We have spent a generation trying to repeal the New Deal and the Great Society, and the fact that the results are disastrous is now clear to all. On December 4, 2008, the LBJ Presidential Library hosted a symposium honoring President Johnson's centennial. Invited to speak, I chose to reflect on the thought that our chief hope in this crisis is to build further, on the foundation that Roosevelt and Johnson laid down.
This is my father's centennial year, as well as Lyndon Johnson's. They
were friends, fellow New Dealers, and allies in the quest for the Great
Society. My father felt that it was a debt of honor, for him to come to
Austin, to this library, in the 1990s to pay tribute to President Johnson,
to heal the rift over Vietnam, and to honor the immense achievements of the
Johnson administration in the economic and social sphere.
I regret that the press of events this fall, including the financial crisis
and the passing of my mother - who danced the Charleston with President
Johnson on Bermuda in 1961 - impeded the preparation of a full paper for
this conference. But perhaps it is just as well. Last summer we were
discussing, with hope but also some skepticism, projects like universal
health insurance and universal pre-kindergarten, which would help fulfill
the promise of the Great Society. Today we are on to a more ambitious
agenda, the resurrection of the New Deal.
We have been thrown back to this by events in the financial sector, eerily
prefigured by the follies of the 1920s, as detailed in my father's classic,
and current bestseller, The Great Crash. Amazingly, it took just nine
years from the repeal of Glass-Steagall to reproduce the central pathology
of that earlier time: the rampant peddling of toxic securities confected
from worthless assets to an investing public that never quite gets the
word. The deep springs of human folly flow ever into the wells of finance.
But when the wells are poisoned - as they were then and are now - many
years can pass before we drink from them again.
How were the wells polluted and by whom? Some blame Fannie Mae and Freddie
Mac, the great quasi-public housing agencies, but their role in sub-prime
securitization was relatively small. The trouble arose primarily in
unsupervised mortgage originators like Countrywide Financial and IndyMac,
those who underwrote the resulting securities, like Citigroup and Lehman
Brothers, and those who rated them, like Moody's and Standard and Poor's.
At the bottom of the pile were borrowers, some fraudulent but most just
naive victims of the hard sell, who accepted loans based on incomes and
credit histories they didn't have, on houses that were systematically
over-appraised, on terms timed to explode within two years or three. At
the top were the Credit Default Swap speculators, whose bets on the chance
of non-payment metastasized risk through the system. Overlooking all was a
complaisant state - a Predator State - which combined commercial and
investment banking, relaxed the underwriting rules, legalized and
deregulated the default swaps, desupervised the mortgage originators and
resolutely ignored warnings of massive fraud from the FBI and other
The result is the first full-fledged financial collapse since 1929. I say
this very carefully, because it is necessary to adjust ideas. Lyndon
Johnson presided over years of stable postwar prosperity, of full
employment with mild inflation and the dollar at the center of a world
system. In 1970, 1974, 1980 and 1981-2 we had recessions; but they were
shocks to a stable system: the oil shocks of 1973 and 1979, the Volcker
interest-rate shock of 1981. These were events you could model, from
impact to effect. The present slump has no similar external cause. It is
the result of an internal system failure, at the heart of the mechanism
that makes the capitalist economy run. We have no known way to calibrate
the scale of consequences of this event, nor their duration. In
particular, the method of averaging past postwar recessions, which is
perfectly defensible in normal times, cannot apply. These are not normal
times. We have in the past two months been overwhelmed by crisis, and
repeatedly surprised by adverse events. There is no reason, now, to expect
this to stop. And therefore there is no reason for any attitude except
realistic pessimism and grim determination.
An astonishing feature of this crisis is the almost complete vacuum of
formal economic ideas with which to analyze it. The relevant masters:
Keynes, Galbraith, and Minsky, were shunted aside in academic economics
decades back. Their place was taken by a generation whose ideas draw on
Walras, Hayek, and Friedman, who held that the economic system is
inherently stable, that unemployment tends to a natural rate, that control
of inflation is the only legitimate goal of central banking, that otherwise
government should do very little and that the pursuit of full employment in
the Johnson administration was, as Professor Christina Romer put it in a
paper delivered right here in September, 2007, a "mistaken revolution." For
Professor Romer, LBJ was the author of "inflation and instability" - though
why Johnson rather than Nixon should be blamed for the inflation of the
1970s is not clear - and the hero of modern macroeconomics is Ronald
Reagan, who had the courage to drive unemployment up to 11 percent in 1982
so as to end inflation once and for all. Thus, she wrote, "The costly
wrong turn in ideas and macropolicy of the 1960s and 1970s has been set
right, and the future of stabilization looks bright."
This, let me stress, is not the conservative vision. It is the standard
view of the entire economic establishment. It is a sign of the fact that
there is, in the panoply of what is called mainstream economic knowledge in
our day, practically no sign of an awareness of how badly wrong things can
go. Until they do.
Roosevelt's economists had a different view, as did their direct
descendants who worked for Lyndon Johnson, and this I think justifies
treating the New Deal and the Great Society as a single coherent whole.
That generation was bred in the Depression and understood the instability
of finance, the importance of regulation, and the role that government can
play. There has been considerable controversy in recent days over what
the New Deal did or did not do, with many repeating the oft-stated view
that it took the war to end the Depression and some arguing that it did
nothing important at all. In a new paper Marshall Auerback corrects this
record, summarizing the actual accomplishments of those years:
"The key to evaluating Roosevelt's performance in combating the Depression
is the statistical treatment of many millions of unemployed engaged in his
massive workfare programs. The government hired about 60 per cent of the
unemployed in public works and conservation projects... It also built or
renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds,
7,800 bridges, 700,000 miles of roads, and a thousand airfields. And it
employed 50,000 teachers, rebuilt the country's entire rural school system,
and hired 3,000 writers, musicians, sculptors and painters... If these
workfare Americans are considered to be unemployed, the Roosevelt
administration reduced unemployment ... to 13 per cent in 1936, to less
than 10 per cent at the end of 1940, to less than 1 per cent a year later
when the U.S. was plunged into the Second World War. If the federal
workfare employees are accepted as employed, the corresponding numbers are
... 7 per cent, 3 per cent and 0.5 per cent. Virtually all the genuinely
unemployed received basic social benefit payments from 1935 on."
Let me add that under Lyndon Johnson the unemployment rate fell to under
four percent for three years in a row, though with mild inflation that was
already subsiding by the time he left office in 1969. It is impossible to
know whether we would have had the inflation except for the economic
influence of the Vietnam war; the test of whether peacetime full
employment is possible without inflation was left to the late 1990s. But
then, the Clinton boom reduced joblessness once again to under four percent
for three years running, and proved that, in fact, full employment without
inflation is entirely possible.
Further, we have the good fortune today to have come through the New Deal
and Great Society and through the forty years since then with most of the
institutions then erected still intact. We still have deposit insurance
and Social Security and Medicare and Medicaid. These institutions and the
memory of others like the Home Owners Loan Corporation and the National
Youth Administration and the Job Corps and the Office of Economic
Opportunity and Manpower Development and Training give us something to work
with going forward, if we can only bring the history to mind. So too does
the Employment Act of 1946 as revised by the Humphrey-Hawkins Full
Employment Act of 1976, a delayed legacy of the LBJ years. The Roosevelt-
Johnson legacy makes our lives vastly easier now, because we can retrace
what they did, and because we can build on the institutions they built.
What then is the agenda ahead? Let me lay things out in rough order of
legislative rather than economic priority, that is by urgency of enactment
and implementation rather than the scale or duration of effect.
We must first stabilize the financial system, quelling panic and stopping
runs. The essential steps are already worked out by trial and (mostly)
error, which could have been avoided if the advice I gave in the Washington
Post on September 25 had been accepted straight away. But over two months
we got there, abandoning an unworkable "market friendly" plan to buy back
toxic assets to a more sensible plan involving (a) expanded deposit
insurance, (b) support for commercial paper and money market funds, (c)
nationalization of Fannie Mae, Freddie Mac, and AIG, and (d) partial
nationalization and recapitalization of the banks. We then learned what we
should have known: none of this will revive the economy. Even with fresh
capital banks are unwilling to lend; even were they willing to lend they
would have trouble finding families and businesses willing to borrow, and
with incomes and collateral to support the loans.
The next steps must therefore target the real economy.
-At the top of the list, we find revenue-sharing and an infrastructure
fund. There is a lot of talk in the news about capital investment, which
is very important; a few days ago the National Governors Association
defined the need at $136 billion over 18 months. It is no less important
to backstop state and local public services and the people who provide
them; if this is not done there will be a major collapse in the public
sector early next year. Increasing the Medicaid match is one easy and
effective way to get money to the states to prevent this.
-To deal with the industrial crisis, reinvent the Reconstruction Finance
Corporation, created under Hoover but run under Roosevelt by a great Texan,
Jesse Jones. The RFC lent to firms and kept them alive while they
developed new production plans and technologies. Meanwhile, to get a large
share of health care costs off the books of the major industrial employers,
especially the auto companies, let's call an LBJ institution into action,
and lower the age of eligibility for Medicare to 55.
-In housing, we need a foreclosure moratorium, mortgage renegotiation, and
mass write-downs of the terms of adjustable rate mortgages, something now
getting underway through Fannie Mae, Freddie Mac, and nationalized banks
like IndyMac. This is a capital transfer to homeowners, permitting them a
stable and sustainable housing payment so long as the rest of the economy
is stabilized so that they do not lose their jobs. Achieving this is not a
small job: it required 20,000 people at the HOLC to monitor and manage a
million mortgages in the 1930s.
-The American elderly, and those who plan to be elderly soon, have
suffered a 40 percent loss in the value of equities in their 401(k)s over
just the last year. This will translate, quite soon, into a major loss of
purchasing power. Individual losses cannot be made good, but suffering can
be averted and the economy as a whole protected by a simple device: raise
the basic Social Security benefit, say by 30 percent, beyond the cost of
living, for the first time in a generation.
The above measures could easily total $450 billion per year of direct
spending, plus an estimated $80 billion of mortgage relief if all ARM's
were written down to 4 percent and fixed at that rate.
-Finally, if more is needed and it may be, there is the payroll tax. Let
the government pay the contribution to the Social Security Trust Fund for a
period of three to five years. Cutting the payroll tax would add about 8.3
percent to the after-tax incomes of working people, and a similar amount to
the balance sheet of their employers, which could be used to create new
jobs. The numbers can be made as large as needed, up to another $900
billion per year. Overall, we've just identified over $1.4 trillion in
potential economic relief, or around 10 percent of GDP. That would place
the range of expansionary fiscal policy between the levels of the New Deal
and those of World War II. If results are favorable at smaller sums, the
payroll tax tier can be scaled back, with the total coming in between 6 and
8 percent of GDP.
The third necessary step is financial sector reform. The world of sub-
prime securitization, over-the-counter credit default swaps, tax havens and
regulation-evading shell corporations is a world that fosters fraud, abuse,
distrust and systemic risk. It is a world brought down by systemic
distrust, by the fact that bankers no longer trust their counterparties.
The bona fides of the credit system, and therefore the economic growth, and
the tax revenue, for which we rely on this system, cannot be restored until
this world ends. Going forward there can be no global finance without
effective global financial regulation. Strict compensation limits on banks
receiving public rescue funds should encourage an entire generation of top
bankers to retire, the sooner the better. When this happens, new
management can get control of the books, the personnel, and the practices
of the banking system. And trust can begin to be restored.
As recovery takes hold, new tasks will come to the fore. An effective
energy policy is necessarily integral to an economic recovery program, for
four reasons. First, the survival of the planet depends on getting control
of the emission of greenhouse gas. Second, the long-term economic
viability of the country depends on developing the new, energy efficient
technologies, in generation, in transportation and in the appliances of
daily life, that can form the basis of our export trades. Third, the act
of investing in these new technologies and enterprises will motivate the
flow of capital to this country and support the position of the dollar.
And fourth, and most immediately, failure to control the demand for oil in
an economic recovery will simply hand the price weapon straight back to the
Saudis, the Iranians, and others who do not have our best interests at
Finally, in this country we underrate a central reason for the
macroeconomic success of the Johnson years. That is, that they occurred
under the umbrella of a stable, dollar-centered world economic system,
created at Bretton Woods in 1944. We are today again (or still) in a
dollar-centered system, but it is an unstable one. It is based on nothing
more than the willingness of China, Japan, and other countries to hold U.S.
Treasury bonds and bills. They do so in their own interest, to be sure,
and are unlikely to stop without grave provocation. But many countries are
left out of this system, and suffer much more than we do from the caprice
and predation of unregulated finance. And our own position, however
favored, is insecure.
The economists of the Johnson era, notably my father and Walt Rostow,
understood that the fortunes of the United States cannot be disentangled
from the progress of India, Africa, Latin America and the rest of the
developing world. President Johnson understood this very well. In the
years since, we have forgotten. But now, with the world in turmoil, would
be well advised to rediscover this deep truth, and to set ourselves the
task of again designing a functional world economic system, dedicated
effectively to stable economic development, to the reduction of poverty and
to the protection of a fragile and endangered planet.