It’s being called the broadest overhaul of Wall Street regulation since the Great Depression. But look closely at the proposal announced this morning by Treasury chief Hank Paulson, and you’ll find a thin veneer of regulatory filagree — designed to appease a public outraged by the mismanagement of its savings and the taxpayer-financed bailout of Wall Street’s well-padded executives, but also, sadly, designed to accomplish just about nothing.
Paulson rearranges and consolidates lots of regulations and seems to beef up the oversight responsibilities of the Federal Reserve. But the Fed would not routinely examine the books of investment banks and hedge funds the way bank examiners now scrutinize regular banks, and agencies like the SEC would actually lose some of their current authority.
Most significantly, the proposal doesn’t call for investment banks, hedge funds, and other currently unregulated financial institutions to hold capital assets proportional to the risks they’re taking on. That’s the case even though the Fed has now subjected taxpayers to the risk of bailing out any large financial institution that gets into trouble because it doesn’t have enough capital to back up its risky bets. Even though two-thirds of subprime mortgages issued in the last five years originated with non-banks that have little or no capital requirements. Even though 80 percent of all lending today is from unregulated banks that hold almost no capital assets.
Paulson says he doesn’t blame the current regulatory structure for current market turmoil. Well, Hank, if it’s not the current Wild-West take-any-risk with other people’s money non-regulatory structure we have now, how do you explain the housing bubble and the credit meltdown and the taxpayer bailout of Wall Street? How exactly are your proposed fixes going to prevent another crisis?
Hank Paulson’s discussion paper – it’s not even meant to be enacted under the Bush Administration – is not broad, it’s not an overhaul, and heaven forbid, if we’re facing another Great Depression, it will do absolutely zilch to head it off.
March 2008
11 posts
So JP Morgan is raising its offer for Bear Stearns, hmm? Well, it still may be a good deal for old JP, because the worst that can happen is JP loses $1 billion. If losses turn out to be more than $1 billion, the Fed – that is, you and I and every other American taxpayer – will make it up to JP. Who knows what the assets are really worth? They may be worth 80 cents on the dollar, in which case Bear’s stocks are a huge value even at $10 a share (remember, their market price before the panic was around $70 a share). They may be worth 90 cents on the dollar – even better for JP. Or they may eventually (in the long run, when the crisis is over and housing values start trending upward again) be worth far more —- maybe, just maybe, even approaching $70 a share. JP doesn’t know. Bear doesn’t know. The Fed doesn’t know. Everyone is guessing. Bear shareholders are playing a giant game of “chicken.” They’re threatening to go into bankruptcy – that is, liquidate the firm and essentially sell off their assets in an auction – if they don’t get a better deal from JP than the $2 per share JP originally offered.
But it’s not just Bear’s shareholders who should be asking for more. You and I as taxpayers ought to be asking for more, too. I mean, we’re bearing the big downside losses if everything goes to hell and Bear’s assets are worth less than zilch. But we don’t get any of the upside gain if any of the bets pay off. That’s what I call a lousy deal.
A similar lousy deal is brewing in Congress where Democrats are readying a bill to guarantee the price of securities containing bad mortgage debt, if investors will buy them and restructure the securities so homeowners have a better chance of repaying their mortgages (stabilizing the interest rates and lengthening the terms of repayment, for example). The betting here is that, by doing this, the underlying assets will be worth more than the investor buyers are paying for them. In other words, once these mortgages are restructured, more homeowners will be able to keep paying them, so houses will be generating real money for mortgage lenders once again. But it’s a gamble for a potential investor buyer. And if Congress takes the downside risk out of the gamble, it seems only appropriate that taxpayers should get a portion of the upside gain. (The Dodd-Frank bill would in fact give taxpayers a portion of any homeowner equity gain.)
We as taxpayers are chumps if we bear all the downside losses but get none of the upside gains.
Here’s a better idea: When the Fed bails out a Wall Street bank in danger of collapsing or when government (under the Democrats’ bill) guarantees the price of securities that have an unknown amount of bad debt wrapped up in them, the government should retain a stake. That way, if Bear Stearns stock eventually bounces back, or if JP Morgan shows a big profit on its purchase of Bear, or if buyers of any securities guaranteed by the government make a profit – whatever the upside gain turns out to be — taxpayers that are footing the bill for potential losses get some of that money. And these upside profits cover us in cases where the gamble turns out bad and we’re left holding the bag.
I’m not suggesting anything so draconian and ideologically objectionable as public ownership. Perish the thought. Let the Brits bail out their big bank and nationalize it, and get any upside gain when and if the bank’s shares become worth something again and the UK sells off the bank. No, I’m making a much more modest suggestion. We should arrange our own bailout deals so that American taxpayers get a portion of the profits on bets that turn out good, in order to compensate us for the bets that turn out bad.
The idea is as American as apple pie: Nothing ventured, nothing gained.
In light of all the blather about “moral hazard” in recent days, several of you have suggested I re-publish my blog from last September 07, on the issue of moral hazard. Herewith:
One day while sitting on a beach last summer I overheard a father tussle with his young son about whether the child was old enough to take out a small sailboat. The father finally relented. “Go ahead, but I’m not gonna save you,” he said, picking up his newspaper. A while later, the sailboat tipped over and the child began yelling for help, but father didn’t budge. When the kid sounded desperate I put down my book, walked over to the man, and delicately told him his son was in trouble. “That’s okay,” he said. “That boy’s gonna learn a lesson he’ll never forget.” I walked down the beach to notify a lifeguard, who promptly went into action.
Letting children bear the consequences of their risky behavior — what some parents call “tough love” — is equally applicable adults, and conservatives have made something of a fetish out of it. A few weeks ago, as George W. announced a paltry plan to help out a few of the millions of homeowners who got caught in the sub-prime loan mess, he reiterated the credo: “It’s not government’s job to bail out … those who made the decision to buy a home they knew they could not afford.”
It’s true that people tend to be less cautious when they know they’ll be bailed out. Economists call this “moral hazard.” But even when they’re being reasonably careful, people cannot always assess risks accurately. Many of the mostly poor home buyers who got into trouble did NOT in fact know they couldn’t afford the mortgage payments they were signing on to. The banks and mortgage lenders that pulled out all the stops to persuade them to the contrary were in a far better position to know; after all, they had lots of experience at this game. So did the credit-rating agencies that gave these loans solid credit ratings, as did the financiers who bundled them with less-risky loans and sold them to other financial institutions, and the hedge fund managers who quietly tucked them into their portfolios.
The real moral hazard in this saga started when Fed Chair Ben Bernanke cut the Fed’s discount rate (charged on direct federal loans to banks) and announced that the Fed would take whatever action was needed to “promote the orderly financing of markets.” Translated, this means that lenders, credit-rating agencies, financial intermediaries, and hedge funds will be bailed out, one way or another, because they’re simply too big to fail. Note that behind every one of these institutions lie thousands of well-paid executives who would have lost big if the Fed didn’t come to their rescue. Even though they had more information and experience at risk-taking than the suckers who borrowed their money, and even though executives at the top of these instutions typically earn more in a day than the borrowers do in a year, moral hazard somehow doesn’t apply to them.
When it comes to risky behavior in the market, America has a double standard. We’re told that economic risk-taking as the key to entrepreneurial success, but when big entrepreneurs take big risks that fail it’s amazing how often they get bailed out. Indeed, the history of modern American business is littered with federal bailouts, loan guarantees, and no-questions-asked reorganizations. Some are well known, such as the Chrylser bailout of 1979, the savings and loan bailout of 1989, and the airline bailout of 2001. Most occur in the relative dark, such as the 1998 bailout of giant hedge fund Long-Term Capital Management (courtesy of former Fed chair Alan Greenspan), the not infrequent bailouts of under-funded corporate pension plans by the government’s Pension Benefit Guarantee Corporation, price supports for big agribusinesses facing market downturns, or the current bailout of Wall Street being engineered by Ben Bernanke’s Fed. Behind every one of these bailouts are CEOs or financial executives who were rescued from their bad bets.
CEOs get away with stupid mistakes all the time. Some, like Robert Nardelli, the former CEO of Home Depot, drive their company’s stock low that their boards eventually oust them. But they leave with eye-popping going-away presents nonetheless. (Nardelli got several hundrd million dollars on his departure.) If you’re an average American who gets canned from his job, even through no fault of your own, you probably won’t even get unemployment insurance (only 40 percent of job-losers qualify these days). Conservatives tell us that unemployment insurance reduces their incentive to find a new job quickly. In other words, moral hazard.
Some CEOs use bankruptcy as a means of getting out from under pesky labor contracts they might have “known they could not afford” when they agreed to them (Northwest Airlines most recently, for example). Others use it as a cushion against bad bets. Donald (“you’re fired!”) Trump’s casino empire has gone into bankruptcy twice — most recently, last November, when it listed $1.3 billion of liabilities and $1.5 million of assets — with no apparent diminution of the Donald’s passion for risky, if not foolish, endeavor. After all, his personal fortune is protected behind a wall of limited liability, and he collects a nice salary from his casinos regardless. But if you’re an ordinary person who has fallen on hard times, just try declaring bankruptcy to wipe the slate clean. A new law governing personal bankruptcy makes that route harder than ever. Its sponsors argued — you guessed it — moral hazard.
Bush’s “ownership society” has proven a cruel farce for poor people who tried to become home owners, and his minuscule response to their plight just another example of how conservatives use moral hazard to push their social-Darwinist morality. The little guys get tough love. The big guys get forgiveness.
The Fed bailout of Wall Street keeps getting larger and larger. Not only has the Fed lent J.P. Morgan thirty billion to take over Bear Stearns, but starting today, securities dealers can borrow money from the Fed on about the same low terms as member banks. The Fed also lowered the rate charged on such loans, and extended the repayment deadline to three months (from one). We haven’t witnessed this scale of bailout since the 1930s.
Will it work? The immediate goal is to stop the runs – runs on banks, runs on securities dealers, and the biggest run of all, the run on the dollar. Stampedes occur when lenders lose confidence that borrowers can pay them back – and worry that all OTHER lenders are losing confidence, too. So everyone runs to get their money out before everyone ELSE gets their money out.
Viewed in large terms, these runs are a consequence of how indebted America and Americans have become. We’ve been living beyond our means for some time now, borrowing to the hilt. This had to end at some point. Even the US dollar has become encumbered with so much international debt that – as the nation’s IOU – it has become endangered. Investors are getting out of dollars because they think everyone else is getting out of dollars.
Can the Fed pour enough money into the system to assure all lenders, domestic and foreign, that their own money (including money left in dollars) will be safe? It’s a tricky dance. If the Fed scares everyone into thinking that the crisis is larger than they otherwise thought, then the stampede gets worse. And by pouring money into the system, the Fed also may create the impression that the dollar could inflate away – losing its value because so many other dollars are on the market. That would only cause investors to dump more of their dollars and switch to euros or yen or sterling or gold or whatever else they can find to put their money into.
The speculative bubble that began to grow in 2003 when Alan Greenspan and company cut short-term interest rates to 1 percent and made money so cheap that every lender pushed money into the hands of any borrower who could stand up straight triggered all this. Housing prices have to drop another 10 percent, and big banks have to write off another $200 billion in worthless assets, if we have a prayer of getting through it – bailouts or not.
So now the New York Fed is bailing out Bear Stearns. Earlier, Bernanke’s Fed created an unprecedented $200 billion lending fund to Wall Street, offering Treasury securities in exchange for mortgage-backed securities. And there’s talk of further Fed bailouts of Wall Street.
These bailouts won’t work because the Street’s big banks are still sitting on what may be another three to four hundred billion dollars of bad debt. The rest of the world economy, through the magic of securitization, may be sitting on another few hundred billion. And because no one knows precisely how much or where this bad debt is, the risk premium is even higher. Which is why credit markets will remain more or less frozen.
We won’t be out of this mess until the speculative bubble that was created when the Fed cut slashed interest rates six years ago fully pops. For that to happen, Wall Street will have to face its real losses and write off another several hundred billion. And home owners across America will have to face their losses and watch the value of their houses drop another 10 percent, about to where they were before the bubble.
The Fed bailing out the big banks is like someone with an helium tank blowing more air into a leaky balloon. It only postpones the inevitable, which is that the balloon will lose its air and float back to earth. For markets to work again, speculative bubbles have to burst, one way or another.
The immediate practical question is how to manage the burst. A Wall Street bailout can help avoid runs on banks and runs on the dollar — but only if conditioned on Wall Street pricing its assets close to their real market values.
The next question is how to cushion the blow for middle and lower-income people who might lose their homes or their jobs, cars, medical insurance, and large chunks of their pensions. This may require federally-subsidized insurance — mortgage insurance so homeowners can meet payments, along with expanded unemployment insurance, health insurance, maybe even pension insurance. All hard to accomplish, but ultimately more important than bailing out the big banks.
Retail sales fell again in February. Unemployment continues to rise. After rallying yesterday, stocks continue to drop. Even though the Fed has taken the extraordinary step of bailing out Wall Street banks and taking over their troubled mortgage loans, Wall Street is still unhappy. The Treasury Department is readying new proposals for helping stranded homeowners, which are expected to be unveiled later today.
What’s going on? Let me explain as clearly as I can.
American consumers are coming to the end of their ropes and don’t have the buying power they need to absorb the goods and services the U.S. economy is capable of producing. This is likely to mean fewer jobs, which will force Americans to pull in their belts even tighter, leading to still fewer jobs – the classic recipe for recession. That recession may turn into a full-fledged Depression if fiscal and monetary policies can’t make up for consumers’ lack of buying power. And there’s reason to worry they cannot because consumers are in a permanent bind. They’re deep in debt, their homes are losing value, and their paychecks are shrinking.
Under these circumstances, the usual remedies won’t work. Wall Street bailouts have no effect because housing prices continue to fall, and the Street is sitting on a giant pile of bad debt. Tax breaks for business won’t generate more investment in factories or equipment because demand for their products what emerges from the factories is dropping. Temporary fixes like a stimulus package that give households a one-time cash infusion won’t get consumers back to the malls because they know the assistance is temporary and their problems are permanent. They’re likely to pocket the extra money instead of spending it. Additional Fed rate cuts might give consumers access to somewhat cheaper loans, but there’s no going back to the easy money of a few years ago. Lenders and borrowers have been badly burned. The values of houses and other major assets are dropping even faster than interest rates can be lowered. Growing numbers of homeowners owe more on their mortgages than their homes are now worth on the market.
We’re reaping the whirlwind of many years during which Americans have spent beyond their means and most of the benefits of an expanding economy have gone to a relatively small group at the very top. Adjusted for inflation, the median wage is below where it was in 1999. The nation’s median hourly wage is barely higher than it was 35 thirty-five years ago. The income of a man in his 30s is now 12 percent below that of a man his age three decades ago. The rich, meanwhile, can’t keep the economy going on their own because they devote a smaller percentage of their earnings to buying things than the rest of us: After all, they’re rich, and they already have most of what they want. Instead of buying, they’re more likely to invest their earnings wherever around the world they can get the highest return.
Some say well and good. They think our consumer society is unsustainable as it is. They argue Americans should learn to accept a lower standard of living and American business must adjust to a smaller domestic economy. This argument leaves out one salient fact: Considered as a whole, the nation has enough productive capacity to provide a higher standard of living for its citizens and also be sustainable. With the right incentives, we could dramatically reduce energy use and carbon emissions while continuing to grow at a rate that provided most people with good jobs at good wages. The problem isn’t economic growth per se. It’s unbalanced growth – too much consumption of goods and services that utilize too much energy and generate too much carbon into the atmosphere. Balanced growth is surely possible. But if the economy heads into a severe recession or Depression, there’s almost no way to achieve more balance. Hard-pressed Americans will be unwilling to sacrifice anything.
The debate over widening economic inequality of income and wealth in America usually pits fairness against growth. Conservative supply-siders contend that the people at the top not only deserve to be richly rewarded because such rewards encourage them to invest and innovate, and thereby benefit everyone else. Liberals concede that some inequality may be necessary to encourage growth but that we have long passed the point where it is either necessary or fair. But the reality we’re now facing poses a different question: Can we have any growth at all when income and wealth are so unequal that most Americans can no longer buy what they produce?
The answer is likely to be no. Go back to the years just before the Great Depression and you see the same pattern. As I’ve noted before, Marriner S. Eccles, who served as Franklin D. Roosevelt’s Chairman of the Federal Reserve from 1934 to 1948, noted this in his memoir “Beckoning Frontiers”:
“As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth — not of existing wealth, but of wealth as it is currently produced — to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”
Is the game about to stop again?
House Democrats will soon propose to deny legal protection to phone companies that helped the National Security Agency wiretap Americans without warrants after 9/ll. This makes sense.
I’m old enough to remember J. Edgar Hoover’s FBI and Nixon’s CIA, and the Federal Intelligence Surveillance Act of 1978. But anyone who’s even halfway sentient ought to know there’s a Fourth Amendment to the Constitution. So you’d think that executives at the nation’s biggest telecoms — AT&T, Verizon, and so on — would be alert to the possibility that government might illegally snoop on Americans. Yet these executives didn’t blink an eye when the NSA came knocking. You want records of domestic phone calls? Sure, help yourself! Emails? Yeah, we got tons. They’re yours!
When word of this leaked out and the companies got sued by Americans who didn’t particularly like the idea of government rummaging through everything they said or wrote, the telecoms went to Congress and complained it wasn’t their fault. They deserved immunity from such lawsuits, they said, because they were only following orders.
Only following orders? What if the government told telecoms to use their technologies to spy on American bedrooms, or turn over our bank accounts, or our photographs, home videos, anything else we store on computers or transmit through cables or over the Internet? The “only following orders” excuse would make telecoms extensions of our spy agencies.
Corporate executives have a duty to disobey government orders when they have reason to believe those orders are illegal or unconstitutional — and make the government go to court to get what it wants. The duty to refuse is especially important when it comes to the nation’s telecoms, whose technological reach is extending deeper and deeper into our private lives.
Sure, there’s a delicate balance between fighting terrorism and protecting civil liberties. But that’s for courts to decide – not spy agencies and not telecom executives. If in doubt, the telecoms could have gone to the special courts set up precisely to oversee this balance, and get a declaratory judgment. The House proposal would give federal courts special authority to hear classified evidence and decide whether the phone companies should be held liable.
The only way to keep pressure on telecoms to protect Americans, and not become agents of our spy agencies, is to continue to allow Americans to sue them for violating their legal rights.
It used to be that when the American economy sank into recession, developing economies sank along with it. But that probably won’t happenthis time. And a big reason lies in the Middle East and in China.
Much of the Middle East is swimming in oil money — petro-dollars — while China has built up its own huge stock of sino-dollars. These petro-dollars and sino-dollars aren’t just sitting there in the Middle East and in China. They’re being put to work - building new infrastructure in both places: skyscrapers, power plants, power grids, roads, ports. And building middle classes that, while still relatively small, want the things middle classes in advanced nations want - cars, refrigerators, houses, and lots of stuff to fill their houses.
All this spending on infrastructure and on goods and services by emerging middle classes, in turn, is pulling in resources, goods and services from the rest of the world. That includes exports from other emerging economies.
This means the world’s developing nations are no longer nearly as dependent as they used to be on consumers in the United States and other rich nations to keep them going by buying their exports. In fact, consumer spending is rising almost three times as fast in developing nations as in rich nations. Real capital spending is rising by double digits there while it’s rising only a bit over 1 percent a year in rich nations. And emerging economies’ trade with each other is increasing faster than their trade with richer nations.
Is this de-coupling of emerging from developed economies good news for the United States? Yes and no. It’s good news to the extent that even as America falls into recession, developing nations will continue to demand some of our exports. They’ll also continue to generate healthy returns for American investors who put money into them. And they’ll invest in U.S businesses and financial institutions that desperately need the capital. These revenues will offset a bit of the decline here.
But in a more significant way, the de-coupling is not at all good news for us. It means the price of many things we buy from developing nations — especially raw materials like oil - will continue to be high, and might even rise. Years ago, recessions in the United States depressed prices in the developing world, including oil prices — and these price drops helped cushion us against even deeper recessions. Now it’s the reverse. China’s almost insatiable need for Middle-East oil, for example, continues to bolster oil prices even though demand for oil is slowing here as the American economy slows. As a result, high global oil prices are making our slump even worse.
So it’s two cheers for the developing world. Emerging economies are growing almost regardless of downturns in rich nations. In terms of global equity and long-term stability, we should all be happy about that. But viewed narrowly and in the short term, from the perspective of world’s richest nation now heading into deep recession, it’s only two cheers rather than three.
I’m thrilled at the record Democratic turnouts across the country, and at the ground-breaking reality of the Democrats’ two candidates. But I’m also becoming anxious at the prospect of a fight that could reduce the possibility of either of them entering the White House in January of 2009.
Is HRC willing to sacrifice that possibility in order to preserve a tiny possibility that she’ll get the nomination? With her win in Ohio and projected win in Texas, that seems so. In the days leading up to the Ohio and Texas primaries, we had HRC’s statement that both she and McCain have the experience to be Commander-in-Chief but Obama doesn’t. This is the first time in my memory that a major candidate in a primary has said that the other party’s nominee would be a better president than his or her own primary opponent. We also had the outpouring of negative advertising from her campaign that both candidates had largely managed to avoid up to this point.
And while I can understand her decision — bolstered by yesterday’s results — to fight on in this primary election, the reality is that she can only win by convincing large numbers of superdelegates to join her and re-engineering the Michigan and Florida primaries to her advantage, and then taking the fight all the way to the convention in August — which if she gets that far, will be one of the most divisive in forty years.
I suppose I should not be surprised. If HRC has experience in anything, it’s in fighting when cornered. When Bill Clinton lost his governorship, it was HRC who commissioned Dick Morris to advise the Clintons on a no-holds-barred campaign to retake the governor’s mansion. At the start of 1995, when Newt Gingrich and company took over Congress and the Clinton administration looked in danger of becoming irrelevant, it was HRC who installed Dick Morris in the White House, along with his sidekick Mark Penn, to “triangulate” by distancing Bill Clinton from the Democratic Party and moving the Administration rightward. (When Morris was subsequently discovered to have a penchant for the toes of prostitutes the White House dumped him but kept Penn on.) And now Mark Penn is the “chief strategist” of HRC’s campaign.
The sad news is that whether the Clinton scorched-earth strategy ultimately succeeds or fails, it will have caused great harm. In the unlikely event it succeeds, the result will be a shame and not a little ironic. Barack Obama has breathed life into the Democratic Party, and into American politics, for the first time in forty years. Not since Robert Kennedy ran for president has America been so starkly summoned to its ideals; not since then has America — including, especially, the nations youth — been so inspired. The Clintons would prefer to write off Obamania as a passing fad, but the reality is that idealism and inspiration are necessary preconditions for positive social change. Nothing happens in Washington unless Americans are energized and mobilized to make it happen. HRC’s tactics are the old politics the nation is recoiling from — internal division and national fear. This only serves to deepen Americans’ cynicism about politics, and makes social change all the harder to achieve.
I think the chances of a Depression are no higher (and not much lower) than twenty percent. Why not higher? Because, unlike then, our monetary authorities know how and when to pump more money into the economy; our Congress and White House know how and when to stimulate with fiscal policy; and the US economy is more integrated with the rest of the world (which is riding out the storm better than we are) than then. But no lower because the similaries with what led to the Great Depression are so stark. Then what do I suggest in addition to the standard remedies? Here’s what I wrote in the NY Times a few weeks ago:
TOTALLY SPENT
WE’RE sliding into recession, or worse, and Washington is turning to the normal remedies for economic downturns. But the normal remedies are not likely to work this time, because this isn’t a normal downturn.
The problem lies deeper. It is the culmination of three decades during which American consumers have spent beyond their means. That era is now coming to an end. Consumers have run out of ways to keep the spending binge going.
The only lasting remedy, other than for Americans to accept a lower standard of living and for businesses to adjust to a smaller economy, is to give middle- and lower-income Americans more buying power — and not just temporarily.
Much of the current debate is irrelevant. Even with more tax breaks for business like accelerated depreciation, companies won’t invest in more factories or equipment when demand is dropping for products and services across the board, as it is now. And temporary fixes like a stimulus package that would give households a one-time cash infusion won’t get consumers back to the malls, because consumers know the assistance is temporary. The problems most consumers face are permanent, so they are likely to pocket the extra money instead of spending it.
Another Fed rate cut might unfreeze credit markets and give consumers access to somewhat cheaper loans, but there’s no going back to the easy money of a few years ago. Lenders and borrowers have been badly burned, and the values of houses and other assets are dropping faster than interest rates can be lowered.
The underlying problem has been building for decades. America’s median hourly wage is barely higher than it was 35 years ago, adjusted for inflation. The income of a man in his 30s is now 12 percent below that of a man his age three decades ago. Most of what’s been earned in America since then has gone to the richest 5 percent.
Yet the rich devote a smaller percentage of their earnings to buying things than the rest of us because, after all, they’re rich. They already have most of what they want. Instead of buying, and thus stimulating the American economy, the rich are more likely to invest their earnings wherever around the world they can get the highest return.
The problem has been masked for years as middle- and lower-income Americans found ways to live beyond their paychecks. But now they have run out of ways.
The first way was to send more women into paid work. Most women streamed into the work force in the 1970s less because new professional opportunities opened up to them than because they had to prop up family incomes. The percentage of American working mothers with school-age children has almost doubled since 1970 — to more than 70 percent. But there’s a limit to how many mothers can maintain paying jobs.
So Americans turned to a second way of spending beyond their hourly wages. They worked more hours. The typical American now works more each year than he or she did three decades ago. Americans became veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.
But there’s also a limit to how many hours Americans can put into work, so Americans turned to a third way of spending beyond their wages. They began to borrow. With housing prices rising briskly through the 1990s and even faster from 2002 to 2006, they turned their homes into piggy banks by refinancing home mortgages and taking out home-equity loans. But this third strategy also had a built-in limit. With the bursting of the housing bubble, the piggy banks are closing.
The binge seems to be over. We’re finally reaping the whirlwind of widening inequality and ever more concentrated wealth.
The only way to keep the economy going over the long run is to increase the wages of the bottom two-thirds of Americans. The answer is not to protect jobs through trade protection. That would only drive up the prices of everything purchased from abroad. Most routine jobs are being automated anyway.
A larger earned-income tax credit, financed by a higher marginal income tax on top earners, is required. The tax credit functions like a reverse income tax. Enlarging it would mean giving workers at the bottom a bigger wage supplement, as well as phasing it out at a higher wage. The current supplement for a worker with two children who earns up to $16,000 a year is about $5,000. That amount declines as earnings increase and is eliminated at about $38,000. It should be increased to, say, $8,000 at the low end and phased out at an income of $46,000.
We also need stronger unions, especially in the local service sector that’s sheltered from global competition. Employees should be able to form a union without the current protracted certification process that gives employers too much opportunity to intimidate or coerce them. Workers should be able to decide whether to form a union with a simple majority vote.
And employers who fire workers for trying to organize should have to pay substantial fines. Right now, the typical penalty is back pay for the worker, plus interest — a slap on the wrist.
Over the longer term, inequality can be reversed only through better schools for children in lower- and moderate-income communities. This will require, at the least, good preschools, fewer students per classroom and better pay for teachers in such schools, in order to attract the teaching talent these students need.
These measures are necessary to give Americans enough buying power to keep the American economy going. They are also needed to overcome widening inequality, and thereby keep America in one piece.
Probably not. But go back 75 years and you’ll find eerie similarities. Marriner S. Eccles who served as Franklin D. Roosevelt’s Chairman of the Federal Reserve from November, 1934 to February, 1948 gave his view of what caused the Depression in his memoirs, “Beckoning Frontiers” (New York, Alfred A. Knopf, 1951):
As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth — not of existing wealth, but of wealth as it is currently produced — to provide men with buying power equal to the amount of goods and services offered by the nation s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers’ loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product — in other words, had there been less savings by business and the higher-income groups and more income in the lower groups — we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.
This then, was my reading of what brought on the depression.
