What have we learned from these crises of capitalism?
The first lesson is that crises are not "black swan" events, using the terminology of my friend Nassim Taleb. They're not just random outcomes. They are the result of a buildup of financial and policy vulnerability and mistakes—excessive risk-taking, leverage, debt, and so on. The first chapter of my book is called "The White Swan" because these events are predictable. But generation after generation, we seem to forget the past. When there's a bubble, there's euphoria. There's irrational exuberance. Consumers can use their homes like ATM machines. Governments and policymakers are happy because they get reelected. Wall Street makes billions of dollars of profits. Everybody's delusional.
What happened to all the toxic assets?
Some of them have been written down, but the policy response has been pray and delay. Many banks are still carrying these assets and loans on their books at face value of a hundred cents on the dollar.
How long will they be under water?
A long time. Prices for homes have fallen by 30 percent from the peak. Prices of commercial real estate have fallen by 40 percent. They may be stabilizing, but prices are not going to go up 30 percent or 40 percent anytime soon. Therefore many of these bad assets have negative equity, meaning the value of the assets is lower than the value of the mortgage or the debt on it. People are going to walk away from their homes.
Aren't they doing that now?
They're doing it increasingly. People refer to it as jingle mail. You put the keys in an envelope, send it back to your banker. It's happening on a massive scale. Especially in the U.S., if you walk away from your home when the value is below the value of your mortgage, they cannot go after you to recoup the difference between the two.
Where's the next bubble?
I see it in the fact that interest rates in all of the advanced economies are near zero. In the U.K., Europe, Japan, everybody can borrow at zero rates. And because of that, it's back to business as usual on Wall Street. Most financial institutions are making huge amounts of profits in proprietary trading—borrowing at zero rates and making investments. It was just announced that in the first quarter, Goldman Sachs (GS) did not have a single day in which it lost money on trading. I worry that zero interest rates are leading to an asset bubble globally. I don't think it's going to burst for the time being, but give it two or three years.
So it's not a specific bubble like a housing or technology bubble?
No, at this point I think it's generalized. Effectively you can borrow at zero rates and invest in any risky asset, and the value of most risky assets for the last year has gone up by 50 to 80 percent.
Other than raising interest rates, what should the government do?
You need tighter supervision and regulation. The Dodd bill is not enough. Institutions that are too big to fail are becoming even bigger. [For example,] JPMorgan (JPM) took over WaMu and Bear Stearns. So if they're too big to fail, they're too big. We should break them up. They're also becoming increasingly too big to be bailed out. And they're becoming too big, too complex, to manage. These financial supermarkets...have become disasters. There's no way the CEO of a bank can monitor the risk-taking of thousands of different traders and bankers. I would say if you're a bankholding company, you cannot do proprietary trading. You cannot have private equity or hedge funds activities. I would go back to the kinds of restriction we had under Glass-Steagall when there was a full separation between commercial banks and investment banks.
On the face of it, is anything wrong with hedge funds?
No, there's nothing wrong with hedge funds. I think they have a role to play. But take an institution like Goldman Sachs. In many ways it looks like a hedge fund...and is more leveraged than any hedge fund. It can borrow from the government at zero rates. So if Goldman Sachs wants to be a hedge fund, be a hedge fund. But don't have taxpayers guarantee your liabilities.
What's going to happen to Greece?
You have riots, people dying in the streets. In spite of this huge bailout program, the public debt and the fiscal adjustment is so large that I think eventually Greece will default or restructure its debt in a corrosive way. There's even a chance Greece might have to exit the European market.
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