The Johnson Legacy and the Obama Challenge: Remarks to the LBJ Centennial Conference

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 sources.

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 heart.

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.

Comments

[rczach]

The article states "...Ronald Reagan, who had the courage to drive unemployment up to 11 percent in 1982 so as to end inflation once and for all." But in his article "The Forgotten Math: Pre-WWII New Deal Saw Biggest Drop In Unemployment Rate in History" (a refutation of recent conservative historical revisionist statements claiming that FDR's New Deal "prolonged the Great Depression"), he sites Census Data, specifically Census document HS-29, which states the following regarding Ronald Reagan.

1981 Unemployment Rate: 7.6% (8.2 million total unemployed)
1988 Unemployment Rate: 5.5% (6.7 million total unemployed)
Unemployment Rate Change: -2.1%
Total unemployment percentage change: -19.0%

Which would seem to indicate that unemployment went down under Reagan -- in spite to the long range damage his economic policies (and philosophy) are still doing to our economy.
Just wondering who's correct on this one?

[outnow]

James,

Let us not forget that Walt Rostow was a war hawk. LBJ bleed us in the war in Vietnam until our country was in shambles. The justification for the war in Vietnam was provided by Mr. Rostow in his misguided misunderstanding of the "containment theory" advanced by others. The problem with the United States is in trying to marry the concepts of free enterprise with the wars of choice for fun and profit.

John Kenneth Galbraith was a towering genius whose sage advise is ignored by the "Chicago Boys" funded by Rockefeller.

I agree with with the rest of your ideas but cannot go along with the idea that bombing Vietnam helped third world countries. While we are at it, can we also agree that free enterprise and the the Fed are incompatible. Where in our constitution did the founding fathers give a private cabal of banksters the authority to control the issuance of money? Why can't our country operate with a system of credit issued by the government? The IMF and the World bank are also "predatory lenders" in the third world - economic imperialism, as it were.

It is "radical" to suggest that the US should follow its own Constitution these days. I am not impressed with the Gulf of Tonkin false flag justification for the wa (LBJ), nor those who advocated the bombing (Rostow) Otherwise, your ideas are good.

[MalleusMaleficarum]

Prof. Galbraith, Many thanks for your analysis of the current economic crisis and the history of the economic strategy of the New Deal and the Great Society. Your father's work has been under-rated by academic economists to the great chagrin of the rest of the world. It is my hope that you will have the opportunity to confer, consult and collaborate with the Obama administration -- frequently -- and hopefully in some official capacity.

However, may I make one observation? Here it is: please, do not presuppose that the Saudis and Iranians are inimical to the West in general or to the USA in particular. It is true that they have not been supportive of neoconservatism or to US interventionism during the Reagan-Bush-Clinton Era, but I trust that you will refuse to partake in the spurious concept of a conflict of civilizations. A recent Gallup survey revealed that 93% of Muslims oppose the ideology of Al-Qaida. The mainstream of the Arab Street wants the same things tthat the rest of the world wants: peace, prosperity and progress to a better social order.

[TheFriendlyAtheist]

Thanks for a great post Mr. Galbraith and thanks for a great book ( The Predator State ), which I plan to reread before Christmas.
I hope you have the ear of the Obama team because you have some of the best ideas for reviving this economy that I've heard so far. I would however go a little farther than you in that I think all commercial banks should be nationalized and all investment banks highly regulated. But priority No. 1 must be to create jobs and get money flowing. Money is like water, it doesn't matter how much is in the pipes, if it's not flowing out of a spigot somewhere it does no one any good.

[wadenelson1]

Sir, I hope you are brought into the Obama administration soon. You are the only economist who has even the slightest grasp of the problems, and possible solutions.

[wrightthewrong]

This is the man I wanted as the Treasury Secretary. He was the only person I heard (see Bill Moyer's show featuring him in September) who seemed to care about the people. Following in his father's footsteps, I dare say. I hope Obama sits up and takes notice of this man.

[jsarets]

The only way out of this hole is public spending. I'm just having a hard time imagining how the federal government can displace the liquidity of a massive private sector capitulation without gross misappropriation of funds.

For all the structural flaws of the financial industry, it's a masterpiece of systems engineering compared to the influence-peddling racket we call the U.S. Congress. For all the public harm attributed to self-interested bankers looking out for their next bonus, consider the harm induced by self-interested politicians looking out for their next campaign.

The only way I see this working is if the funding apparatus is federally decentralized. The money has to bypass the pork-barrel buffet and go directly to our communities. We're all in this together, but there's no one size fits all strategy that makes sense across the nation.

The situation is too dire to replay the ideological debates of the postwar era. Put the money where the people live and let us decide how to strengthen our communities. Normal people aren't fascinated by the frameworks of economic theory. We just do the best we can with what we have.

The policy wonks think they've got all the solutions, and they should air them at their local city council meetings. But progressive or conservative, making decisions for ourselves is our birthright, and we deserve to have meaningful access to public policy at an appropriate level.

[RoloTomassi]

"For all the structural flaws of the financial industry, it's a masterpiece of systems engineering compared to the influence-peddling racket we call the U.S. Congress."

This is an absurd notion; Congress is certainly corrupt, but key players in the financial industry colaborated with congress to reach this height of irresponsibility, and cannot be absolved in any fashion. And as far as campaign corruption goes, again, equal players from the financial industry deserve no breaks or gerater consideration, and it is a certainty that Wall St. drove the deregulation agenda congress acted on; we can rest assured that campaign contributions from that sector played a major role.

This isn't a case of apples and oranges...these are all bad apples, and all at fault.

[jsarets]

Yes, exactly. They're all bad apples. They couldn't have found their way into either basket without being or becoming bad apples. So how can we expect a massive federal government re-inflation program to go any better than a massive financial industry inflation scheme?

I'm not saying that Congress is necessarily any worse than Wall Street. I'm just saying that it would be foolish to argue that they're necessarily any better.

[Hank007]

The first lesson an econ major should learn is 'people are greedy, and will behave like spoiled children if you let them'. The author lays out some great ideas, but they require government to act on behalf of the people, not just rich people and big business. American politicians just are not good at that anymore, though I hope Obama will be different. In just about every other developed country, bettors, I mean 'investors' have to pay a small, usually .02% tax to play in the stock market. That alone would generate more money than the bailout is begging for. I am still amazed how few 'experts' have the cubes to admit that oil prices are down, because they went up as a simple desire by big oil to raise prices; Iran publishes a photoshopped picture of missiles, and prices jump??! Seriously?

This is a good article, but apparently once again proves me and my buddies understand economics better than the pros. We saw the oil prices, home prices, and robbery, I mean bailout for what they were.

[northicus]

All of Galbraith senior's books should be read by policy makers. Its more than obvious that the unregulated free-market need some over-sight and policing.

[kenny453]

This guy is a freaking genius, or is channeling one. The moves made so far by Obama's transition team and his picks for treasury and economic advisor did not inspire confidence in me that he will have the stones to do what this crisis requires and this article describes much of what should be done.
The "free market, trickle down, disaster capitalism" school (of course it's a "school", none of them have ever had to work for a living) has had it's turn and run the ship aground. It's time to throw them overboard and turn the wheel over to some grownups while we rebuild a nation and an economy that creates the most good for the most people. We've lived under the opposite philosophy for awhile now and it's not pretty.

[cheforacle]

To the contrary, from the pronouncements Obama has made, and certainly the numerous articles written by his advisor Lawrence Summers in the last year in the Financial Times, the Obama team seems to be heading in the direction Galbraith calls for: strong stimulus of the economy, relief for homeowners including a moratorium on foreclosures and rewriting of mortgages, numerous public works projects, investment in green technologies within the context of projects that can be started quickly. It appears that Obama is getting advice very similar to that so eloquently and persuasively advanced by Galbraith in this article.