My Interview With Economist James K. Galbraith
Economists go to work every day at universities, financial institutions, think tanks and government offices prepared
for battle. They fight using historical models, statistics, public statements and complex computer algorithms. Their war
is the war; they fight to influence world leaders who command the course of history.
This war remains somewhat hidden until catastrophe strikes, collapse is imminent and the economists are wheeled out to
explain what happened. This occurred after the stock market crash of 1929 and the subsequent Great Depression and is
going on again today as the reality of the so-called Great Recession begins to sink in.
According to unapologetic Keynesian economist James K. Galbraith, his side has won, but not without massive collateral
Galbraith is the Lloyd M. Bentsen Jr. chair in Government/Business Relations and professor of Government at The
University of Texas at Austin. He has written numerous books, the most recent of which, "The Predator State: How
Conservatives Abandoned the Free Market and Why Liberals Should Too," was published in 2008. It details the peak of a
"predatory" governing system under President George W. Bush, which, despite its rhetoric, had long ago abandoned the
"free market" principles and began to feed off of the institutions of the state. He demonstrates a unanimous acceptance
of government involvement in the economy among policymakers, even before the Obama administration's rise.
In a recent interview, Professor Galbraith and I discussed the efforts of the Obama administration to solidify the
economy and begin to put the pieces back together. I asked him about the recent accusations of massive fraud by famed
bank regulator William K. Black, the ongoing recession and about his personal strategy for restoring the US economy.
Matt Renner: You have been outspoken in your criticism of economists who have provided economic guidance for past
administrations. What is your judgment of the Obama economic team and their actions to date?
James K. Galbraith: I think the administration got off to a strong start with the expansion package [also known as the
stimulus package] which was about as strong a bill as you could hope to get through Congress in three weeks. I felt that
it was probably based on an overly optimistic underlying forecast and probably too small to turn around the economy
effectively in a short amount of time. But the political judgment that you couldn't have gotten a bigger bill is
On the bank plan, the administration is following a policy that is in some ways a continuation of the [former Treasury
Secretary Henry] Paulson plan under the Bush administration. In some respects, the plan goes back and makes some
mistakes that the previous Treasury started to make and then turned away from. This is all very troublesome. The issue
is a question that effects the strategic direction of the economy and the stability and soundness of the banking system
The choices being made in the [Obama administration Treasury Secretary Timothy] Geithner program going forward are
misguided. This program is based around the assumption that the assets will recover values. But when you look at the
stress tests, they seem to have been largely designed as a statistical exercise relating the valuation of different
classes of assets, which the banks hold in different proportions, depending on institutions, to the performance of the
The deeper problem with those assets is that they are, in the case of subprime mortgage securities, based upon
documentation that is in many cases missing, contains misrepresentation and fraud on the face of the documents. Those
are securities which are intrinsically unsafe, which will default at very high rates, which should never have been
securitized in the first place and should not be treated as though they were financial assets.
That distinction is an extremely important one and one that the Treasury has not fully taken on board. An economically
viable asset that is underwater because of economic conditions is different from one that is based on fraudulent
underwriting, which was programmed to default at very high rates, therefore, is permanently impaired.
If I'm right about the underlying quality of a large part of that asset base, then these loans are going to default and
go back to the Federal Deposit Insurance Corporation (FDIC) on a nonrecourse basis. That means that this plan is a way
of rescuing incumbent management and bondholders of the major banks that were most responsible for the crisis and, in a
disguised way, transferring the losses from the books of the banks, where they sit now and have to be recognized, to the
FDIC and the taxpayers. It is a way of avoiding the necessity of devaluing those assets now and requiring their present
owners - the banks - to take the losses that are appropriate to take.
The strategic reason that the administration is doing this is to preserve the large banks. The result of the decision
to do that is that in a financial sector, which is much too big relative to the economy, the shrinkage that will occur
will fall elsewhere. It will force smaller banks to the wall and it will force institutions which are more community
oriented and more vulnerable to be bought up or suffer from very big increases of insurance charges. We will end up with
a banking system which is much more concentrated than it should be and where you have these enormous executions of small
banks, which experience shows you really can't prevent.
MR: In an interview with Bill Moyers, bank regulation expert William K. Black did not hedge in describing the Wall
Street collapse as a result of massive fraud starting in the board rooms and CEO offices of Wall Street. What is your
take on this? Has the American economy fallen victim to a group of confidence men?
JKG: Bill Black is a comprehensive expert on the subject of bank fraud. He is not prone to exaggeration or polemic. He
is a lawyer and criminologist who uses words with considerable precision. One of the things that Bill has noted is that
as far back as 2004, the FBI warned that there was an epidemic of mortgage fraud on the way. The [Bush] administration
failed to do anything about it and did not give the FBI the direction and the resources required to make dealing with
white-collar fraud a priority.
So, you had fraud in the origination of the mortgages, fraud in the underwriting. You also had fraud in the ratings
agencies, which were operating according to a business model where they did not get paid unless they issued the
favorable ratings, and they issued ratings on assets they could not examine. They examined using statistical methods and
did not look at the underlying documents to asses the possibilities that the assets they were rating were rotten to the
But of course they were. A subprime mortgage is an intrinsically problematic instrument. It is an loan issued to people
who can't document their incomes, whose credit histories are bad, and were issued on assets whose values were
MR: Do you think this fraud was a plan?
JKG: Sure it was! There was a whole class of lenders out there, many of whom were completely unregulated, the
Countrywide Financials of the world, others of whom should have been regulated but were effectively desupervized, the
Indymacs and the Washington Mutuals, where the business model was "push those bonuses out the door, get as many of them
signed up as possible because if they pay for the first 30 days, we can sell them and pocket the fees. After that, it
isn't our responsibility."
Systematically, in this industry, the people who previously specialized in risk management used to say, "show me the
documents proving that this will be a safe mortgage," were given instructions by top management, "get out of the way,
and get these mortgages issued." There are plenty of records showing that these lenders were told to drop the standards.
That was the revenue model for the institution. You have a model which is fraud in origination, fraud in the conveyance
and fraud in the rates.
MR: Do you see people going to jail for these crimes?
JKG: In the savings and loan crisis there were 1,000 felony convictions for S insiders and about 700 or so went to jail. This is a bigger crisis, so you could easily be talking about a larger
number of convictions. It is a question of whether the Justice Department does its job. The records available for
sending people to jail are clearly present, so there is nothing mysterious about what needs to be done regarding
investigations of the appropriate criminal referrals and prosecutions.
Aside from the Department of Justice, the regulators are highly important. In the case of a troubled bank, the FDIC has
the power to install new management. One of the responsibilities of the new management is to cooperate in criminal
referrals as appropriate. When the new management comes in, you have people who have not been paid off and who are not a
party to the old deals, who are interested in the long-term survival of the bank and are prepared to participate in a
clean audit. When they encounter evidence of corruption and fraud, as they inevitably will as they go through the books,
they are to make an appropriate criminal referral. That is how the prosecutions happen.
MR: We have seen a systemic failure on the part of government regulators to prevent Wall Street from destroying itself.
Some regulators saw this coming and were silenced. Under the Bush administration, we saw investigations of A.I.G.,
Fannie Mae, Bear Sterns, Bernard Madoff, and others sabotaged, quashed or settled without assigning fault. The
Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) seem to have failed the American people.
Was this incompetence, negligence, conspiracy or something else?
JKG: Oh, I don't think those are mutually exclusive. I think that, as always, you'll have incompetence, negligence and
conspiracy at various parts of the operation at various times. It is clear that the culture of the Bush administration
was a culture of debt predation, a culture of complicity. The boom that was associated with subprime mortgage
securitization - the housing boom - served very particular purposes and there is no doubt that those purposes lined the
pockets of the friends and supporters of the Bush administration. The Bush administration's method of operating was to
place friends and allies of the most aggressive and rapacious parts of the financial sector in charge of the regulation
of that sector.
I would call attention to the systematic deregulation of commodities futures trading, which underpinned the pillage of
California in 2000 and 2001, a la Enron, a Texas corporation headed by the largest contributors to George W. Bush. There
was very strong reason for suspicion that this was a politically sanctioned raid on the state of California.
MR: Specifically, on the big misses by the SEC and the DOJ, do you think that their investigations were tainted by
politics? Why were they pushed off of investigations of companies who were involved in the collapse?
JKG: It would not be for me to make a specific accusation without being able to document it. But it is for the current
Justice Department to look into that possibility very closely and to ask just exactly where the decision on the targets
and timing of investigations were made. Then we will know.
MR: In your recent book, you talk about the need for progressives and Democrats to break free of the "free market"
frame. How can they do this and what should replace it?
JKG: A major theme of the book is that the conservatives, under whom we have lived for the better part of the last
three decades, whatever their views were in 1981 when they came to power, by the time we got to the younger Bush
administration, the conservatives had already abandoned any serious belief in these free market liturgies.
The Bush administration was one that did not try to dismantle the state and was not interested in that. It was merely
interested in making it possible for their constituencies and their clients to profit from the largest ongoing state
institutions including Social Security and Medicare. The drug benefit [Medicare part D], which was designed to provide
maximum profit to the drug companies, and the manipulation of regulation in the financial sphere make this clear.
The message of my book is that liberals should not feel intimidated, as they had for several decades, into repeating
their often insincere allusions to the same "free market" dogmas. It is not as though these were the actual governing
principles of the various conservative administrations. The main function of the "free market" dogma in recent years has
been to constrain the way liberals could talk about economic policy.
One thing that struck me is how quickly, once you point this out, the dogmas have collapsed. In the aftermath of the
financial crisis, it is in fact clear, that the American public overwhelmingly supports effective and prudential
regulation on a whole range of areas. They want effective regulation of the food chain, of consumer products, of
transportation, and they want effective regulation of banks so they don't get ripped off all the time. Regulation is
MR: Then regulation or strong state presence in the market should replace the "free market" ideology?
JKG: It already has. It did in the last election. I was just astonished when push came to shove how quickly one could
start speaking realistically about what needed to be done in terms of re-regulation without any fear of political
The debate has changed in a fundamental way. Friends of mine said that I had been moved to the center faster than any
man in history who didn't change his views.
Even a year ago, when I wrote "The Predator State," the book had to be crafted very carefully with the expectation of a
considerable amount of rebuttal and criticism. But that hasn't happened, in fact, the book expresses a view which is
practically mainstream opinion. What has happened to the very large majority of the economists who still hold these
conventional ["free market"] views is that they are increasingly walled off from any practical policy debate. If they
were to express those views in public debate these days, people would say "where have you been and what planet do you
MR: How far do you think we are through the crisis and this recession?
JKG: Prediction on that is extremely dubious. But I'll lay out a plausible scenario. There is a good Keynesian case
that the economy will reach a floor, production will stabilize and even start to grow again. There are two reasons for
this. We have seen a major inventory liquidation, which always happens in a slump, where production falls more rapidly
than consumption does. Eventually you have to reorder. The second point is that, to the surprise even to the most
dyed-in-the-wool Keynesian, and there aren't very many of us, the budget deficit really has gotten to a very big number.
That is a good thing because it means that the government is helping the private economy restore its savings and its
purchasing power. It is a very ugly process because it means that the budget deficit is going up because people are out
of work so they aren't paying as much tax and have started drawing unemployment and other welfare benefits. But the
effect on the economy is to stabilize it after a certain period of time. And that the numbers are getting to be very
large, so they will have that effect. And on top of that, you have the stimulus package, which has got to be helpful
So, there is a case for finding a floor and a resumption of production. But the case has several weaknesses. The first
one is that households are still trying to get their debts paid down and to stay in cash as much as possible, deferring
purchases of new cars and homes. Also, the falling asset values are such that people don't have collateral to support
new loans if they wanted to take them. We don't know how quickly the household sector can turn around its expenditures.
The second problem is that in a recession, your domestic capital tends to get destroyed. This is particularly true in
the auto sector. Any subsequent return will see more outsourcing and more imports, so a lot of the recovery will leak
overseas, which will take away from the turnaround here in the US. Third, bad things can still happen. They can still
happen in the financial sector and they can happen overseas. The situation in Europe's financial sector is quite
frightening and on the verge of spinning out of control.
European banks are more leveraged than they are in the United States and the response of government is subject to
massive coordination problems. There isn't the same kind of unified government and activist central bank that we have in
the US at the moment. The US at least got a governing structure out of [Presidents] Roosevelt and Lyndon Johnson that
permits us to react in a crisis. The Europeans are patching it together on weekends with major impromptu meeting of the
finance ministers. They may be able to do it, but the risk that things may fall apart is looming.
MR: If you had a magic lamp with a public policy genie inside, what would your one economic policy wish be? This being
a policy genie, you only get one wish and you can't ask for a policy granting you more wishes.
JKG: Broadly, tackle this problem from the bottom up, not the top down. The most important thing is to improve the
security of the population. The effective way of doing that is through the social insurance system, in particular,
Social Security and Medicare. I'm going to slip three things in.
MR: O.K., you can have three.
JKG: First would be enhancing Social Security. Second would be to enact a holiday on the payroll tax, and third would
be to reduce the Medicare eligibility age to 55. I think if you get those things, you will greatly help American
households get through this recession and greatly help the elderly population survive the collapse of their stock
portfolios and home values. The Medicare piece would take the health care burden off of private companies for the part
of the work force that tends to get sick and enable a lot of people who would be able to afford to retire to do so.
People-centric measures would be very, very helpful.
MR: All three of those policies would increase government spending down the road. Why wouldn't that be a prohibitive
JKG: Balance sheets have two columns. If we are talking about a transfer of payments where the increase of government
liability is exactly matched by an increase in wealth of the population, that is exactly what you want to do. You can't
increase the assets of the population without increasing the liability somewhere else. It does not mean that those
measures would be unsustainable. In terms of health care, it could save money because you'd have a significant sector of
the population moved over into an insurance system, which is substantially cheaper to run than the insurance system they
are now in, or in many cases not in.
For more information on the work of Professor Galbraith visit his web site.
To view the Bill Moyers interview with bank regulator William K. Black, visit the Bill Moyers Journal web site
is an editor and Washington reporter for Truthout. He can be reached at Matt@truthout.org