David Coates, Worrell Professor of Anglo-American Studies, addressed the ongoing financial crisis in a speech, “What Went Wrong? Causes of the 2008 Financial Meltdown,” on April 2. Coates received his Ph.D. from the University of Oxford and taught at the universities of York, Leeds and Manchester before joining the Wake Forest faculty in 1999. His most recent books include “Blair’s War” and “A Liberal Tool Kit: Progressive Answers to Conservative Arguments.” This Q & A is adapted from his speech.
The image of the cake is there just to persuade us to probe beneath the surface, and to see how underlying and immediate causes interact. At the surface level, this has been a crisis about housing and housing finance — about the sale of subprime loans to people who ultimately defaulted. At that level, too, it has been about something called “securitization” — the packaging of these mortgages into securities that were sold on to other financial institutions. The fact that they were sold — and that their sale was inadequately supervised — takes us to the related but deeper issue: the need to strengthen both industry and public supervision of the creation and distribution of these new financial instruments.
But deeper still, this has been and remains a crisis about credit and debt, and not just government debt or housing debt, but also general consumer debt and international debt. To avoid a repetition of this kind of crisis we need to act at all three levels simultaneously and in a coherent and consistent manner, not just intervene at the level of housing finance alone.
How about the role of regulation?
The financial sector is already heavily regulated, and has been since the 1930s. But there are gaps in the regulatory structure, particularly financial institutions like hedge funds and in relation to new financial instruments like credit default swaps. And some of the firewalls created in the 1930s to separate commercial and investment banking, and to keep housing finance in the hands of specialist institutions — those firewalls were systematically weakened in the last decade.
Add to that a generalized reluctance — during Alan Greenspan’s years as Fed chairman — to keep a tight regulatory oversight on the exploding financial sector, and we have paid the price of regulatory failure. The G20 summit in London last week was clear on the need for new regulation. The U.S. Treasury Secretary has been clear on that, too; and to his credit, Alan Greenspan has also conceded that more and different regulation is now required.
Inadequately regulated financial practices have triggered a global recession of a scale we have not seen since the 1930s, so it is hardly surprising that the vast majority of key players and commentators concede the urgent need for new regulatory institutions and standards.
Talk more about the role of debt — consumer debt, government debt and international debt.
People worry most about government debt. They hear the big numbers, and are told by many conservative commentators that we are stacking up debts on our children. I don’t personally see it that way. Well-directed public spending now can leave our children better schools and roads, and generate private sector economic growth (and tax revenues) that will bring that public sector deficit down. Well-directed public investment can trigger the new technologies, as once it triggered the computer, to create possibilities in the future that literally now lie beyond our imagination.
And if I’m wrong, and there are still public sector deficits a generation from now, they will be deficits owed by some of our children to others of our children. Debts exist within generations, not between them. All one generation can leave to another are real things — real schools, real roads, real technologies. If we want to leave a positive economic legacy, we need to develop those!
What worries me more is our debt to overseas creditors — especially the Chinese Government — that has built up because of our loss of competitiveness in manufacturing; and our levels of personal household debt, that have built up because of stagnant real wages for the vast majority of working Americans in the decades since the end of the Vietnam War. Most U.S. families have maintained or increased their living standards through that period by working more hours (we now work on average more hours per year than any other leading industrial economy, including the Japanese!); by sending more and more family members out to work; and by maxing out our credit cards.
The international debt erodes our freedom of action as a world power. Our personal debt leaves us all vulnerable to rising interest rates or mortgage payments. Those are the debts that leave us fragile, and on which we need to act. It is those debts to which this crisis has been a wake up call — or to which at least I hope it has!
Republicans like to blame Barney Frank for the meltdown. Time magazine published a list of the 25 people to blame for the meltdown; who’s in your top five list?
There’s a lot of blame legitimately to go round, but less to Barney Frank than many right-wing commentators would have us believe. He didn’t make the Time top 25, and rightly so. This is a systemic crisis, rather than one caused by “bad apples”; but clearly big responsibility lies with Countrywide Financial (the chief sub-prime lender) and so with its CEO, Angelo Mozilo, and perhaps too with the architects of excessive deregulation (Phil Gramm would figure high in my list, I think, as indeed he did in Time’s). The head of Fannie Mae — Donald Mudd — took a lot of criticism too, as did his predecessor, Frank Raines. But in the end it’s less the people than the system and the governing philosophy. Changing the people alone won’t solve the problem.
Has the financial crisis been a “teachable moment?” How have you brought current events into your classroom?
It is a huge teaching moment, of course. How can it not be? I have fabulous students, and I encourage them to read as widely as they can — serious newspapers like The Wall Street Journal and The Financial Times, plus the publications of the important think tanks (the AEI, Cato, Heritage, Brookings, the EPI…) and the emerging scholarship in comparative political economy on the linkages between finance and industry. There is some very impressive material on different forms of housing finance in different models of capitalism that has recently come out, and is particularly timely.
At the G20 Summit in London, some world leaders blamed America and Wall Street for triggering the financial crisis that spread so quickly around the world. Is that a fair assessment?
Well, it always takes two to tango, and overseas financial institutions were very keen to join the dance. But undoubtedly the crisis originated here, and spread through the global system through the willingness of overseas investors to bring their spare money to the U.S. Whether they will be so keen in the future I rather doubt; and if they aren’t, the financing of our trade deficit-and indeed of our public deficit — is likely to be harder. So I don’t think this is a time to go bashing the French again; the suggestions of their president (and the German Chancellor) on stronger financial regulation can only help us all.
How did the collapse of the housing finance system in the U.S. influence other countries so rapidly?
Their banks bought U.S.-generated mortgage-backed securities that turned out to be toxic. Losing confidence in themselves, they dried up their credit flows too — bringing economic stagnation and rising unemployment to their people as well. Then, additionally, if they depended heavily on exports to us (China, for example) they suffered a double-whammy.
Was anything of substance accomplished at the summit?
Time will tell but I suspect yes: tighter financial regulation, and the creation of greater Special Drawing Rights at the IMF — a potential supply of new money globally that will help stimulate output and trade again.
Earlier you argued against government debt, yet the government is now in even more debt because of the massive stimulus package. So doesn’t more government spending compound the problem?
Excessive government spending can crowd out private marginal investment if there is a lot of competition for investment funds. But when private investment has stalled, public spending is vital to get the whole show moving again. And remember there are major sectors of the U.S. economy which have long depended heavily on government contracts and subsidies — particularly military engineering and agriculture. We are not as much an “Adam-Smith”-like economy as we like to tell ourselves: the really profitable sectors of our economy have very strong links to the Pentagon and the agriculture department, and always have had!
Should the stimulus package have been weighted toward more tax cuts?
Personally, I don’t think so. It all turns on what “multiplier effect” you get from spending a dollar of taxpayer money. There is a debate about that, too, but the middle of the road models I’ve seen suggest a much bigger short-term impact from a dollar spent on infrastructure than from getting even corporate taxation down, let alone personal taxation.
You said in your speech that “the long-term weakness of the U.S. economy requires a resetting of the underlying social contact.” What did you mean by that?
Economies always rest on social contracts — sometimes formal, sometimes not — deals between major social groups. We’ve had two big ones here since 1945: the one running into the 1970s that collapsed in the stagflation of that decade; and the one created by Ronald Reagan that just gave us this huge recession. The first one was built on a deal between Northern manufacturers and Northern trade unions, tying wages (and benefits) to productivity, and allowing both to rise together. It broke in the 1970s as the rate of productivity growth slowed and as groups excluded from the deal (particularly African-American workers) challenged it, but while it lasted demand for U.S.-made goods stayed high and living standards rose.
The Reagan deal broke the link between rising productivity and rising wages. It was built on a trickle-down theory of wealth creation that left real wages/hour stagnant for the majority of Americans, as I said earlier, and tolerated (encouraged even) vast wealth taking by a few. The second Bush presidency’s tax cuts were predicated on that theory, and accentuated income inequality significantly. We are at a moment of paradigm-shift again; we need to get back, I think, to a closer relationship between productivity and wages, so that we begin again to buy goods with what we earn now, not with what we might earn tomorrow and which we get to now via our credit cards, with their 18+% interest rates. Currently we pay banks for the privilege of borrowing the increased wages we never received. Not a very good model, in my view, and one which has just hit its own buffers big time!
Many people think that the president and Congress are treating the financial industry and the auto industry differently; a bailout to the bankers, but not the union auto workers. What’s your take on that?
I think so, too, and I think it is a great mistake. We need a strong manufacturing sector in this country, and that will require a redesigned car industry. But a “slash and burn” strategy for the Big 3, in the midst of a collapsed demand for cars of any make because of the credit crisis, is not an appropriate way to proceed. Nor are double standards credible: if contracts are sacrosanct in one sector, why not in all? I would go fast on the banks and slow on the cars, and not the other way round!
Aren’t we entering dangerous territory when the president of the United States can “fire” a chief executive of a company (GM)?
We are certainly entering new territory — new to us, that is, but not necessarily new to other successful industrial economies. We do need a serious national debate on industrial policy, one focused not just on “green issues and oil”, vital though all that is, but on how we best regenerate U.S. small and medium size manufacturing, and get the financial sector down in size relative to the real economy it lubricates. No doubt the policies emerging from that debate may require changes at the top of some companies, but we need the policy first and the firings (if any) second, not the other way round.
You started out by giving us three layers to what caused the financial crisis. What are your three layers to get us out of the crisis?
My own preferences are these: (1) a redirection of government funding to enable house owners to reduce the amount of principal they owe on their houses, by the federal government offering to take, say, a 20% stake in all houses under a certain value, doing that by offering a very low interest loan. That 20% stake to be paid back at sale (the federal government getting a fifth of any capital gain) with the interest on that loan not settable against tax and the mortgage not available as collateral for any financial instrument. That could put a lot of money back into circulation fast, put a floor under house prices, and stop a foreclosure tsunami.
(2) A new single regulatory agency for the entire financial sector, with possibly even a temporary monopoly given to Fannie and Freddie on first mortgages (with Fannie and Freddie nationalized-sorry !!) Certainly no “unregulated” financial markets/institutions any more; and some way back to the 1930s separation of housing finance from the rest of the credit system, if possible; and (3) policies to raise American wages and to wean us off cheap foreign imports. Lots to talk about, of course, under all of those, especially number 3!
Have we seen the end of the Reagan era “where government is not the solution, government is the problem”?
I sincerely hope so. Government is not the problem here, and if it was the problem, it was so only because it was NOT taking its governing regulatory responsibilities sufficiently seriously. If we had had more government, not less-timely in its regulatory intervention-this crisis could have been avoided.