07/18/2009 05:12 am ET Updated May 25, 2011

Deleveraging Everything! A Conversation With Heinrich Thyssen

We've had advice on digging out of the global financial hole from the bankers who put us in the hole, and we've had advice from the government bureaucrats who aspire to get us out -- sometimes they are the very same people! But we have yet to climb very far out of the hole and -- regrettably -- we have not heard very much from business people (outside of the collapsing automobile industry) who have a huge stake in actually reigniting the real global economy.

In recent conversation with Heinrich Thyssen, one of the most thoughtful and successful international businessmen I know, and someone also involved in supporting international civil society and interdependence (full disclosure, my Interdependence Project has been the beneficiary of grants from his foundation), I heard some fresh and bluntly expressed ideas that deserve wide circulation as we now examine the latest Administration proposal for banking regulation.

Thyssen concurs in the general indictment of excessive overleveraging as a key contributor to the economic meltdown, but points out that "leveraging was increased to insane levels irrespective of whether it made economic sense" because leveraging was the only way for the United States to sustain its trade and its hyper-consumption and for Europe to support is expensive social system. In other words, continued progress and prosperity was dependent on "ever increasing deficits."

Perhaps most importantly, for Thyssen, this debt and the subsequent leveraging was not just a problem for the banks, but a problem for government itself -- which was in effect spending more than it had, and operating on credit provided by China and others buying U.S. government notes. So responsibility for the crisis belongs not just to irresponsible banks, but to irresponsible government since "government debt and liquidity infusions by central banks" played a major role in precipitating the crisis.

Leveraging is of course what permits banks and other financial institutions to lend out more than they take in, and earn a profit (interest) on the difference. A leverage ratio considered safe used to be around ten to one, a dollar in hand for every ten loaned. But leading up to the recent crisis, leveraging went to 20 to 1 or 30 to 1 and higher, mostly because of bank deregulation and greed, but also, as Thyssen argues, because of the need to fund growth in both the first and third worlds (uneven as it might be). Moreover, government itself indulged in deficit spending far beyond its assets (another form of leveraging), making things far worse.

When so many of the leveraged loans went bad (mortgage and credit card defaults), the over-leveraged banks could not cover their losses. Leveraging seemed to work when the housing bubble and the prosperous economy were going up, but were doomed to fail with a vengeance when they went down. With government, already deficit-ridden, acting as the source of banking bailouts, the problems were shifted from banks to the state supposedly to save them. More crisis ahead!

Like almost everyone, Thyssen recognizes that deleveraging is necessary. But if it is no more than "a shift of leverage from speculative and failed investment banking business to already extensive public debt" it cannot "cure the problem." This will only "curtail commercial lending with no hope of curing the real systemic fault." As such it is "clearly not socially defensible, and could prolong the current problems to the detriment of future generations."

What is required, argues Thyssen, is to "separate the commercial banking business, which undoubtedly is of public interest, from investment banking, which is not. The risk and high return of investment banking should remain private and the market left to take care of overcapacity and failures, while a properly regulated commercial banking business must remain in a position to provide a credit to industry and private individuals."

Moreover, it is not just banks but government itself that must be deleveraged -- the opposite of what is happening now with bailouts. Thyssen's solution is to encourage government regulation, oversight and investment in commercial banking, which supports public goods. But he wants to get government out of propping up the investment banking business, first of all because investment banking does not directly impact public interests, but also because bailouts actually worsen government deficits and add to the leverage crisis.

Today's preferred solutions are doing the very opposite: "The proposed rescue packages simply try to deleverage the current system, which in essence supports the investment banking activities."

The focus must be instead on reigniting lending by commercial banks and leaving investment institutions to the market. With respect to commercial banking, I suggested in a recent blog that the government use pass-through credit vouchers (redeemable only when loans are made) to assure that support to the banks actually would be funneled into loans to homeowners, individuals and businesses. To Thyssen, however, the aim is to clearly separate financial investment institutions like hedge funds from the commercial banking industry, and to restore to government responsibility. Which means deleveraging government as well as banks.

For Thyssen, much of the problem arises out of the "short-term and local-minded" approach favored by government and the media. "We need to find leading thinkers who understand the fundamental trends and propose solutions promoting interdependence and a willingness to accept consequences."

Many of us voted for President Obama with such fresh thinking in mind. But what we got was Larry Summers and Tim Geithner. Maybe they should start listening to real businessmen like Heinrich Thyssen.