The heterodox economists who predicted the financial crisis have solutions for it, too

It’s been three years since the global economic meltdown, and still no one’s gone to jail for the fraudulent behavior that pervades the revolving door between Wall Street and K Street. Like a breath of fresh air, the Occupy Wall Street movement has gained serious traction. People are demanding action, but what? There are lists of grievances about a government that is closer to plutocracy than democracy; there are complaints of bailouts and rising inequality; there are demands for abolishing the Federal Reserve Bank; and there is a pressing need for the growth of decent jobs.

Within the media, the OWS movement has been portrayed as scattered and confused, and there is good reason for this: Economic education is dominated by a model whose conclusions support the interests of the one percent, while economic ideas that support the 99 percent have been suppressed.

Nowhere is this more evident than in the Kabuki theater we call Congress, where the focus is on cutting the deficit, not job creation. We are told austerity is needed, but it’s austerity for the poor and middle class, which means entitlement cuts and tax increases for those groups. In the financial media, the pages are littered with questions like these: Why aren’t the US and global economies growing? Why haven’t the Fed’s quantitative easing policies worked? Why didn’t Obama’s stimulus program work? Why haven’t any banksters gone to jail? If big finance is the disease, then what’s the cure?

On the one (right) hand, some economists demand austerity; on the other (left) hand, some economists say we need more spending. As Harry Truman would say, “Someone get me a one-handed economist!”

Like our media, government, and lives in general, the discipline of economics is dominated by a pro-market, pro-corporate agenda. It is not an accident that the policy implications of their models support the interests of the one percent. The so-called top-rated journals only publish articles that adhere to this dominant, market-oriented model, a model that failed to have one economist (among tens of thousands) recognize and predict the bursting of the largest financial bubble in history. This failing caused one of their own, Paul Krugman, to pen an article in the New York Times Magazine titled, “How Did Economists Get It So Wrong?” And these are the same economists upon whom we are relying now to solve the crisis! Is it any wonder why we’re three years from the meltdown and unemployment is still stuck above nine percent? It’s time for a regime change.

On the fringes of this mainstream are a handful of alternative, or heterodox, economists—Post Keynesians, Institutionalists, Austrians, and Marxists—who reject the unrealistic mathematical models that can only characterize an imaginary economy. Of the economists who saw and predicted the financial crises, all are associated with one of these alternatives, and the majority are associated with the Post Keynesian school, influenced significantly by the works of the late Hyman Minsky.

Here’s one simple, yet striking, example of how heterodox approaches differ from the dominant model: We incorporate the use of debt financing, while debt is completely absent in the mainstream model. Post Keynesians argue that profit-seeking financial institutions are the root cause of instability. Banks make profits by issuing debt (loans), and to increase profits, they must increase the growth of debt and other forms of credit; however, ultimately, the payments for this paper must come from the incomes earned by firms and consumers. The problem: 1) income growth is constrained by the growth of the real economy, which has averaged about three percent per year over the past 60 years (four to five percent if you include inflation); however, 2) private sector debt (excluding government debt) tends to grow about six to 10 percent per year (where we are on this range usually depends on how heavily regulated finance is or isn’t). These divergent growth paths are unsustainable. The growth of debt requires more and more income dedicated to debt payments, so, at some point, the bubble bursts, and there is a financial crisis.

Post Keynesians would argue that the past 30 years of financial deregulation paved the way for the current crisis. A high profit rate for finance requires a high growth rate of debt: Big finance wants big profits, and big profits require big, debt-financed bubbles. However, regulation constrains the ability of finance to generate debt, and therefore profit. We supposedly learned this lesson from the Great Depression, which was also the result of a debt-financed bubble (the ratio of private debt to income hit 230 percent in 1930), and regulations were passed in the 1930s that severely constrained banks’ ability to create debt. Financial crises were almost nonexistent for the next 30 years, and the business of banking became boring, but it was stable.

In 1980, with the Depression a distant memory, financial interests pushed for and got deregulation. Financial interests continued this push through 2000, with deregulation finally giving way to the theory that finance could “self-regulate.” The title of a recent book by noted former regulator Bill Black summarized the outcome of this theory: The Best Way to Rob a Bank is to Own One.

And the result of self-regulation? The largest run-up of debt in history, as the ratio of private sector debt-to-income hit 300 percent in 2008; the FBI reported an epidemic of mortgage fraud; three of the largest investment banks were forced to merge, or failed; ratings agencies lied; Fannie Mae, Freddie Mac, and AIG were taken over by the government; and the Fed was forced to use trillions of dollars to bail out the underlying fraudulent behavior. Yet no one went to jail.

While Post Keynesians and other heterodox economists were warning of impending disaster in 2006-2007, 95 percent of the economists in the US were clueless because there’s no possibility of crisis in their model. This is why Fed chairman Ben Bernanke, the mainstream’s number one cheerleader, was also telling us in 2007 that “all is well.”

Is there a solution? If insanity, as Einstein said, is doing the same thing over and over again and expecting the same result, then the last thing we need to do is listen to those same purveyors of economic fantasy who are now telling us that austerity is the solution. It’s a solution, but it’s a solution that the one percent want imposed on the 99 percent. Meanwhile, heterodox economists like Randy Wray, Bill Black, Dean Baker, James Galbraith, and Robert Pollin are offering solutions that promote the interests of the 99 percent.

These progressive economists, and the centers and institutes with which they are associated, have proposals to get us out of the crisis and build an economy designed for all to prosper, not just the few. If you want to learn about these proposals, visit websites like the Levy Institute (Wray and Galbraith), or the Political Economics Research Institute (Pollin), or the Center for Economic and Policy Research (Baker). Or visit blogs like Steve Keen’s Debtwatch or UMKC’s NewEconomicPerspectives. You also can find resources from thousands of heterodox economists on the website for the Heterodox Economics Newsletter, which I co-edit.

Things are changing. The OWS movement shows that people are “sick and tired of it and are not going to take it anymore.” Heterodox economists are finally being asked for their input. For example, in response to a recent GAO report that found, “Top executives from Goldman Sachs, J.P. Morgan Chase, General Electric and other firms sat on the boards of regional Federal Reserve banks while their firms benefited from the central bank’s policies during the financial crisis,” Senator Bernie Sanders of Vermont formed an advisory panel of economic experts to make recommendations on reforming the Fed. All of the economists mentioned above are included on this panel. And last week a group of Harvard students walked out of an introductory economics course taught by Greg Mankiw, a leading purveyor of the “one percent model,” protesting the conservative bias in his book and instruction.

The people are awakening, and the winds of regime change are in the air, but the power of vested interests won’t go quietly.

Dr. Ted P. Schmidt is an associate professor in Buffalo State College’s Department of Economics and Finance and co-editor of the Heterodox Economics Newsletter.