guarantee.
The third item on my list would be re-instating a Glass-Steagall type separation between commercial and investment banking. The Volcker rule, which limits proprietary trading by banks with insured deposits, was a step in the right direction. However it looks as though the industry is using the rule-making process to turn the law into Swiss cheese. It is likely that most banks will be able to find loopholes that will allow them to do as much proprietary banking as they want.
Anyhow, these would be my top three reforms. Politically, all of them would be very tough sells right now. By contrast, at the peak of the crisis, the industry would have voluntarily agreed to the last two in order to get the money they needed to stay alive.
PP: You write in the book that the idea that the banks repaid all the money from TARP is misleading. Could you explain this, because this myth is very prevalent in the mainstream media?
DB: Yes, this is really kind of a joke. The banks got loans at way below market interest rates from the government, and we are supposed be grateful that they repaid the loans? The difference between the market interest rate and the rate they actually paid amounted to a huge subsidy. This is something that anyone with even a passing familiarity with business or economics would recognize, which is why it is so insulting when political figures go around yapping about how the money was repaid with interest.
To see this point, suppose the government gives me a 30-year mortgage at 1 percent interest. If I make all my payments and pay off the mortgage has the government made money? By the logic of the politicians claiming that we profited by the bailout, the answer is yes.
A serious assessment would look at what the market rate for these loans was at the time they were made. To take one example, just before we lent $5 billion to Goldman through TARP, Warren Buffet lent $5 billion himself. He got twice the interest and a much more generous deal on warrants. Plus he knows that it was likely that the government would bail out Goldman if it got in trouble.
Elizabeth Warren commissioned a study of the implicit subsidies in the bailouts when she was head of the TARP oversight panel. As I recall, it came to over $100 billion on just the first batch of TARP loans to the large banks. This didn’t count the value of later TARP lending, the much larger lending programs from the Fed, nor the extensive set of guarantees provided by the Fed, Treasury, and the FDIC.
All of these commitments involved enormous subsidies. In the business world firms pay huge amounts of money if they want their debt to be guaranteed. And everyone understands that a below market loan is essentially a gift. That is why it is so insulting when they try to imply that the public has profited from these loans.
You can make the argument that it was good policy to subsidize the financial industry to get through the crisis, but to pretend that we did not subsidize them is just dishonest.
Incidentally, the reforms Baker suggests are similar to those recently suggested by Rolling Stone‘s Matt Taibbi as a starting point for the Occupy Wall Street protesters. More on those later.