ZC: Paul Volcker wants to ban proprietary trading by commercial banks, but said recently that he’s not in favor of bringing back the Glass-Steagall separation between commercial banking and investment banking. Is that enough?
JS: Well, I’m in absolute agreement that you have to ban proprietary trading and he’s seen the risk of that. But I think you need to go a lot further than he seems to be willing to go at the current time. First, we have to do something about the too-big-to-fail investment banks. Goldman Sachs, we’ll bail it out, AIG we’ll bail it out. We need to make sure that our reforms don’t just address the depository institutions, but all of the large financial institutions that pose the problem. Back in the 1990s we even engineered a bailout for the largest hedge fund, Long-Term Capital Management. So you have to go beyond the depository institutions, beyond traditional commercial banks.
And secondly, there are lots of forms of risk-taking. Proprietary trading is one, but for instance, the big banks are issuing these derivatives, these credit default swaps that brought down AIG. And that means if they’re issuing them, the U.S. taxpayer is underwriting them because we underwrite the commercial banks. That means we, ultimately, are bearing the risk. We shouldn’t be participating in this kind of gambling.
ZC: As soon as Goldman Sachs got its bank holding company status in 2008, the first thing it did was move all its derivatives operations under the commercial bank unit. It was very clear it wanted to use deposits to fund that business.
ZC: We’ve talked a lot about banks so far, but there is more to the economy than banking. It’s been a really bad year for American households. Do we need a second stimulus? If so, what should it look like?
JS: We clearly need a second stimulus. There are a couple of ways of seeing this. When the Obama administration first moved on the stimulus, it posed a scenario that was not really rosy, but one that proved a little too optimistic. It expected unemployment without the stimulus it would be around 10 percent, with the stimulus it would be brought down to 8 percent. Others like me thought things were going to be much worse, that without the stimulus, unemployment would be around 12 percent and with the stimulus, it would be about 10 percent. And the pessimists were right. Well, when the world turns out to be worse than you thought it would, you have to adjust what you do.
But even a much bigger stimulus would have only brought the unemployment rate down to about 8 percent, which is still totally unacceptable. So right now I am very much in favor of a second round of stimulus. Hopefully, it will be better designed and more targeted to job creation and actually stimulating the economy. The tax cuts in the first round weren’t designed really to stimulate the economy very much and didn’t work very effectively.
ZC: And what do you do to create jobs? Are we talking fiscal aid to states? Unemployment benefits? A new WPA?
JS: The first thing I would do is aid to the states. The states have balanced budget frameworks. The revenues are down by around $200 billion because of the recession. If they don’t get aid, they have to either raise taxes—which is very hard in the current environment—or cut back expenditures. And what they inevitably cut are teachers, nurses, firefighters and a whole set of crucial public services which are all the more important in an economic recession.
So the first thing is to provide states with money, and that spending goes right to the economy very quickly. You don’t have to set up new programs and it really does save jobs. I would also do one of the things that Obama is pushing now which are job credits to encourage companies to hire more workers. Focus a little bit more direct attention on jobs. We don’t know how effective these are going to be. There is some debate, but it seems to me that if we don’t try we’re not going to get anywhere.
The forecast right now is that it will be the middle of the decade before unemployment returns to normal—that should be very worrying. That kind of situation should be completely unacceptable because it creates severe long-term problems. If you have young people who remain unemployed for extended periods of time, they lose their job skills. Economic studies show very clearly that their lifetime incomes will be significantly lower than if they had been able to get jobs and enter the labor force.
ZC: It’s almost as if they aren’t living in the same economy as everyone else. Changing gears a bit—how did every policymaker miss this? We had everybody at the Fed and the Treasury insisting as late as 2007 that everything was fine. How does the biggest credit bubble in history and the worst financial crisis in history just go unnoticed by every major public official?