William Galston: Before we turn to our chosen topic of infrastructure renewal in America, let’s set the stage with your assessment of the overall condition of t he American economy and its prospects under current policy. How do things look to you?Bernard Schwartz: The word “worrisome” comes first to mind. The intersection of current U.S. policy and the global marketplace will leave us, I fear, with an even more bifurcated economy than we have now. The super-rich, the rich and the upper-middle class will probably do very well with the 2.5 to 4 percent growth rates we’re likely to see over the next few years. The part of the U.S. economy that will do well is connected to particular activities from which the upper strata will benefit disproportionately. Further stagnation and even decline is likely to characterize the lower economic portion of our society, and perhaps the next highest quintile, the lower-middle class, as well. This is not a new phenomenon, of course. This polarization in the economy was going on even before our recent economic crisis. It’s rooted in the ongoing shift from a predominately industrial society to a more knowledge- and service-driven one, and the inability of our educational system to keep up with new forms of demand for labor. But the recession may be intensifying this pattern. In the future, we’ll still do manufacturing, of course, but not the old-style heavy and labor-intensive kind. And clearly, the so-called Great Recession-driven businesses have become more efficient by substituting technology for labor. Now, the government will continue to be the provider of last resort for the poor as these dynamics play out. But the broad middle class may well face a cul-de-sac of opportunity and upward mobility, and that’s very troubling, not least for the embittered politics that will ensue. But—and this takes us to infrastructure—we do have a responsible way to manage this dilemma that we’re not utilizing. WG: What is that responsible way? Bernard Schwartz: Either through the formation of a capital budget or access to some other additional moneys, we could eliminate a huge chunk of our infrastructure deficit. Our decaying infrastructure is a serious problem, and we have the manpower, the technology and the capital to tackle it. We can devise a growth-oriented policy for all our citizens, not just those who are already better off, and rebuild our infrastructure at the same time. This will bear economic dividends for everyone now and for future generations, too. And I just find it frustrating that we’re not seizing on a solution that’s right before our eyes. WG: Why do you think we’re balking? Does it have to do, perhaps, with the inadequacy of the economic recovery policies that have been adopted and implemented thus far? Have we not spent enough to stimulate the economy, or have we spent on the wrong things? Bernard Schwartz: I think the response has been in the right direction, but it’s been inadequate to meet the real economic problems in the country. And one of the reasons for that is an unwarranted fear of deficit spending, which sometimes springs from a misguided ideological orthodoxy about the size of government. I don’t believe that there is some magic limit that defines what the debt-to-GDP ratio should be. When I hear people say, well, it’s already too high and can’t go any higher, my answer is, “Why can’t we go any higher?” The current ratio of government public debt to GDP is approximately 64 percent, so we’ve already gone higher and the sky has not fallen. WG: So you’re not particularly impressed with either the EU standard, which is a 60 percent debt-to-GDP ratio, or with recent economic work suggesting that debts above 90 percent bring severe impacts on growth? Bernard Schwartz: That’s right. I’m not impressed because I don’t know where those numbers come from. No one can look at our history and determine for all times and situations what the proper ratio should be. We’ve had some periods in our history in which the debt was higher than 100 percent: a period of great crisis after World War II, for example. We had to spend the money and worry about repaying it later on, which we did. What we’re facing now may not be as critical to the nation as victory in World War II, but it certainly feels pretty critical to 29 million un- and underemployed Americans. I believe we can afford, for a two- or three-year period, a 100 or 110 percent debt-to-GDP ratio, or whatever number it takes to turn the situation around, as long as there’s a way to repay that debt over several years. WG: And that brings us back to investment in infrastructure, right? Bernard Schwartz: Yes, exactly. Of course it matters what we borrow money for. It would be foolish and irresponsible to borrow it just to finance more consumption—especially consumption of mostly imported goods. But if we invest borrowed funds in an economic essential like infrastructure, and produce jobs here in the United States at the same time, that’s entirely different. That’s wise. And that’s why, if we want to keep America as a first-tier nation for our children and grandchildren, we must increase our infrastructure investment. WG: Increase by how much, do you think? Bernard Schwartz: Prior to around 1970, government spent about 3 percent of GDP per year on investment in infrastructure. Our government did it from the very beginning by investing in roads and canals. After the Louisiana Purchase our efforts grew enormously. We built the Erie Canal. We helped finance the construction of railroads. We pursued electrification far and wide. But in the early 1970s the GDP portion for infrastructure fell to about 2 percent and has remained there since then. That missing 1 percent per year amounts to about $2 trillion of cumulative deficit, which, not coincidentally, is the figure cited by the American Society of Civil Engineers for what fixing the mess we’ve made will cost us. I think we can invest at least $1 trillion over the next decade to bring us up to the kind of country we want to be. And that’s what we need to do, regardless of the deficits. WG: What’s the connection between America’s changing role in the international economy and the recommendations you’re making? Are you concerned that we’re not just squandering opportunities but that we’re also falling behind other countries? Bernard Schwartz: It comes to the same thing, it seems to me. But I’m not especially worried about the United States being overtaken by other countries. As you know, a year or two ago, many supposedly smart thinkers about global issues asserted that we must get used to no longer being the world’s pre-eminent power, and many of them pointed to the economic crisis as key evidence of our decline. Today, however, we see that the crisis has affected almost every nation, and that most nations are looking to the United States for leadership. We haven’t lost our pre-eminence and influence, in my judgment. I think in some ways we may have even gained more of both. Sure, we have problems, but every country has problems, and most of them have problems worse than ours. So I see great opportunity for America right now. We can strengthen our own economic circumstances and lead the way globally in higher education, medicine and research-driven innovation in dozens of fields. And I don’t mind taking on a bit more debt to do that, because these are investments that will pay off big in future years. WG: Your distinction between borrowing for consumption versus investment is worth pursuing a bit more. Over the past three decades the U.S. growth model has rested on ever-expanding household consumption. Since 1980, as we were underinvesting in infrastructure, the amount of household consumption as a percentage of household income doubled, from 65 percent to about 130 percent. In your judgment, is that growth model sustainable, and if it isn’t, what’s the better way? Bernard Schwartz: Plainly, it hasn’t been sustained. But we have to be careful in how we understand the reasons. Yes, both personal and government debt grew rapidly over the past 25 years, but again, what matters isn’t the numbers so much as the numbers of what. There’s nothing wrong with lending to homebuyers, for example, but lenders ignored prevailing standards, and supposedly sophisticated brokerage houses like Lehman Brothers and Bear Stearns were wildly overleveraged. It’s not that they were necessarily making the wrong kinds of loans, that they were financing consumption as opposed to investment. It’s that, thanks to deregulation and particularly to the repeal of the Glass-Steagall Act, the overleveraging spilled over the boundaries of common sense and was allowed to infect vast swaths of the economy in one way or another. We have some understanding now of how this happened. The institutions or agencies that actually made the loans no longer collected the return on those loans. Loan management was packaged and sold to newly created creditors who had no independent ability to monitor the loans and couldn’t even identify the debtors in many cases. So the whole creditor/debtor relationship changed in a way that the kind of sound judgment that used to be integral to banking was no longer necessary, because the loans would be sold to other people, or even possible, because things had become too complex for anyone to follow. In effect, we allowed a separation between the transactions themselves and their consequences. The result, if I had to limit myself to one word, was greed. If I had two words, I’d describe it as unaccountable greed. WG: So what should we do? Bernard Schwartz: It’s clear to me that we have to go back to some kind of Glass-Steagall arrangement in which the capital structure for people wanting to invest in commercial banks is kept apart from the financial bankers. Financial institutions should raise their capital independent of the commercial banks. If they want to risk their own money, that’s their right, but they should not be allowed to risk other people’s money such that they get implicated in the kind of massive overleveraging that can crash the entire economy. WG: Is that an argument against the secondary market? Bernard Schwartz: I think we need a secondary market for rural competition, but that doesn’t mean that a small town in Kansas can’t also have a regional bank devoted to local issues. Every little town in America used to have bankers who understood the central components of local economic activity. Today the person who’s responsible for those loans in Anytown, Kansas, sits in an office on Wall Street, and he couldn’t care less about what it takes for a company to restore itself if it gets in trouble, or what it takes for a local baker or candy shop owner to survive. As far as Mr. Wall Street is concerned, that small business is just a number, just a name. They have no relationship, no trust between them. That’s a loss for America. And by the way, there’s a connection between relationships of trust in the banking and financial sectors and the whole question of financing infrastructure renewal—specifically, where to get that $1 trillion we were talking about a moment ago. WG: I think I know where you’re going with that statement. If I may? Bernard Schwartz: Sure, go ahead. WG: Your $2 trillion figure is an interesting number for several reasons. It is, as you said, roughly the estimate of the underinvestment in infrastructure over recent decades. If we were to raise infrastructure spending by 1 percent per year, starting next year, we’d spend about $2 trillion by 2021—$140 billion this year, compounding to $230 billion by 2021. But what’s really intriguing is that the Fed released a report a few months ago to the effect that there is $2 trillion in private capital sitting on the sidelines essentially earning no return. Corporations and wealth holders aren’t investing it. Instead, they’re keeping it in short-term Treasury bills that aren’t making much, interest rates being what they are. They’re more worried about losing what they have than they are motivated to invest in order to increase what they have. You see a way, do you not, to mobilize private capital both at home and abroad to bolster infrastructure investment, and to get the money into the hands of local governments and institutions that know best what their communities need? Bernard Schwartz: I do, yes. The key problem, as you say, is that there’s not enough capital in the system. We can fix that by devising mechanisms by which private investors would be rewarded for investing their capital for positive, progressive projects that they can follow in their own states, countries and towns, and with some reasonable assurance that they’d be repaid with interest. Wall Street is not pursuing this today, despite the fact that there are plenty of mayors and governors who want to borrow money for infrastructure investment in their localities. My answer (though it’s not the only one) is to create an infrastructure investment bank which, if it operates as a bank should, could leverage four to five times its capital stock from the private sector. So it would not cost the government $1 trillion to get $1 trillion worth of investment, but only a fourth or a fifth of that. WG: Hasn’t President Obama talked about that kind of bank? Bernard Schwartz: Well, that’s what I thought the President had in mind when he mentioned twice recently the idea of an infrastructure bank. But he didn’t articulate what he meant. I envision a bank that would work like the Reconstruction Finance Bank of the United States. It would have independent directors who would have some initial capital from the Federal government. The President mentioned $50 billion. The bank could issue new equity and could use that money to borrow, guarantee and grant infrastructure projects on the basis of a proper structure that allowed for repayment. The opportunity to do this now is as attractive as it ever has been because interest rates are so low. Today a bank could issue a debt of forty or fifty years at historically attractive rates and have no shortage of takers. And note that we’re not re-inventing the wheel here; we’re looking to introduce into the financial structure some of the tools we’ve used in the past, like municipal bonds—only they’d be bonds specifically for infrastructure. They would require mechanisms for repayment, like user fees, tolls or increased tax rolls. WG: So why aren’t we doing this? Bernard Schwartz: We’re not doing it because the people in a position to make this happen on Wall Street are doing so well now that they don’t want anything to change. The financial sector is thriving. Most of it paid no price at all for the havoc it caused. They don’t need to take risks right now, and the government, unfortunately, is not forcing the issue. WG: I’d like to zero in on some of the mechanisms you just outlined, because there’s some confusion about how an infrastructure bank would actually work. Let’s suppose that the Federal government decides to create the bank, Wall Street’s attitude notwithstanding, and endow it with a certain amount of public seed capital. What’s the mechanism whereby the bank would then leverage that at a ratio of four or five to one? Bernard Schwartz: It could, for example, issue more stock, so that the government, instead of being the only stockholder, would be one among many. It could issue preferred stock, which would be accorded a higher rate of return. Wherever the capital comes from, the directors of an infrastructure investment bank could use the initial amount to raise more capital from institutions that take a long view—say, thirty to fifty years. Thankfully, there are still some of those around. They could also use long-term bonds to attract the participation of institutions overseas that have plenty of money that they would love to invest in an agency in which the U.S. government is a co-investor. And foreign investors do not benefit from municipal bond tax breaks, because they don’t pay American taxes. The same could be said of American institutions that are tax-exempt; they might be interested, as well. But whatever the source of the capital, it could be multiplied by four or five, a fairly conservative way to leverage that capital, into $1 trillion fairly quickly. Provided that this money is invested properly, by the fourth or fifth year it should start getting repaid back to the bank, bringing more funds for reinvestment into infrastructure. So we’re talking about a base of $1 trillion that could grow to $1.5 trillion fairly quickly and to the magic number of $2 trillion well before 2021. WG: What would be the legal relationship between this infrastructure bank and the Federal government? Bernard Schwartz: There are several possibilities, but essentially the Federal government would be an investor in the bank and set up certain conditions in its charter that it expects the bank to meet. One is that it will be a job-creation engine for investment in infrastructure in the United States. And it could stipulate that the chairman and vice chairman would be appointed by the Federal government, by the House and Senate, and that the board would have people from business, from academia and from civil society in general. They would be responsible for the proper granting of loans and collection of payments, and for the funds that are utilized by various municipal agencies that are debtors. WG: Would there be an explicit or implicit Federal guarantee? Bernard Schwartz: Yes and no. I’m not being coy. Let me explain what I mean. I think the sort of infrastructure bank we’re talking about could work very well if, as its majority shareholder, the government exercised some control over the entity. If it’s the minority shareholder, it would depend on how the bank’s charter is written. But these are not deal-breakers, one way or the other. After all, it isn’t as if we haven’t done this before, and done it both well and not so well. For example, we should not set up an infrastructure bank the way that Fannie Mae and Freddie Mac were set up. Those entities were never fully guaranteed by the Federal government, but it was assumed that the full credit of the United States stood behind them. Now we’ve come to a point where that assumption is no longer so solid, and even to a point where it’s possible to imagine the liabilities of those entities compromising the credit-worthiness of the U.S. Treasury. That’s a poor model for an infrastructure bank. I’d rather see everything laid out much more explicitly, and I don’t think the government has to be the guarantor. WG: That’s an important point, and you understood exactly why I asked the question. Obviously, government-sponsored enterprises give off a pretty bad odor right now, so I think it’s important to emphasize that you’re not proposing to establish another one. You’re talking about a real bank, about an institution to finance investments in infrastructure that can produce a return of capital and interest to the bank over time. That implies selecting only those projects that produce a revenue stream. So the question that follows is, which forms of infrastructure investment are most amenable to that kind of revenue model? Bernard Schwartz: I would like to see a bank that addresses not just transportation, but our overall national infrastructure opportunities, including high-speed rail, power grids, the improvement of ports, waterway systems, air traffic control and all the rest. These are becoming high-tech, cutting-edge areas, and they encompass vital systems and services for thousands of cities and towns. I think these are inherently attractive investment opportunities. There is money to be made here, without a doubt. A bank could address any kind of project so long as the borrower demonstrated a capacity to pay back the loan. I think just about any project would involve user fees or some regeneration of capital so that the loan could be repaid. But the bank would have to be satisfied with that promise or else it would reject the loan. If the bank rejects a would-be borrower, it could still get funds from another bank. As I see it, the infrastructure bank wouldn’t be the exclusive way to address infrastructure investment needs. We’d need an investment of about two times what the bank could probably handle. But the Federal government should involve itself in the mix and, if necessary, take the lead. Sometimes that’s the best way to achieve the kind of society and the level of widely shared prosperity we want. WG: Last but not least, a question that skeptics have on occasion put to me: If there’s an opportunity for private capital to be invested profitably, then why can’t existing funding mechanisms accommodate it? Specifically, why can’t states and municipalities issue revenue bonds, bonds depending on tolls, user fees, expanded tax bases and so on without the intermediary of a new infrastructure bank? What’s missing in the current structure? The skeptics usually say that nothing is missing, that the reason these investments aren’t being made is that they can’t pass a market test. What’s wrong with that argument? Bernard Schwartz: I’m not sure anything is wrong with that argument in theory. Why, indeed, can’t private industry do this? All I know is that, in practice, for thirty years it hasn’t done it. It’s a classroom argument that doesn’t reflect how Wall Street works today. Isn’t it obvious, after what we’ve been through these past few years, that private enterprise doesn’t always take care of the nation’s necessary business? Sometimes systems fail not because they can’t work, but because they don’t work. All I’m suggesting is that, at a time when the private system isn’t working in this particular area, there’s a role for another system that doesn’t threaten private enterprise but that complements and supplements it. It’s not an either/or decision. Both can operate. The gist is that we need to invest $1 trillion in infrastructure in the next decade, and we need to create millions of jobs doing it. No one is against this; rather, everybody agonizes over how to find the money. Well, this infrastructure bank concept is a way to find the money, using public and private capital, with private and local municipality oversight. I think that if we demonstrate the will to do what’s necessary for our country, to show both that it can be done and what we will suffer if we fail to act, then all the artificial objections about deficit spending and “big government” will melt away. At any rate, I want to put that proposition to the test. WG: All I can say to that is amen, and thanks for talking with me. Bernard Schwartz: Thank you, Bill; you’re a well-informed inquisitor.
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Appeared in: Volume 6, Number 4Bank on It: A Conversation with Bernard Schwartz
Published on: March 1, 2011
Published on: March 1, 2011
A conversation with Bernard Schwartz and William A. Galston on
options for financing U.S. infrastructure renewal.