Columbia Professor Jeffrey Sachs: Financial System Is "Lawless" (Part 1)

(Continued from last week)

A question and answer session ensued, and one questioner identified himself as a member of the Tea Party, who was upset as an American to learn that the international community now sees America as a failed government, and asked Dr. Sachs if he sees a failure of government on all levels. Dr. Sachs responded as follows:

"Yes, I think this is a profound failure of government without question. And it is, I think from the Tea Party to, if I could say is the last which I probably would be classified in, I think we would agree that the symptoms are government failure, massive corruption, massive legalized corruption of large money interests that have taken over the regulatory process, regulatory capture. Probably the diagnosis would be pretty similar on many different points of the spectrum. I think what's interesting for me, and so let me describe two questions, on kind of the response to this. Because one response is that we ought to make government work, and the other response is we can't make government work, we ought to basically close down another part of government and understand that it can't work. And these are both logically consistent positions in my view.

"One thing to add to the evidence base, is that when the financial crisis hit on September 14, 2008, the Wall Street Journal, which is normally our voice of libertarian free markets, ran an editorial a few days later saying 'Are you crazy, don't you understand market failure? Of course we have to bail out the banks. You know, the whole world economy will fail if we don't go in and bail them out' and so forth.' You could call that a loss of nerves, you could call that hypocrisy, or you could call that a diagnosis, whichever one you want. But the point is, very soon after the financial crisis hit, the call, even from the free market right for bailouts, was there.

"And another complete example of that is Paul Ryan, who purports to be a voice of libertarian thinking, but he voted for TARP at the same time, and said 'Of course we have to bail out these institutions, otherwise the markets will collapse.' So that, of course, only deepens the puzzle, it doesn't solve the basic conundrum of whether this is irremediably broken or whether this is a hypocrisy that needs to be solved. The hypocritical part I find is that the moment that the bailout happened, the Wall Street Journal immediately reverted to form in its language and its claims after this very big bailout had occurred then it went back to its free market stances as if nothing had happened.

"I think that there at least two parts of a good answer to this, one is to create a situation, maybe along limited-purpose banking, maybe along institutions that are not too big to fail, so that you really can let these institutions go under to an important extent,, and get away from this compulsion of not only bailouts, but the hypocrisy that comes along with it. I think that that is certainly part of the answer.

"I do think that there is a truth, though, to the fact that a fractional banking system, if we're going to keep it, and we probably are, as Milton Freedman rightly said, it is inherently a fragile institution that is subject to self-fulfilling collapse. As he said, the one stone can start the avalanche, and it's the job of the Fed to prevent that from happening. And this means that the bailouts in some sense, in some ways, some lender of last resort, fulfillment is going to be inevitable, and in that context, regulation is also going to be inevitable. I don't think we're going to really get around the need for some regulatory performance, and we need to analyze why it is that it has been such a complete failure. Part of it is technical, no doubt, that markets can de-regulate around regulation, but part of it is really political corruption that probably could be addressed in a more straightforward way.

"I'll personally say in a word of moral outrage, I don't believe that there is any theory in the world, that justifies the incomes that these people are taking. This is in my view, a prima facie market and political failure. I know a lot of these people, there's no way in the world that their marginal productivity is orders of magnitude close to their income levels. And I find it completely disgusting that they are allowed to make large political contributions. You know, we have the Hatch Act, we have other limits on political contributions, and I think that the Fed should be a lot more serious in pointing out these contradictions and trying to create space for itself to be a decent regulator again."

Another questioner pointed out the lack of public disclosure and intertwining of the political and judicial arms of the system which allow fraud to occur. Dr. Sachs responded:

"I think your point, Larry, is a very powerful one. And at not a literal level of single-purpose banking, but of a more general level, Glass-Stegall successfully did that for quite a long time. And its removal was a very, very cynical play, by Rubin, Summers, Clinton, Gramm and others who all had very strong interests. personal interests in the outcomes of that deregulation. And exploited the gaps that they created. And then to the chagrin of some of us, at least, were invited right back into the White House in early 2009, after they had made this calamitous mess, to be the ones supposedly to fix it. And I know that Summers, for example, continued to really institute moral hazard policies right and left by fighting against any limits on compensation of these people who had entered into the breach. So this is a case where institutional reform of separating fractional reserve banking and basically the provision of liquidity from gambling should be done.

"But I would add this other point, which is that a lot of what's happened actually, and what's been revealed, is in my view, prima facie criminal behavior. It's financial fraud on a very large extent. There's also a tremendous amount of insider trading, and you can even watch it, when you're living in New York, how that works, so it's not so mysterious. But we don't even act. I take John Paulson, for example. Paulson worked together with Goldman Sachs, to defraud massively, many European banks, which bought the toxic mortgages that Paulson had put together. When this ABACUS deal was taken up by the SEC, Goldman ended up paying a small fine. The chair of Goldman, of course, continued in his position and continued at White House State dinners, and Paulson wasn't even mentioned once in any of the proceedings, and he took home a $1 billion paycheck the next year, even as Goldman was paying a roughly $700 million fine, if I remember correctly, for the abuse that Paulson was part of. I can't believe, no matter what the financial regulations, we can't do better than that. That's really pathetic."

Dr. Sachs was then asked how affirmative he might be for the re-enactment of Glass-Stegall Act. He responded:

"I think it is quite important to recreate a mechanism where liquidity is separated from large-scale financial gambling. It's really, in my opinion as a macroeconomist, it's the collapse of liquidity that is the real macro danger. The rest is the collapse of confidence, lawlessness, decency and so on. But what made Lehman so damaging, of course, was how it affected the money markets, the interbank loans, and the complete drying up of commercial paper. This was the devastating effect, it was basically March 1933 replayed. So liquidity is what is the real value here from a macroeconomic point of view. Loss of wealth, I could care less whether they make more or less money. I don't even care whether they make big money particularly, except I think a lot of them are crooks, and that it's based on a lot of nefarious behavior. But the macroeconomic significance is a kind of Diamond in the banking crisis, which we know to be part of a fractional reserve banking system, and it seems to me analytically we have two, we have basically two levels of decision making. One is separating liquidity in the banking sector, from other kinds of speculative financial activity. This I would do for sure. And I would never have put Goldman Sachs back under the Fed's protection as a banking unit, so that it could receive direct loans from the Fed. That's ridiculous, and sad, actually.

"But the second point then is Larry's point, and this is whether fractional reserve banking itself has value enough to keep it in its current form. I'm not convinced I have to say one way or another, I kind of grew up in a fractional reserve banking system, I do believe that it provides liquidity in normal times, if regulation is good. I tend to believe that there is value in reserve banking, but it's also highly volatile, as theorists have recognized at least for 150 years, and as Milton Freedman agreed, as Diamond said, as Larry has pointed out, and I think we have the choice, could we really have liquidity without fractional reserve banking. If we could we might be able to address another degree of this problem. The final point, of course, is separating the politicians from the crooks, but maybe that's so close together that they can't actually be separated, maybe it's just the same community."

The next questioner asked if the international community thought they could develop their own monetary systems or would still be dependent upon the American and European financial systems for commerce. Dr. Sachs answered:

"I think in general for most small countries, or most developing countries, I'll put aside the very largest ones, there is a sense of almost complete dependency on the international system, their payments, their lines of credit, interbank markets, the need for swap facilities with the Fed or the ECB, the pervasiveness of tax havens, the extent of flight capital from their countries, the legal structures where basically, very clever US lawyers helped to free all of these countries from their tax revenues, they feel very much dependent on a system that they feel is dysfunctional, but also they've been well-schooled for the last 25 years their goal is to be part of the international system. They just woke up to a system that they find very destabilizing, and they don't see any clarity of the way forward. And most of the advice that they get is to be part of the system and be quiet, basically. This is how the system is, you join it, you stay on good terms with the Fed, with the IMF, with others, and there is very little sense of autonomous potential among these countries. Really, I can only emphasize the palpable anger and vulnerability that's felt right now, is very, very high."

The last questioner simply thanked Dr. Sachs for cutting through all the economic theory and emphasizing that economics is really all about values, ethics and people. Dr. Sachs closed by saying:

"Well, thank you very much for saying it and practicing it. I do believe by the way, I'm just going to end here because I've been told I have to run to the UN in fact right now. I believe we have a crisis of values that is extremely deep. Because the regulations and the legal structures need reform, but I meet a lot of these people on Wall Street on a regular basis right now. I'm going to put it very bluntly: I regard the moral environment as pathological, and I'm talking about the human interactions that I have. I've not seen anything like this, not felt it so palpably, these people are out to make billions of dollars, and nothing should stop them from that. They have no responsibility to pay taxes, they have no responsibility to their clients, they have no responsibility to people, counterparties in transactions, they are tough, greedy, aggressive, and feel absolutely out of control, in a quite literal sense. And they have gamed the system to a remarkable extent and they have a docile President, a docile White House, a docile regulatory system, that absolutely can't find its voice, it's terrified of these companies. If you look at the campaign contributions, which I happened to do yesterday for another purpose, the financial markets are the number one campaign contributors in the U.S. system now. We have a corrupt politics to the core, I'm afraid to say, and both parties are up to their necks in this. It has nothing to do with Democrats or Republicans, it really doesn't have anything to do with right-wing or left-wing, by the way. The corruption, as far as I can see, is everywhere. But what it's led to, is this sense of impunity, that is really stunning, and you feel it on the individual level right now, and it's very, very unhealthy. I have waited for four years, five years now, to see one figure on Wall Street, speak in a moral language. And I've not seen it once. And that is shocking to me. And if they won't, I've waited for a judge, for our President, for somebody, and it hasn't happened. And by the way, it's not going to happen any time soon, it seems."

Dr. Sachs' speech has implications for us all, even on a state level. Last year our Legislature considered House bill S.3504, concerning honest, sound money. The bill stipulated:


The bill was passed and sent to the Senate, whereupon it was held up by the Senate Finance Chairman Hugh Leatherman. Unfortunately, inaction on this matter is not an option, because America cannot continue to exist with a dishonest financial system.

All over the world, countries realize that our system is completely fraudulent and are urgently trying to establish their own alternatives to bypass the dollar. For example, recently Australia, normally considered to be our ally, and China announced an agreement to trade using China's currency, the yuan, not the U.S. dollar. Some experts say that China's plan is to ultimately back the yuan with gold. Our only solution is the same and the states must exert their own authority to establish an honest financial alternative to the U.S. dollar. The only available, Constitutional, honest solution is gold and silver, which have been used as money dating back to Biblical times. However, the Bible states that "the fear of the Lord is the beginning of wisdom" (Psalm 111:10), so our state and nation will never gain the understanding necessary to institute an honest money system until we repent of our sins and turn back to God.