James K. Galbraith has a tour de force piece in the Washington Monthly on the economic and financial crises, what's at their core and what's necessary to move forward.

Galbraith echoes and reinforces many of the criticisms and recommendations Breakthrough has been offering on the economy for the past six months: more public spending (a lot!); nationalize the banks so they can be cleaned up and re-privatized; and ultimately, spark a new engine of economic growth in the birth of a new clean energy economy.

Galbraith isn't shy either about criticizing President Obama and Treasury Secretary Geithner for stimulus.  It's not bold enough, it reflects the middle of the road economic consensus (and is therefore too timid), and it reflects a misguided attempt at bipartisanship.  Here's the choice quote there:

Second, the new team also sought consensus of another type. Christina Romer polled a bipartisan group of professional economists, and Larry Summers told Meet the Press that the final package reflected a "balance" of their views. This procedure guarantees a result near the middle of the professional mind-set. The method would be useful if the errors of economists were unsystematic. But they are not. Economists are a cautious group, and in any extreme situation the midpoint of professional opinion is bound to be wrong.

Galbraith also identifies the need for quick nationalization and reprivatization of major banks by FDIC:

Only a dogged political refusal to admit this [that big banks are now insolvent] has since kept the banks from being taken into receivership by the Federal Deposit Insurance Corporation--something the FDIC has the power to do, and has done as recently as last year with IndyMac in California.

He's of course strongly critical of Geithner's new life-support plan for banks:

Geithner's banking plan would prolong the sate of denial. It involves government guarantees of the bad assets, keeping current management in place and attempting to attract new private capital. (Conversion of preferred shares to equity, which may happen with Citigroup, conveys no powers that the government, as regulator, does not already have.) The idea is that one can fix the banks from the top down, by reestablishing markets for their bad securities. If the idea seems familiar, it is: Henry Paulson also pressed for this, to the point of winning congressional approval. But then he abandoned the idea. Why? He learned it could not work.

Paulson faced two insuperable problems. One was quantity: there were too many bad assets. The project of buying them back could be likened to "filling the Pacific Ocean with basketballs," as one observer said to me at the time. (When I tried to find out where the original request for $700 billion in the Troubled Asset Relief Program came from, a senior Senate aide replied, "Well, it's a number between five hundred billion and one trillion.")

The other problem was price. The only price at which the assets could be disposed of, protecting the taxpayer, was of course the market price. In the collapse of the market for mortgage-backed securities and their associated credit default swaps, this price was too low to save the banks. But any higher price would have amounted to a gift of public funds, justifiable only if there was a good chance that the assets might recover value when "normal" conditions return.

Galbraith drops this interesting observation as well: that the multiplier impact of public spending on GDP is lower during economic slumps than otherwise, often for the same reasons tax rebates are also less effective:

Strapped and afraid, people want to be in cash. This is what economists call the liquidity trap. And it gets worse: in these conditions, the normal estimates for multipliers--the bang for the buck--may be too high. Government spending on goods and services always increases total spending directly; a dollar of public spending is a dollar of GDP. But if the workers simply save their extra income, or use it to pay debt, that's the end of the line: there is no further effect. For tax cuts (especially for the middle class and up), the new funds are mostly saved or used to pay down debt. Debt reduction may help lay a foundation for better times later on, but it doesn't help now. With smaller multipliers, the public spending package would need to be even larger, in order to fill in all the holes in total demand. Thus financial crisis makes the real crisis worse, and the failure of the bank plan practically assures that the stimulus also will be too small.

The conclusion of course, is that what we've seen proposed today is far too inadequate for the crisis at hand.  Galbraith writes, "If the banking system is crippled, then to be effective the public sector must do much, much more."

He then turns to look at the "commonplace" assumption that the New Deal was too small to pull the US out of the economy, something only done (eventually) by WWII.  Galbraith rejects this analysis, saying:

A new paper by the economist Marshall Auerback has usefully corrected this record. Auerback plainly illustrates by how much Roosevelt's ambition exceeded anything yet seen in this crisis:

"[Roosevelt's] government hired about 60 per cent of the unemployed in public works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York's Lincoln Tunnel and Triborough Bridge complex, the Tennessee Valley Authority and the aircraft carriers Enterprise and Yorktown. 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, including Willem de Kooning and Jackson Pollock."

In other words, Roosevelt employed Americans on a vast scale, bringing the unemployment rates down to levels that were tolerable, even before the war--from 25 percent in 1933 to below 10 percent in 1936, if you count those employed by the government as employed, which they surely were. In 1937, Roosevelt tried to balance the budget, the economy relapsed again, and in 1938 the New Deal was relaunched. This again brought unemployment down to about 10 percent, still before the war.

The New Deal rebuilt America physically, providing a foundation (the TVA's power plants, for example) from which the mobilization of World War II could be launched. But it also saved the country politically and morally, providing jobs, hope, and confidence that in the end democracy was worth preserving. There were many, in the 1930s, who did not think so.

Of course, Galbriath notes:

What did not recover, under Roosevelt, was the private banking system. Borrowing and lending--mortgages and home construction--contributed far less to the growth of output in the 1930s and '40s than they had in the 1920s or would come to do after the war. If they had savings at all, people stayed in Treasuries, and despite huge deficits interest rates for federal debt remained near zero. The liquidity trap wasn't overcome until the war ended.

It was the war, and only the war, that restored (or, more accurately, created for the first time) the financial wealth of the American middle class.

During the war years, government price controls, rations and soaring private incomes left Americans with excess income and nowhere to spend it.  

And so, with nowhere else for their extra dollars to go, the public bought and held government bonds. These provided claims to postwar purchasing power. After the war, the existence of those claims could, and did, establish creditworthiness for millions, making possible the revival of private banking, and on the broadly based, middle-class foundation that so distinguished the 1950s from the 1920s. But the relaunching of private finance took twenty years, and the war besides. And so, with nowhere else for their extra dollars to go, the public bought and held government bonds. These provided claims to postwar purchasing power. After the war, the existence of those claims could, and did, establish creditworthiness for millions, making possible the revival of private banking, and on the broadly based, middle-class foundation that so distinguished the 1950s from the 1920s. But the relaunching of private finance took twenty years, and the war besides.

Galbraith's conclusion from this historical lookback:

the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.

So what do we do now?  What policy steps should be taken immediately to start the healing of our national economy?  Here's Galbraith's plan (which sounds much like what Breakthrough has advocated):

The first thing we need, in the wake of the recovery bill, is more recovery bills. The next efforts should be larger, reflecting the true scale of the emergency. There should be open-ended support for state and local governments, public utilities, transit authorities, public hospitals, schools, and universities for the duration, and generous support for public capital investment in the short and long term. To the extent possible, all the resources being released from the private residential and commercial construction industries should be absorbed into public building projects. [And] There should be comprehensive foreclosure relief...

Second, we should offset the violent drop in the wealth of the elderly population as a whole. The squeeze on the elderly has been little noted so far, but it hits in three separate ways: through the fall in the stock market; through the collapse of home values; and through the drop in interest rates, which reduces interest income on accumulated cash. For an increasing number of the elderly, Social Security and Medicare wealth are all they have.

That means that the entitlement reformers have it backward: instead of cutting Social Security benefits, we should increase them, especially for those at the bottom of the benefit scale.  Indeed, in this crisis, precisely because it is universal and efficient, Social Security is an economic recovery ace in the hole. ...

Third, we will soon need a jobs program to put the unemployed to work quickly. Infrastructure spending can help, but major building projects can take years to gear up, and they can, for the most part, provide jobs only for those who have the requisite skills. So the federal government should sponsor projects that employ people to do what they do best, including art, letters, drama, dance, music, scientific research, teaching, conservation, and the nonprofit sector, including community organizing--why not?

Finally, a payroll tax holiday would help restore the purchasing power of working families, as well as make it easier for employers to keep them on the payroll. This is a particularly potent suggestion, because it is large and immediate. And if growth resumes rapidly, it can also be scaled back. There is no error in doing too much that cannot easily be repaired, by doing a bit less.

And of course, these steps to prime the economic pump must be coupled with a real effort to clean up the banks, starting with nationalization of insolvent banks.  Galbraith writes:

As these measures take effect, the government must take control of insolvent banks, however large, and get on with the business of reorganizing, re-regulating, decapitating, and recapitalizing them. Depositors should be insured fully to prevent runs, and private risk capital (common and preferred equity and subordinated debt) should take the first loss. ...

Too big to fail?  Too big, period. That's what Galbriath seems to think about the "swaggering" big banks and financial giants of today:

Ultimately the big banks can be resold as smaller private institutions, run on a scale that permits prudent credit assessment and risk management by people close enough to their client communities to foster an effective revival, among other things, of household credit and of independent small business--another lost hallmark of the 1950s. No one should imagine that the swaggering, bank-driven world of high finance and credit bubbles should be made to reappear.

Concerned about the deficit?  Then you haven't really been paying attention.  This is a crisis, remember, and "the deficit and the public debt of the U.S. government can, should, must, and will increase in this crisis," Galbraith writes.

They will increase whether the government acts or not. The choice is between an active program, running up debt while creating jobs and rebuilding America, or a passive program, running up debt because revenues collapse, because the population has to be maintained on the dole, and because the Treasury wishes, for no constructive reason, to rescue the big bankers and make them whole.

Concerned that the increasing deficit will drive inflation or lower the U.S. Government's credit overseas?  Again, don't be.  Galbraith says:

so long as the economy is placed on a path to recovery, even a massive increase in public debt poses no risk  ... the rest of the world recognizes that the United States performs certain indispensable functions, including acting as the lynchpin of collective security and a principal source of new science and technology. So long as we meet those responsibilities, the rest of the world is likely to want to hold our debts.

[And] in the debt deflation, liquidity trap, and global crisis we are in, there is no risk of even a massive program generating inflation or higher long-term interest rates. That much is obvious from current financial conditions: interest rates on long-maturity Treasury bonds are amazingly low. Those rates also tell you that the markets are not worried about financing Social Security or Medicare. They are more worried, as I am, that the larger economic outlook will remain very bleak for a long time.

Of course, at the end of all of this, Galbraith recognizes that without a new major engine of economic growth, there'll be no lasting recovery, no rebirth of a strong housing sector, no restoration of the security and prosperity Americans have lost in their plummeting 401k and home values.  And short of starting another World War - WWII doubled U.S. Production for five years, Galbraith notes - what are our options?  There's really only one, he concludes:

Today the largest problems we face are energy security and climate change--massive issues because energy underpins everything we do, and because climate change threatens the survival of civilization. And here, obviously, we need a comprehensive national effort. Such a thing, if done right, combining planning and markets, could add 5 or even 10 percent of GDP to net investment. That's not the scale of wartime mobilization. But it probably could return the country to full employment and keep it there, for years.

Moreover, the work does resemble wartime mobilization in important financial respects. Weatherization, conservation, mass transit, renewable power, and the smart grid are public investments. As with the armaments in World War II, work on them would generate incomes not matched by the new production of consumer goods. If handled carefully--say, with a new program of deferred claims to future purchasing power like war bonds--the incomes earned by dealing with oil security and climate change have the potential to become a foundation of restored financial wealth for the middle class.

Building a new, prosperous, clean energy economy will take some time.  It won't be as quick as the wartime mobilization of 1942-44 Galbraith writes, "But we could manage it over, say, twenty years or a bit longer."  What we need, he concludes, "are careful, sustained planning, consistent policy, and the recognition now that there are no quick fixes, no easy return to "normal," no going back to a world run by bankers--and no alternative to taking the long view."

Unfortunately, as one might expect in a crisis situation, delay and inaction are not our friends.  There is little time to begin implementing the ambitious and necessary reforms Galbraith calls for here.  As he writes:

A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly. Does the Geithner team, forged and trained in normal times, have the range and the flexibility required? If not, everything finally will depend, as it did with Roosevelt, on the imagination and character of President Obama.

On the economy, it's time to go big, or go home.