Great Leap Forward


In a word, no.

Or, at least, not much. While it would be nice to believe that Larry Summers had to withdraw from the race to take over the Fed because of his substantial role in creating the global financial collapse, I think it had more to do with his outsized personality. Before you start celebrating his defeat remember that Goldman Sachs still must approve any choice and President Obama may yet choose one of its anointed candidates over Janet Yellin.

For much more on Larry and the Obama administration’s capture by Goldman, read Greg Pallast’s piece here:

The catch-phrase at the Whitehouse since the days of President Clinton is “What would Goldman think?”. Apparently all policy is subjected to the “Goldman test”—is it good for Goldman Sachs? If not, well, you know what—it gets dumped.

So here’s my thoughts on what we should have learned, as we mark the five-year anniversary of the event that sparked the crisis. An interviewer asked me to identify the three most important lessons, which I thought a bit too ambitious, so here are three important lessons.

1. The crisis exposed the dangerous and lawless culture prevailing at the world’s biggest financial institutions. We now know, beyond any doubt, that it was fraud from bottom to top. For example, every single step in the mortgage backed securities business was fraudulent. The mortgage originations were fraudulent—with the originators lying to borrowers about the terms, and then crudely doctoring the paperwork to make the terms even worse after borrowers had signed. The property appraisers falsified the home values. The investment banks misrepresented the quality of the mortgages as they were securitized. The trustees lied to the buyers of the securities about possession of the proper paperwork. At the urging of the industry’s creation, MERS, the banks lost or destroyed the property records, making it impossible for anyone to know who owns what and who owns whom. The mortgage servicers “lost” payments and illegally foreclosed using documents forged by “robo-signers”, wrongly evicting even homeowners who owed no mortgage. Now those homes are being sold in huge blocks to hedge funds at cents on the dollar so that they can be rented back to the former owners now living on the streets. It is not too much to say that foreclosure and dispossession was the desired result of what President Bush had called the “ownership society”: move all wealth to the top 1%. I’ve just given one example—you will find a similar level of criminality in every line of business undertaken by the biggest banks, from manipulating bond markets to setting LIBOR rates, from manipulating commodities prices to front-running stocks and trading on insider information.

2. The crisis demonstrated that real reform can only be undertaken in the depths of a crisis. Once Wall Street had been rescued behind closed doors by the US Fed and Treasury (it took $29 trillion!), there was no hope of reform. The biggest institutions just got bigger. They are back to doing the same things they were doing in 2007. Even the very weak Dodd-Frank reforms will never be implemented—Wall Street put together armies to delay, water-down, and eventually prevent implementation of any changes that would constrain the financial practices that caused the crisis. Franklin Roosevelt did it the right way in the 1930s: declare a banking “holiday”, demand resignations from all top management, and refuse to allow banks to open until they had a plan that would lead to solvency. Almost all the New Deal financial sector reforms were enacted in the heat of the crisis. The important lesson that should have been learned: in the next crisis, we cannot let the Fed and Treasury meet behind closed doors to rescue the “vampire squids” that are destroying the economy. We must drive the stake through their hearts when they are weakest.

3. The crisis brought into public view the longer term trend toward “financialization” of the entire economy. The FIRE sector gets 40% of corporate profits and 20% of value added. That is, quite simply, crazy. Everything has become financialized—from college education (student loans are a trillion dollars) to homes, healthcare (Obamacare makes this worse), and even death (so-called death settlements and peasant insurance in which employers bet that workers will die early). Wall Street has financialized energy and even crops. It has turned worker’s pensions against them, by using their own retirement funds to bid up the price of gasoline at the pump and bread at the grocery store. Just wait until they use pension funds to drive up the price of water at the meter!

In a very important sense it is wrong to label what happened following Lehman’s bust a crisis. Life at the top has improved tremendously since 2007, as high unemployment has softened labor even as income and wealth gushed toward the top 1%.

Of course, for the bottom 99% it is a crisis, but not a financial crisis. And it did not begin in 2007, but rather in the early 1970s. It is a long-term jobs crisis. It is a long-term wage crisis. It is a long-term education, housing, and healthcare crisis, as necessities are priced beyond the reach of most workers.

So what needs to be done?

Where to begin? Over the medium term I’m pessimistic because I do not think much can be done until Wall Street crashes and we shut down the “dirty dozen” biggest global financial institutions. They will prevent any substantial reform. We need to downsize finance by two-thirds or three-quarters or even nine-tenths. Obviously, that cannot happen until the next crash. I’m reasonably optimistic that will happen in the not too distant future.

But when real economic reform becomes possible, what do we need? First, jobs. We cannot rely on the private sector to produce them. Jobless growth is the future, so we cannot rely on growth to produce the needed jobs. Government has got to get involved. Fortunately, there’s much that needs to be done—public infrastructure, ramping up education and healthcare, environmental restoration, aged care, and improvement of public spaces. We will need a permanent Job Guarantee (or Employer of Last Resort) program to ensure that all who want to work can participate. Second, and related to the first, we need decent wages—which means substantial increases for the bottom two or three quintiles. Again, this cannot be accomplished by relying on the private sector, which will always engage in “race to the bottom” dynamics. The government must play a role—by setting high standards for minimum wages, benefits, and working conditions. This is actually easy to do once the JG/ELR program is in place as its compensation package will become the de facto minimum.

We are all shocked, SHOCKED! that Washington has not gone after Wall Street’s crooks. Actually it isn’t shocking at all. The Wall Street foxes are all spread throughout the Obama administration, running Treasury and the New York Fed and heavily represented in every agency that has any supervisory power over Wall Street. So long as Wall Street sucks up 40% of corporate profits, that is where all the money is, and Washington runs on money. With those foxes guarding the henhouse, you’d have to be a fool to believe that the Obama administration would go after any CEOs of the biggest banks.


shawnkc33September 18th, 2013 at 6:54 pm

I agree that having government start a program that provided jobs would be an efficient and streamlined means of getting people to work and dealing with our unemployment status, in an ideal situation. I am concerned that too many people, including myself, are wary of our government's intentions and effectiveness to complete such a task. Even if they were able to work together and focus on what needed to be done, is this even in their best interests in all practicality?

I know you have discussed the issue of pre-distribution over re-distribution before, as an effective means of opening credit to more people, instead of Wall Street and the select few. If proper pre-distribution was possible would this not be an effective way to start hiring? Would a proper distribution of the trillions of dollars that went to wall street (and possibly more considering most economists agree there was not enough to adequately kick start actual growth) have done more to kick start the economy and allow the private sector begin hiring, expand production and provide a catalyst for more growth.

I realize the premise of my question is based on the old-hat debate of big vs small government. However, in this article you have articulated the fine line we all know exist between government and our economy's financial sector. I do concede that any change in policy would require a change in all role players, but maybe a pre-distribution would be both morally and productively more effective…

JMarcoSeptember 19th, 2013 at 3:53 am

I think one of crucial moments when financial regulation became moot occurred in 1998 when Fed. Res. Chairman Greenspan and others in Clinton Admin. blocked Brooksley Born attempt to regulate derivatives. Another example of real inept regulation was when Harry Maraopolos went to SEC with proof that Benard Madoff's wealth management business was a fraud and SEC failed to even do a test of his investment transactions using outside records.

As someone who worked for over 15yrs for Wells Fargo I still wonder how the Bank regulators allowed WF to transfer loan without proper paper trail and recording transfers of deeds to property tax authority as required in most states. I remember when WF lost a large sum from bad loans in 1980's from "Savings and Loan real estate fiasco" that occurred mostly in CA, AZ and TX. I was one of unfortunate employees that was laid off while the bank still gave out its large bonuses to same Loan executives that had approved the bad loans.

Lake Erie LiberalSeptember 21st, 2013 at 2:35 am

Professor Wray,

Maybe not the place for this question but I got into an argument with an Austrian wherein I presented the claim that if the FED did nothing in the face of deficit spending, the net credits into the banking system would create excess reserves and that the banks holding the excess reserves would bid the overnight rate down to zero.

Then, I realized I didn't understand why that was the case. I was just repeating what I've read from you MMters.

It seems to me, intuitively, that if JP Morgan Chase had excess reserves and little old Citizen's bank from Sandusky, Ohio or what have you needed to borrow reserves, that JP Morgan would charge higher interest rates on the excess reserves to be borrowed rather than "bid them down to zero/the interest rate the FED pays on reserves".

I guess I just really don't understand it. Can you explain why a bank would bid them down to zero???

PZSeptember 21st, 2013 at 6:23 pm

There is this fallacy in economics that income distribution reflects market conditions ie. supply and demand for different kinds of people. In reality decisions are made by decision makers and income differentials reflect value judgements of decision makers. If all decision making power is at the hands of corporate managers they are sure to reward themselves quite hefty. So it is not surprising that CEO pay have been raising 20-30% yearly for the last decades while wages of ordinary workers have stagnated.

Earl GrinolsSeptember 24th, 2013 at 7:09 pm

I think a simple suggestion is best: Make reserve requirements a rising function of bank size and too-big-to-fail can be made to solve itself.