This is the English transcript of Dr. Sebastien Gay’s interview with BFM, Business&FM newspaper and Business FM radio.

1. The efforts to overcome crisis in all countries where economies have suffered from the global developments involve two major principles - increasing role of the state in strategic industries and large-scale financial support. What are the long-term risks of such approaches?

There are several long-term risks associated with adopting a government-driven strategy to address the emergencies in strategic industries.  Most concerning is the incentive structure that is established by such an approach; those large companies that struggle in a weak economy will attempt to hold the country hostage by claiming their necessity.  As the responsibility for business mistakes shifts from big companies to the government, the companies’ management teams will be more willing to take greater risks because they will not bear the costs if they fail.  It is also important to point out that the term “strategic industries” is a judgment-based term, where “strategic” is based on whether the industry is a significant player in the economy.  If government takes a greater role in those industries it considers “strategic” it is, in essence, selecting the winners and losers of the economy and denying the market its role in making that choice.  Greater government involvement in strategic industries can also discourage innovation and entrepreneurship, encourage more mergers and acquisitions, and dissuade private investment, particularly in small companies.

Large-scale financial support by the government also bears similar long-term risks; however, the increase in financial support brings an additional factor to consider.  For now, the government is supporting its increased spending by printing money (a short-term solution) and borrowing from growing nations like China.  International relations may be seriously impacted by the shifting dynamic between the United States as a debtor and other international players as its lenders.

2. Bad assets represent a key problem that has led to the freezing of the markets. How would you assess the idea to create special banks to accumulate such assets, the so-called “bad banks”. What should be the proportion between public and private capital in such banks? And what could be the mechanism to raise private capital for this purpose?

The “bad bank” concept is a good idea so long as the government is able to resell the bundled bad assets on Wall Street.  The government should have 100% capital in the bad banks in the beginning.  The government can issue bonds to raise capital for the new banks.  The mechanism to raise private capital for this purpose is the securities market. The first issue to unpack is the idea of the “bad assets.”  These assets, particularly sub-prime mortgages, were always high-risk assets.  The reason they were high risk was because (1) the sub-prime mortgage industry was very fragile and (2) there was a chance that significant amounts of money could be made by securitizing them as mortgage-backed securities.  Some market players who refrained from selling off the assets on the stock market profited off the short-run fees, but should reasonably have been aware that the long-run result was collapse.  What has changed from then until now is the lack of uncertainty; before, there was a chance – however small – that the risky assets could succeed on the stock market and there were investors willing to buy and resell them quickly.  In order to restore investor confidence in these so-called “bad assets,” there must be increased uncertainty (i.e. the possibility of positive yields) injected into the securities market.  The market player in the best position to do so is the government.  The government should work on the other side of the market to make sure there is less certainty about foreclosures so that a positive risk-analysis is put back in the securities market.  Whoever grabs the bad assets at their cheapest can potentially make a huge gain.  In the long run, however, the problem remains that such markets for risky mortgage-backed securities and other similarly risky assets exist at all.  The so-called “bad banks” should be temporary to allow such securities to eventually disappear and greater regulation over such industries must be implemented.  There should be no newly created sub-prime mortgage-backed securities, and the existing ones will expire at the final payment of the corresponding loans.  Moreover, loan regulations must be put in place to prevent dishonest loan practices from occurring as freely as they have in the past.

3. Are there any dangers in expanding the consumer credit stimulation program, Term Asset-Backed-Securities Loan Facility (TALF)?

The purpose of TALF is to increase the availability of credit to small businesses and consumers.  There are many benefits of such a program; namely, it can restore consumer confidence, stave off increasing unemployment, and clean up banks’ balance sheets.  Of course, it fails to resolve other pressing concerns.  First, there is no guarantee that banks will offer new loans under the program.  The brief experience with TARP suggests that banks do not want to use the money provided by the government for the intended purpose of loosening the credit market. Second, the program is only delaying what could be a more dangerous problem down the road if the newly-acquired loans fail, which adds greater burden to the government in the long run.

4. During the last years, there has been much discussion that America “lives beyond means”, that the “world finances the American economy”, etc. If we put aside politics, the new stimulus package to be passed by the Congress requires more than $800 billion. It means the public borrowing will rise. What could be the sources of further borrowing for the administration, particularly - internal or external?

There are not many options available on the borrowing front.  The government can issue bonds to raise capital and will certainly borrow heavily from international players, particularly China.  It is not a good situation for the US economy.  The most the government can hope for is earning tax revenue from new or growing industries in the future.

Find the original interview at: http://www.bfm.ru/news/2009/02/20/sebastien-gay.html

The latest government stimulus plan is another disappointing addition to the collection of recent stimulus packages mistakenly trying to fight fire with fire.  The logic of Congress and the White House seems to be that the economy will be revived by giving people more money to spend. Government officials – from Obama to Pelosi – caution us on the importance of regaining confidence to restore the economy.  How quickly they forget what brought the economy to its knees!  We are in this crisis because Americans’ expectations of spending are too high.  We gambled on credit card debt and convinced ourselves to buy houses we could not reasonably afford.  We had too much faith in our government to watch over us, and too much faith that our nation’s companies were playing fair.  I do not claim that the White House or Congress has bad intentions, but sometimes the best of intentions can turn into a nightmare.   The cynicism Americans are feeling toward big company players like AIG and toward Congress and the White House is a good thing.  We are responsible for vigilant oversight of them, too.  Developing a practice of bailouts lessens the expected cost of financial failure – both personal and corporate – which can create dangerous risk analyses down the road.  Furthermore, in the long run, the stimulus package can itself become a part of the problem, as we will sustain the bad habits of over-spending.

Instead of reinforcing bad habits, a perhaps good (albeit painful) solution to the economic crisis is to let Americans go through the pain to set lower spending expectations.  We need to let people go through hard times in terms of lowered consumption (not lowered health, of course) to bring reality to the economy.  The economy will then be built on reasonable expectations, and we will be more prepared for the next inevitable recession.  A good way to accomplish these needed long-term goals while also ensuring that basic necessities are given to struggling Americans is to give people a small, monthly rebate check of $50 or $100 over the next two years.  A small rebate will allow Americans add a little money in the economy without overspending and creating a spending bubble.  My proposed solution is not an electroshock to the economy, but rather a supervised slow recovery process.  In addition, “short-term responsibility” legislation should be put in place to limit financially over-extended individuals and over-leveraged companies from pursuing new lines of credit and leveraging.  People and companies over the limit should be required to report to financial advisers on a monthly basis to verify that they are making sound decisions (Think about it as a parole officer for credit).

Achieving a reasonable level of consumption and returning to full responsibility for our debts will help us return to the optimal level of consumption.   Let’s all acknowledge the elephant in the room.  We cannot return to the kind of spending we once mistakenly enjoyed.

The Emergency Economic Stabilization Act of 2008, more commonly referred to as the “bailout plan,” has caused significant debate, suspicion, and anger among the American people.  As giant companies cried out for help in the face of imminent collapse, Congress wrote a $700 billion check ostensibly to rescue the economy from the alleged devastation that would otherwise have occurred.  The economy, however, continues to struggle.  The New York Times reports today that unemployment in the United States has reached a 14-year high, rising to 6.5 percent.  The stock market continues to bounce uncontrollably, which does nothing to help restore consumer confidence.  It has been widely reported that the bailout money is not being used to restore the economy, but rather, for executive bonuses.  Time magazine reported that executives of those firms receiving bailout funds can expect to earn bonuses worth about “15 times the income of the average American household.”  The American people, watching prices rise, job opportunities fall, and their retirement funds slip away, are asking themselves what went wrong.

One of the main arguments in favor of the bailout package was that the collapse of some companies, notably AIG, would have too much of a negative impact on the economy.  American citizens were cautioned that the economy would crumble if these companies weren’t propped up.  Perhaps that is true.  The question, however, is: Why were these companies allowed to become so singularly powerful in our economy? If a company has too much power in its own market, the government intervenes through antitrust law to rein it back from excessive power.  There is a vital, relevant market that appears to have been neglected by the antitrust movement:  The Public Market.

The United States government is familiar with protecting Americans from unfair and corrupt business practices, largely through antitrust law.  Antitrust law, initiated by the Sherman Act in 1890, protects American consumers and competitive firms from the harm that arises out of anti-competitive activities, such as price fixing, cartels, and predatory pricing.  The Act was supplemented by the 1914 Clayton Antitrust Act, which granted the government the authority to intervene earlier to prevent such illegal behavior. The spirit of the Sherman and Clayton Acts is rooted in the fact that consumers are often coerced into paying higher prices and competitive firms generally struggle to stay in business when monopolies exist.  The Antitrust Division of the U.S. Attorney General’s Office and the Federal Trade Commission (FTC) are responsible for monitoring signs and symptoms of anti-competition in the market.  One of the ways in which the Attorney General and the FTC have measured unfair business practices since 1985 is through a market share analysis:  If a company has too high a percentage of the relevant market, the Department of Justice is responsible for investigating its excessive power and punishing the company for it.

It is time for the United States government to enact similar legislation with its eye towards the Public Market, which we shall define as any market with significant public involvement.  Significant public involvement can be established in the following ways:  (1) significant financial investment by individuals, (2) significant repercussions to individual financial investment in the event of collapse, and/or (3) significant ties to other firms that have significant investment by individuals.  Significance should be understood as an unreasonably risky level.  The legislature should establish a threshold, past which significant public involvement is deemed unacceptable and must be hedged in.  If and when the FTC and Attorney General report significant public involvement, the accused firm must post bond to insure the public against any negative repercussions as it corrects itself.  An index, similar to the one used in antitrust law, must be established as a function of significant public involvement.  The index will be a function of the firm’s aggregate public involvement as a fraction of United States Gross Domestic Product.  The bond required for those firms with significant public involvement will be a function of each firm’s involvement.  The bonds will only be reimbursed if the firm reduces its public involvement without damage to the economy.  Through such legislature, the United States government would achieve both short-term and long-term goals necessary to revitalize the economy:

(1) Improve consumer confidence;

(2) Increase transparency;

(3) Increase firm responsibility for harming consumers; and

(4) Minimize the need for a similar bailout in the future.

Of course, there is some responsibility on the part of consumers for the economic crisis in which we find ourselves.  To minimize the future risk of poor individual credit decisions, we recommend Credit Licenses, similar to drivers’ licenses:  If a consumer wants a loan or a credit card, she must take a class and, later, a government-administered exam to demonstrate her competence at making significant financial decisions.  In particular, each consumer must be able to comprehend the details of any consumer credit agreement and must be able to calculate the financial effect of revolving credit.  If the consumer credit agreements are excessively complicated such that a consumer with a high school diploma cannot comprehend them, the government must enact regulation to improve transparency.

Financial analysts, politicians, and reporters have described the current crisis in such a complicated, complex fashion that American consumers may understandably feel disempowered.  It is important to remember, however, that the complexity of an industry must not protect it from inquisition.  Consider the case of the physician:  If a physician makes a mistake on a patient – no matter how technical or complex the procedure – he may be sued for malpractice and may pay damages.  In the case of the current economic crisis, there were, simply put, traders and analysts lacking the competency and wisdom to understand the repercussions of their mistakes.  When the economy was doing well, those mistakes were accepted or ignored.  But when the economy began to slip, the lacking abilities turned devastating.  The financial institutions have a responsibility to their shareholders and consumers to make appropriate staffing decisions.  At the end of the day, regardless of whether the financial institutions could accurately predict the damage they would cause the economy, economists and lawyers will be prepared to estimate the damages now.

This article was written by Dr. Sebastien Gay and Nadia Nasser-Ghodsi.  Nadia is a 2011 J.D. Candidate at the University of Chicago Law School.