Have Geithner's Zombie Ideas Won? Paul Krugman on the "Cash for Trash" Program
Editor's note: The following interview by Democracy Now!'s Amy Goodman with economist and NY Times columnist Paul Krugman continues AlterNet's coverage on this crucial political moment for the Obama administration and the country on the issue of what to do with the collapse of the financial and banking industries. Yesterday on this topic, AlterNet ran an editorial and articles by Bill Greider, Matt Taibbiand Frank Rich. In the coming days, look for more coverage and articles about activist campaigns sprouting up on this issue.
Amy Goodman: Treasury Secretary Timothy Geithner has unveiled the Obama administration’s plan to finance the purchase of up to $1 trillion in so-called toxic assets from banks and other ailing financial institutions. The plan relies on private investors, namely hedge funds and private equity firms, to team up with the government to relieve banks of assets tied to loans and mortgage-linked securities. There have been virtually no buyers of these assets thus far because of their uncertain risk. As part of the program, the government plans to offer subsidies in the form of low-interest loans to coax private funds to form partnerships with the government to buy troubled assets from banks. This is intended to unclog the balance sheets of banks and allow them to resume normal lending.
Also, the Obama administration this week is expected to announce new proposals for financial regulation, executive pay, accounting standards and other issues, ahead of the G20 summit in London on April 2nd. The new economic proposals come as Congress is to begin debating the administration’s $3.6 trillion budget proposal for next year.
Meanwhile, public outrage over the AIG bonus scandal has further undermined support for Timothy Geithner as Treasury Secretary. AIG is paying out over $165 million in bonuses after receiving a $170 billion taxpayer bailout. Geithner has been criticized in Congress and elsewhere for not doing more to block the AIG bonuses and his overall response to the financial crisis.
In an interview broadcast [Sunday] on 60 Minutes, President Obama expressed strong support for Geithner. He was interviewed by 60 Minutes correspondent Steve Kroft.
Kroft:Your Treasury Secretary, Tim Geithner, has been under a lot of pressure this week, and there have been people in Congress calling for his head. Have there been discussions in the White House about replacing him?
President Obama: No.
Kroft: Has he volunteered to or come to you and said, “Do you think I should step down?”
President Obama: No, and he shouldn’t. And if he were to come to me, I’d say, “Sorry, buddy, you still got the job.” But look, he’s got a lot of stuff on his plate, and he is doing a terrific job. And I take responsibility for not, I think, having given him as much help as he needs.
Goodman: Geithner is scheduled to testify before the House Financial Services Committee on Thursday about overhauling financial regulation.
Paul Krugman is a Nobel Prize-winning economist, professor of economics and international affairs at Princeton University, and a columnist at the New York Times. His latest book is The Return of Depression Economics and the Crisis of 2008. His column in today’s Times is headlined “Financial Policy Despair.” He joins us on the phone from his home in New Jersey.
Welcome to Democracy Now!, Paul.
Krugman: Good morning, Amy.
Goodman: Well, you say, “Zombie ideas have won.” Why are you calling that Timothy Geithner’s plan today?
Krugman: A zombie idea is an idea that you keep on killing, because it’s a bad idea, but it just keeps on coming back. And what this is is we’ve had this idea since Henry Paulson came out with his plan six months ago, the Bush administration, that the real problem is that the market is undervaluing all of these toxic assets, and what we need to do is have taxpayers go in and buy them at a fair price, and that will solve all of our financial problems. And that’s what happened. The Geithner plan is a complicated, disguised variant on the same idea. It’s the zombie that you keep killing, and it just keeps coming back.
Goodman: Called “cash for trash”?
Krugman: Yeah, that’s—that was the phrase that was out there six months ago, which I picked up. And yeah, it’s basically saying that, you know, there’s nothing really fundamentally wrong with our banking system; there’s just this crisis of confidence, and so nobody wants to buy, you know, asset-backed securities, nobody wants to buy stuff that’s ultimately backed by home mortgages, and if only we could get people to see that these things are really pretty decent assets, then the banks will be in fine shape. And that’s the trouble. You know, there’s an argument that says maybe they were somewhat underpriced, but to make this the centerpiece of your financial rescue plan is just—well, as I wrote in the column, it leaves me with a feeling of despair.
Goodman: Members of the Obama administration hit the Sunday talk show circuit yesterday to drum up support for the administration’s plan to purchase up to a trillion dollars in troubled mortgages and other so-called toxic assets. Austan Goolsbee, a key White House economic adviser, was on Face the Nation. Harry Smith of CBS News quoted from your writing about the administration’s plan. This is an excerpt.
Harry Smith:There’s been a lot of negative press about this thing that hasn’t even been unveiled yet, and Paul Krugman, in his blog today, said, “For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose.”
Austan Goolsbee:I don’t think that’s an accurate description. I mean, if the government doesn’t make money, the private sector doesn’t make money either. I mean, these guys are coming in in a partnership, and one of the reasons you want to have the partnership is precisely so that, A, the government doesn’t massively overpay for these troubled assets that are on the balance sheets, and B, so that everybody’s got skin in the game and you don’t get into situations where you’re paying guys for failure.
Goodman: Paul Krugman, your response?
Krugman: The important thing is not the shared equity. I’m sorry, it’s hard to avoid lapsing into jargon here. But 85 percent, at least according to the counts over the weekend, 85 percent of the money is going to be a loan from the government, which is a non-recourse loan, which means that it’s backed only by the assets that these guys are buying, which means that if the thing loses more than 15 percent of its value, which is highly, you know, possible, given how uncertain these things are worth, then the investors, the private investors, just walk away. So there’s—exactly, it’s a heads I win, tails you lose. If the stuff—you buy something at $100 and it goes up to $150, you make $50. You buy it at $100 and it goes down to $50, then you only lose $15, because the other $35 gets even by the taxpayer. So it’s a—it’s the same thing.
It’s basically what happened with savings and loans in the 1980s. They were deregulated and basically put in the position where the deposits were guaranteed, but the owners of the banks could do whatever they wanted, and so they took these huge risks, and most of the risks turned out bad. But if the risks turned out bad, it was the taxpayers’ problem, not the bank owners’ problem. Same thing here. They’re deliberately setting it up, so that there’s this huge incentive to—you know, basically where the upside belongs to the private investors, but most of the downside belongs to you and me.
Goodman: So you socialize the debt, you privatize the profit. Why—
Krugman: Yes, it’s, lemon socialism. The minuses are the taxpayers; the pluses are the private investors.
Goodman: Why doesn’t the government just buy all up all of the toxic assets then, like the FDIC does?
Krugman: Well, the FDIC guarantees a bank’s debts, basically, so the deposits are secure, and then if it says the bank is bankrupt, then it goes in and it seizes the bank and then sells the toxic stuff for whatever it can get. That’s what I advocate; that’s what we ought to be doing. I think they’re just daunted by the scale of this thing. The FDIC normally does, you know, two or three banks a week, even in bad times, and they’re small banks. Here we’re talking about quite possibly Citigroup, which is $2 trillion in assets. It’s a very big thing. And I think the reason they keep on coming back, the reason the zombie ideas won’t stay dead, is the lure of an easy solution, that you can just wave a magic wand and the problem goes away, and they’re still looking for magic.
Goodman: Do you think Timothy Geithner, the Treasury Secretary, Paul, should step down?
Krugman: You know, I don’t have a strong view on that. It’s certainly becoming a problem, and he’s really got to clean up his act if he wants to stay there. Basically, look, this is not Geithner. Ultimately, the buck stops in the Oval Office. The question is, why is President Obama going with the soft side, the hope over analysis, on this stuff? So I don’t have a big commitment on Geithner, one way or the other.
Goodman: Can I ask you something about the AIG bonuses that have caused such an uproar? I mean, why wasn’t there strict regulations about how the stimulus money could be used, how the TARP could be used? Why wasn’t there regulation here?
Krugman: Well, if I was going to take the side of the government people, I’d say it’s hard to write those regulations in a way that doesn’t have unintended consequences. You know, there was a time when they tried to put limits on CEO pay, and it ended up leading to the explosion of stock options, which was not a good thing.
But I think it basically comes down to the mindset, that the view still, apparently, dominant in—even in this administration is that there’s nothing really fundamentally wrong with the system. There were some mistakes, and there was some bad luck, but we don’t want to shake up the system too much. We don’t want to really rebuild it. We don’t want to tear up the relationships with those people who we thought were so smart and now look so dumb, really are smart, and we want to keep them on the job. It’s a problem. I think there’s too much conventionality. To some extent, the Obama administration is still partying like it’s 2006.
Goodman: Paul Krugman, what would a new system look like? What would you advocate?
Krugman: I think, in the end, we’re going to have to go back to something that is kind of like the system that emerged from the New Deal, which was tightly regulated banks and financial institutions, limits on risk taking, fairly high taxes for high earners, which—it turns out that, you know, low tax rates create incentives, but the incentives are actually to play dangerous games with other people’s money. A lot of things need to be updated for the twenty-first century and information technology and so on, but basically, our grandfathers got this thing right. Our grandfathers understood that finance is useful but dangerous and needs to be very tightly hedged about with regulations.
Goodman: You write, “The Obama administration has apparently made the judgment that there would be a public outcry if it announced a straightforward plan along these lines,” which is, you know, government buying up the troubled assets, “so it has produced what Yves Smith calls ‘a lot of bells and whistles to finesse the fact that the government will wind up paying well above market [value] for”—and you can’t say the rest.
Krugman: Yeah, I still can’t say the rest, which was not Times style. But yeah, ultimately, when you get the—when you get through the complexities and the salesmanship, this is just a complicated way of having the government pay, having you and me pay, for buying these assets at more than any private investor is willing to pay for them.
Goodman: You talk about why you’re so vehement about this right now, why you see this is the critical moment.
Krugman: I think—this is a political judgment. We can argue this back and forth. But I think that Obama doesn’t get many shots at this, maybe just one. There’s already a huge public outcry, which doesn’t distinguish between the things we need to do and the things that were just mistakes. And for Obama to go and do this plan and put a lot of taxpayer money on the line and for it not to work, which I’m almost certain is what would happen, I don’t think he can come back to Congress for a plan that might actually work. I think that there’s a real—the stimulus is something of the same thing. You have to do this right, right away, because the political mood is getting ugly, for good reason, and there’s not a lot of patience with failed approaches, especially failed approaches that seem like your administration is just too close to Wall Street.
Goodman: Paul Krugman, can you talk about the role of foreign sovereign wealth funds and explain what they are?
Krugman: Oh, yeah. It’s just when a foreign government has a bunch of money which it is investing in the United States or in other countries, and as opposed to—this is when you do something beyond just plain parking lots of money in bank deposits or US government debt, which is where most of the foreign money is. You know, I think that’s a much exaggerated issue. It’s—yeah, these are governments playing with large sums of money. At least so far, all the evidence is that they’ve been really pretty dumb investors. The Chinese appear to have given us a substantial subsidy by buying a lot of stocks at the top of the market and losing them. So I’m not that—I don’t think it’s a central issue.
Goodman: And this issue of counterparties, a word we’re just learning right now, that AIG gets all of these billions of dollars, and they use some of it to pass through to banks once—well, to entities like Goldman Sachs, to UBS, which had to pay a massive fine to the US government, so we’re paying their fine for violating us?
Krugman: Well, this is—the counterparties—basically, think of the financial system as this web of connections. And the reason that we’re stepping in to rescue these companies in the first place is that we’re afraid that if you break the web at one point, it unravels across a pretty wide range. And that’s not just a theory. When Lehman Brothers was allowed to fail, in fact, a huge gaping hole opened up across the financial system. So this is the reason that we’re rescuing them in the first place.
Now, the only thing you can say is that if we’re going to be doing this, then we do need to look hard at who else we’re rescuing, and we need to say, “Look, you guys have to make some sacrifices as part of this, as well.” What we’re seeing right now is that it’s basically all free money from the taxpayer with no quid pro quo. And that gets to the heart of the dispute over what our policy is right now.
Goodman: Finally, Paul Krugman, has this made you reevaluate your support of NAFTA, the whole push for sort of unregulated globalization, why so many people took to the streets in the Battle of Seattle, for example?
Krugman: Yeah, the answer is no. There’s a huge distinction between letting actual trade in goods, stuff, real physical stuff, proceed, which is terribly important to the poorest countries, above all—when somebody asks, you know, why am I in favor of, more or less, free trade, my answer is, I’m really thinking about countries like Bangladesh, which literally are only able to keep their heads above water by their ability to sell labor-intensive stuff, thanks to their low wages. It’s really critical.
I’ve never been a fan of unregulated movement of capital internationally. This was a big fight back in the late ’90s between some of us who say, you know, “We need to regulate, we need to limit this stuff,” and people who said, “Oh, no. You have to trust the markets.” And what’s—it’s the hot money that’s the issue here; it’s not the auto parts from Mexico. That’s a different discussion. It’s the hot money from all over the world that is the crisis right now.
Goodman: And the UN panel that will next week recommend the world ditch the dollar as its reserve currency in favor of a shared basket of currencies?
Krugman: You know, there have been millions of plans—well, I’m exaggerating, but there have been many plans along those lines. That’s not a decision that can be taken by an international body. The dollar is the reserve currency because people think it’s the safest place to park their money. The euro is a natural competitor, except that the Europeans are as messed up in their policies as we are, if not more so, right now. But the way to deal with that is not to have some body agree that we’re going to do something different, but to simply have the world—have the natural competitors to the dollar make themselves worthy of the competition.