As things stand, the crucial act of denial in the banking sector, in my view, is that it has not come to grips with the extent of fraud, abuse, and failures of documentation that underlay the crisis in the first place. We know from the evidence that we’ve seen so far that there were massively fraudulent practices in mortgage origination—that these practices were abetted by the underwriters and by the ratings agencies, which declined and even refused to look at the underlying loan documentation.  And I think the failure to confront that problem—which was covered over by the “stress tests” and the revision of market-to-market accounting rules—remains an unresolved issue.

I think it’s fair to say that so far, what we’re looking at here is a failure of the rule of law.  We have lots of reasons to believe that a serious investigation, criminal and civil, would lead to a very large-scale prosecutorial response.  That’d be the case in the largely now-defunct industry of mortgage originators; it would be the case with respect to some of the ratings activity; it would be the case with respect to the accounting behavior of some of the largest investment banks.  Fraud begets fraud.  In the case of Lehman Brothers, there was a systematic evasion of recognition of the extent of the losses that were occurring and already known to Lehman’s top management, who manipulated their accounts in order to avoid reporting how deficient that capital impact already was.  The last time I looked, accounting fraud was considered a criminal activity.  If it turns out that the regulators knew that this practice was going on and looked the other way, then the regulators also would become, it seems to me, the targets of an investigation.  The regulating authority at the time was the New York Federal Reserve Bank.  If you want to restore confidence in the system—confidence in a system—this is an exercise through which you must pass.  You cannot have a situation in which the broader public, which is not stupid, is getting new information every month—sometimes more frequently than that—which indicates to it that massive wrongdoing was protected and covered up, and continues to be.

In March of 1933, Roosevelt closed the banks.  They were closed for, I think, ten days.  And they were audited, and only those that were deemed solvent were allowed to reopen, and when they did, people lined up to put their money back in the banks.  It was a clear assertion of the public responsibility, and stability in the banking system.  And my view is that comparable action in January or February of last year would have created a much stronger climate for major changes. 

First of all, it would have given you an opportunity to, as I said earlier, shrink the banking system, to replace its management.  That would have changed the political climate, because the remaining banks would have been less inclined to use their existing lobbies to block banking reform, and the whole terrain of public/private interaction in this area would have been substantially different.  Something similar can be said on the fiscal side—though that is a much more complicated judgment because they had to get a bill through Congress.  And I can understand why respecting the political limits of what the Congress was prepared to do got you something which was better than nothing, whereas getting you what you needed to do might have gotten you nothing rather than something.  Nevertheless, the package was not large enough to make a decisive difference—it was large enough to hire back a lot of teachers that were being fired, but not large enough to prevent crises in the fiscal affairs of New York and California and Florida and other places; large enough to stabilize the job situation, but not large enough to put it on the path of improvement by now, with the result that most people looking for jobs are not seeing the prospect that they will be created. 

Now, maybe if things get underway, six months from now jobs are being created, the mood will shift in a favorable direction.  But what I fear is that it won’t, and I think that the opportunity to have done it already by now—well, of course, was missed.  And the consequence of that is a second wave of political upheaval in which—this was predictable a year ago, and I wrote something to this effect—every snake-oil salesman in the country would start having a field day.  That’s an understandable reaction.  The first thing that you try, which was based upon sensible principles, but not applied with sufficient force, doesn’t do the full job, then people start cropping up from every corner saying you should have done it my way.  “You should have eliminated the government, you should have cut spending, you should have cut taxes.”  And, of course, you’re going to find an audience for any well-organized and well-funded and media-boosted cacophony of that kind.  And that’s what you’re getting, that’s what the Tea Party movement is, for example.

The Tea Party is a tool.  It is a stirring up of the grass roots.  Of the “rabble” by people who make a professional practice of stirring up people who they have no intention of ever ceding actual power to.  I think the Tea Partiers are largely sincere, naïve people who are maybe under the impression that they are being empowered, but the people behind them have no more intention of actually implementing their ideas, of giving them a leadership role, than Ronald Reagan had of overturning Roe v. Wade, for example.  The purpose of the Tea Party is to create a blocking force, particularly aimed at healthcare reform, and to fuel this sort of Scott Brown phenomenon, wherein more people, like the current Republican Congressional leadership, will get themselves elected.  Then we will see that, fundamentally, they’re the same lobby-driven, obstructionist forces—the same predatory forces that they were all along.

The larger society cannot function in an environment of unrestricted predation.  That’s certainly not a system which can operate on a democratic principle.  The entire structure and function of government is to ensure that predators are subject to restraints, and we actually have a fairly high standard in that respect.  We say no man is above the law.  We write laws which ostensibly apply to everybody in matters of clarity and honesty of economic accounts, the reporting thereof, and the transparency of the process of protecting investors.  And it’s the application of that system of management and controls which gives the would-be predator a sphere of activity. We say, okay, let’s be realistic: eliminate all of the predator wannabes of the high predator classes, well, you have a system which is called socialism, and the difficulty with socialism is the lack of economic dynamism; that’s a straightforward and historically demonstrated fact. 

So, in designing a system, you want to have a degree of culling of the uncompetitive, you want a bankruptcy process, you want to have competition, especially through technical change—and regulation can help set the direction in which that competition occurs—and you want to have the spur of economic incentive and profit.  All of that is highly desirable.  The problem is that if you take the view that the spur should be unlimited, that the culling should be unrestrained, then you turn the economy into a battlefield.  And the thing about a war is that the cost and the destruction, characteristically, very soon, greatly exceed what you would have agreed to if you had full sense in advance.  Every war is like that.  And every situation of unrestrained predatory activity is also going to cause much more destruction than you’re willing to tolerate, which is exactly the financial crisis in a nutshell.

Let’s talk a little bit about the problem of regulation, the problem of standards in that context.  How does this play out within any particular sector—group of enterprises.  I’ve always felt that it’s very important to understand that an enterprise develops over time, habits are formed, and some enterprises, with habits formed in an earlier period—older capital equipment, less efficient operations, generally employing more labor, and with more intense management-labor conflicts—tend to be more reactionary in any political context.  A newer enterprise engaged in the same activity has got a margin of profitability that the older one may not have, and it’s taking advantage of the latest techniques.  Let’s say some environmental standard is designed to those techniques that are not costly for the newer enterprise to implement, whereas for the older one, retrofitting—putting a stack-gas scrubber on your smokestack—is a cost.  So it’s the older guys, it’s the more reactionary guys who are always in the forefront of opposing regulation.  Whereas a sensibly designed regulation is one which is within the range of what is technically feasible for the more progressive branches of the activity.  You may want to have a regulation that is being phased in in five or ten years that sets a technical standard that people are asked to try to achieve—a fuel-efficiency standard, emissions standard, for example.  But the regulations in force at any given moment need to be regulations that are within the range of what is technically possible, otherwise they’re not going to be met, right?  I mean, it’s as simple as that.  And so, the point that I make in The Predator State about regulation is that it is a kind of forcing mechanism which splits one type of business from another.  It splits the more progressive from the more regressive.  And the purpose of the exercise is to put pressure on the regressive guys and eventually to make them change or drive them out.

All of the politics of regulation is about this.  In a reactionary, badly run state like Texas, regulatory politics is about “grandfathering.”  In practical terms, it’s about saying to an existing enterprise, “no, we’re not going to apply that standard to you.”  So then you adapt the regulation to everybody’s level of pollution, and you never get anywhere.  In a progressive moment in regulatory history—and the Carter administration had such moments—the Labor Department was cooperating with the more advanced and progressive textile companies to get the cotton dust out of the air, and that meant that the company for whom getting that new machinery in was least problematic was going to come to dominate the market, and did.  That’s fine.  So, my view is that understanding the interaction between regulation and technical progress is absolutely crucial to understanding what the policies are all about in this area.

What the Reagan period did was to obscure this question, by casting regulation as a burden on business, by speaking of business as a monolithic entity—which I think was a chosen political strategy on their part, and something in which the economic profession colluded, obscuring the kind of argument that I’m making—and then empowering the representatives of the business lobbies.  And the business lobbies are almost always dominated by the reactionary elements, because they’re the ones who have the most to lose.  They’re the ones who want to fight the government.  That’s the problem when you’ve got an administration like the George W. Bush administration, which turns over the regulation to the lobbyists, who fundamentally undermined not only the regulations themselves, but also the forces for technical change and technical progress that are embedded in good regulatory practice.  And then, of course, in the case of finance, you’ve created conditions for collapse, which is, of course, exactly what happened.