The Perils of Deregulation
Kevin Phillips' description of the Ponzi pyramid seems about right.
I'd add that at the bottom was the growing gap between the 25 year slowdown in wages and middle class incomes and the intensified pressures of a "shop-til-we-drop" culture. I don't know how much of the story was culture and how much was inadequate incomes. But the drop in the personal savings rate from 10 percent when the Reagan era began to less than ½ of one percent today clearly reflects a working/middle class whose definition of a decent life is now beyond their monthly income - and for many, if not most, their monthly payments as well.
The most telling number in Kevin's collection of charts shows the expanding importance of finance in the economy.
The structural shift away from manufacturing to Wall Street pretty much guaranteed economic growth based on speculative bubbles. Debt is what the finance industry makes. Innovation is aimed at producing debt more efficiently. Ergo the leveraged securitization of just about everything. What is it about the Great Depression that our policymakers don't understand?
The hostility of Wall Street to regulation goes beyond the natural inclination of business not to want to be policed by government. Modern finance thrives on instability. For those on the inside, the direction of the market doesn't matter, so long as it's changing. Today's NY Times front pages tells us that hedge fund managers made billions (yes, that's a "b") last year as markets tanked.
Manufacturing requires long term horizons. Plant and equipment take years, sometimes decades, to make back the return on investment. Investors want some degree of stability. This was John Kenneth Galbraith's point about the development of the post World War II New Industrial State, in which government and business collaborated to decrease market instability in order to encourage investment.
The domination of finance has radically changed the definition of economics and economic policy. If economics is about buying a security at 11:30 in the morning and selling before 3pm, the last thing you want is government regulation. Slowing the process down by ten minutes could cost you a bundle.
As Kevin notes, it's not like Bear Stearns is the first. The punditry is "Shocked. Shocked." But we've been bailing out speculators at the same time that we have been de-regulating them. Washington now acts as enabler to Wall Street's binge drinkers. When they crash, moral hazard be damned. The Fed and the Treasury - suddenly faced, they say, with the threat a "meltdown" -- pay their tab, clean up the mess and let them belly up to the bar again. Is the 'meltdown" danger real? No one in the government,and probably no one in the world, now has enough information to know.
As soon as Bear Stearns collapsed, Bush's Treasury Secretary Henry Paulson (formerly of Goldman-Sachs) and Bill Clinton's one-time Treasury Secretary, Bob Rubin (formerly of Goldman-Sachs), rushed to caution against "overregulation." Not to worry, guys. If history is any guide, Washington's response will be hearings, hand-ringing and some toothless reform that depends on self-regulation and the filing of a few more unintelligible forms in the name of Transparency. You're in the catbird seat; too big to fail and too complicated to regulate. Is this a great country, or what?
I don't know, Jeff. You say that, "the drop in the personal savings rate from 10 percent when the Reagan era began to less than ½ of one percent today clearly reflects a working/middle class whose definition of a decent life is now beyond their monthly income," but I think it's fairer to say that since the Reagan years wages haven't kept pace with the perfectly reasonable desires of middle class Americans.
The problem isn't that people ar eliving beyond their means, it's that they're being inadequately compensated for their work.
April 16, 2008 2:55 PM | Reply | Permalink
To be fair, Faux doesn't say that middle class people inflated their definition of a decent life. It could have held steady.
It is true that some expectations are higher. It is also true that some costs are much higher, such as college. The issue, as always, is not the absolute measure but the relative.
It used to be consensus that the American Dream was everybody had a chance to grow up to be President. Now the Dream is hedge-fund wealth, and even running for president seems reserved for the well-off.
These days there is no payoff in steady income and savings. That is the route to medical conditions exhausting the savings. The only route to success (if it means insane wealth) is the long shot, super-leveraged, likely illegal manipulation of securities. The same dynamic leads young men in the ghetto to join gangs and deal drugs. What's the point of working at McDonald's?
But if we removed the immense-wealth payoff, through steeply progressive tax rates, we would see a return to steady income and savings being a popular goal, and a decline in the allure of empty financial speculation. Bring back manufacture by restoring protections for the industry, and discourage financialization by making it expensive.
April 16, 2008 3:08 PM | Reply | Permalink
Debt is what the finance industry makes.
Actually, what it "makes" is money. And by "money" I don't mean profit -- although it makes that, too. And the question -- well before the question of whether and where should we regulate -- is how does it do it.
By borrowing with one hand and lending with the other, at gearing ratios above 1 and, astoundingly, as much as 30.
But how do financial institutions -- the GSEs, the commercial banks, the investment banks, the hedge funds -- manage to find lenders who are willing to turn over their wealth to these institutions that make nothing and that own virtually nothing based on nothing more than an unsecured promise that, if everything turns out well, they'll be repaid?
Today, for one reason, only -- that the government (Congress, the Treasury, and/or the Fed) guarantees that their creditors, if worse should come to worse, will be repaid with taxpayer money.
Forget about regulation! For as long as government guarantees investors against their losses, it offers them an opportunity for rent seeking too good to pass up, and they won't.
April 16, 2008 3:05 PM | Reply | Permalink
Thanks Tom Wright. Maybe I wasn't clear enough for Destor. The point about the savings rate is that when wages were rising with productivity, people saved, but when wage stagnation began, personal savings fell. This seems to suggests to me that the problem of excessive debt is mainly one of inadequate income -- as Destor says.
That said, there is something in the story that does have to do with the culture -- at the very least with the accelerated intrusion of more and more sophisticated advertising in our lives. Before the Neo Cons and Neo Libs took over the debate on economic policy in the Age of Reagan, there was a respected view that "wants" could be manufactured by advertising. A point that most anyone over the age of 12 understands. But such thoughts are beyond the pale of proper policy discussion today.
Ellen, you're right that bailouts lead to bailouts. But without regulation, bailouts are inevitable. After 1929, no government is going to risk a financial meltdown. So either you try to head them off with rules that restrain the irrational exuberance or you accept that the taxpayer will ante up. Speculative bubbles existed long before government bailouts. The average investor, it turns out, isn't any more rational than kids in the candy store.
April 16, 2008 5:09 PM | Reply | Permalink
Thanks Jeff. It's very cool that you wade into the comment field. We need more of the contributors around here to do that.
April 16, 2008 6:45 PM | Reply | Permalink
. . . bailouts are inevitable. After 1929, no government is going to risk a financial meltdown.
May I remind you of what one thoughtful commentator said, recently:
"Is the 'meltdown" danger real? No one in the government,and probably no one in the world, now has enough information to know." Jeff Faux
April 16, 2008 7:28 PM | Reply | Permalink
the taxpayer is the new serf in the old feudal system of the lords of the land who exempt themselves from taxes as they impose them on the rest of us ... but they convince us of their ready protection providing our 'security' against the barbarians ...
April 16, 2008 5:19 PM | Reply | Permalink
Is the 'meltdown" danger real? No one in the government,and probably no one in the world, now has enough information to know.
Yes and no. Yes, the financial system will meltdown (and is doing so now). Must it take the real economy with it it? Not if the right measures are taken. The real problem is that the political power of Wall Street makes it unlikely that the right measures will be taken. Certainly, the Bush regime, or any Republican these days, is not going to stand up to Wall Street.
First, we need something like a "bank holiday" but just for derivatives contracts. This prevents the financial system from totally crashing, which was the fear behind the Bare Sterns rescue. Second, at the same time, the top derivatives dealers, which are the eight largest commercial and investment banks (and which account for over 90 percent of the derivatives) should immediately be put into receivership. If management complains, lock them up, send them to Gitmo, whatever, just get them the hell away from the controls. Third, freeze all adjustable rate mortages at the present rate, and roll back all the past eight months’ resets. This keeps people in their houses. Fourth, impose a one fifth of one percent tax on all financial transactions. (look up Tobin Tax on Wikipedia and Google). Financial trading is so massive right now that this small tax of less than one percent will raise nearly $1 trillion (tr not b). But as it will also knock out most of the speculation, that amount raised will rapidly shrink along with financial trading. Fifth, the amount raised from the Tobin tax is used to fund a crash program of alternative energies, and of retrofitting residences and public buildings in our inner cities. This is aimed at creating a massive employment boom and getting a real economic recovery going.
The key, I think, is to freeze out the derivatives. Only a handful of commercial and investment banks can afford the technical abilities required to create and trade derivatives on any scale, so I think a crash of financial derivatives can be isolated from the rest of the economy. See my blog here: http://www.eurotrib.com/?op=displaystory;sid=2008/4/14/234335/523
The real hard part is going to be to force capital to be patient again. As Faux points out, "Modern finance thrives on instability." Wall Street will fight this tooth an nail. Some of them MUST go to jail. A few should probably be tried for murder - such as whoever was behind the equity fund buyout of the nursing home chain in Ohio, where the staff was cut in half within months, and patients began dying. That is murder by spreadsheet. Let us treat it as such. One or two such applications of simple justice, and Wall Street will get the idea we are not f***ing around about these issues anymore.
It is almost entirely political. Do we want an economy based on financial games, usury, and speculation - or do we want an economy that is based on producing and distributing what people need and in which people are fairly rewarded for their work? If it is the latter, then do we have the will to force a showdown with Wall Street, with its superior financial ability to brazenly purchase political power.
There are food riots spreading around the world, and the effects of climate change appear to be accelerating. We are running out of time to decide. It's Wall Street versus America. It really is that simple.
April 16, 2008 7:16 PM | Reply | Permalink
Anthony,
Even if we could muster the will (to force a showdown with Wall Street), how do we achieve the means?
Doesn't WS pretty much already 'own' those forces of gov't we might have once availed ourselves?
We might not actually have the time to put legitimate representatives back into those offices created to uphold justice, which are now consistently held by the unscrupulous greed-machine enablers, before the meltdown can be significantly averted.
It's as if giving BushCo the power of CiC of the world's most deadly killing machine is only the tip if the iceberg which barely hints at what we have given to those entrusted with safeguarding our economy!
April 16, 2008 7:59 PM | Reply | Permalink
WRE - Are you familiar with Naomi Klein's The Shock Doctrine. The thing to realize is that the meltdown has already begun - we are in the middle of it now. The Bare Sterns "bailout" shows that "they" at this point will do whatever it takes to rescue the financial system. Their actions so far have initiated a process leading to hyper-inflation in goods, at the same time the financial crash has created a deflation in assets. Already, there are food riots in other countries in response to the price increases of food. (The increase in food prices have many causes, the financial crisis is only one of those causes.) So, economic conditions are going to continue to get worse for most people. In the U.S., that means much worse for about the bottom 40 percent, and for a little worse for the middle 40 percent. See my "The Crash is past. Comes now Inflation" at http://www.dailykos.com/story/2008/3/3/9553/67940/30/467808
All this brings me to Naomi Klein's The Shock Doctrine. We are entering a period of intense turmoil in which the politically improbable becomes the politically possible. The Wall Street big boys would like to push through the final repeal of the New Deal (see "The war against the New Deal has just won an Astounding Victory" at http://agonist.org/numerian/20080401/the_war_against_the_new_deal_has_just_won_an_astounding_victory
However, the potential also exists for the opposite to happen - for progressives to enact our agenda, rather than Wall Street and the conservatives enacting their agenda. What we have to do now is learn as much as we can about economics and finance and politics, and influence as many people around us as we can. It does not sound like much, but actually, it is an extremely difficult task. We just have to get the ideas out there, because, if our ideas are not out there when the next crisis hits, then "they" win by default.
April 16, 2008 8:25 PM | Reply | Permalink
Yes, I've seen Naomi Klein talking about her 'The Shock Doctrine' -- probly on 'Democracy Now!' ... I should probly read it too! Very convincing from what I've seen ...
I'm trying to learn more about all this by visiting here for instance; I might check out your links too, as well as others etc ...
I agree the turmoil seems deep and pervasive, alright! For me, it also has definite 'spiritual' connotations or connections, i.e. the corresponding inner condition of mankind (state of soul) undergoing massive challenges, as well as potential changes, as reflected in our outer or worldly life or state of humanity in the world.
We have a lot to put right. I'm certain we will require the help of 'divine guidance' to achieve what we need! That's my personal bent! ;-o
April 16, 2008 9:14 PM | Reply | Permalink
WRE - spiritual, hmmm? You might like this:
The Lost Tradition of Biblical Debt Cancellations
http://www.dailykos.com/story/2008/3/23/124942/291/413/482680
April 16, 2008 9:48 PM | Reply | Permalink
fascinating, thank you!
I believe there is something similar in Islamic law as well ...
I appreciate your sharing these excellent resources! I'm sure to be checking out your site too ...
April 16, 2008 10:40 PM | Reply | Permalink
Re: Is the 'meltdown" danger real?
Kinda like asking, Just how bad would nuclear war really be? It's one of those things that we don't need to know.
April 16, 2008 8:53 PM | Reply | Permalink
Not if we're willing to throw up our hands, declare our intellectual impotence, and give the direction of our futures over to a bunch of then-and-now Wall Street knaves.
But then, it is so very comforting to be relieved of responsibility.
April 16, 2008 9:12 PM | Reply | Permalink
Is the danger real? Yes and no. But it all depends on what the President does. Under Bush, we're doomed. We are being sacrificed to save Wall Street.
But if someone else were President, I believe it is possible to sacrifice Wall Street to save the nation and its people. Here's the key:
"It should be noted at this point that most people -- even the most financially sophisticated -- are under the misapprehension that what banks do is to first take in deposits (i.e., pre-existing money) and then, second, loan them out again. This is actually what credit unions do and what "licensed deposit takers" (prior to the Financial Services Act) used to do. The fact is, however, that credit institutions (aka banks) actually create loans first as new money which become deposits second."
This is from Chris Cook, who used to be a director of the International Petroleum Exchange in London. See http://www.eurotrib.com/story/2008/3/28/61233/4406
This is the same point being made by Ellen.
Let me simplify this key point - are you ready for it? -
MONEY CAN BE CREATED OUT OF THIN AIR.
Did you get that? I'll repeat: Money can be created out of thin air.
Now, the next key question is: what does that "thin air" money get used for? If it is used to purchase physical goods and services, and to invest in the future expansion of output then things pretty much stay in balance and everyone's happy.
Everyone, that is, except the usurers and speculators, who would rather use the "thin air" money to create even more "thin air" money. When you allow this to happen, the end result is always, always bad. This is the problem we have run into today. There is a fundamental mismatch: the financial system can create an unlimited amount of debt. The real economy cannot do the same for physical wealth. (see "The roots of the subprime crisis" at http://www.eurotrib.com/?op=displaystory;sid=2008/3/11/122016/316
So, when you have a financial meltdown, it's usually because the ability to create money out of thin air was being used for private speculative gain, rather than for the public good. The solution, therefore, is relatively straightforward: you use the sovereign power of government to cancel or negate all useless "thin air" money - in our case today, some $500 trillion of derivatives - and you use the "full faith and credit" of the government to either reorganize that "thin air" money or create new "thin air" money while making sure that it is directed only into useful and productive activities. No speculation, no usury.
Of course, it does not work out all that simple, largely because of the massive political crises that are created as the faction of usurers and speculators attempt to maintain their prerogatives. That's basically the story of the creation of the conservative movement: a bunch of rich twits who were unhappy with the New Deal restraints on their ability to get rich quick kiting "thin air" money decided to create a movement to demand "free trade" and "free markets." That's really what it all boils down to.
The usurers and speculators will do anything to prevent this, including attacking, deprecating, and sabotaging the "full faith and credit" of the economy. The last time it got this bad, Franklin Roosevelt stuck to his guns, a bunch of usurers and speculators (including George Bush's grandfather) ended up asking retired Marine General Smedley Butler to stage a military coup and impose essentially a banker's fascist dictatorship. I am NOT making this up! See http://en.wikipedia.org/wiki/Business_Plot Fortunately, General Butler listened to the bankers very politely, then turned right around and screamed "foul" as loud as he could. Unfortunately, all the coup plotters got off without even a scolding - we would probably be better off today if at least a few of them had been shot for treason.
So, the technical side of what to do to stop and get out of a meltdown is relatively simple. It's the politics that presents the real messy problems.
April 16, 2008 9:36 PM | Reply | Permalink
Yes, Anthony, and we still don't know how to route out the corrupt officials who are pre-primed to sell us out before they are even installed in office.
Honest people who might actually effect worthwhile and urgently needed changes are 'de-selected' in our process of choosing viable candidates; the media reinforces the certainty of those tragic eliminations, and we are left with mostly only those more or less willing to go-along to get-along types of choices.
The fact that we were not able to dump BushCo before its term expired is proof of how pervasive the corruption has become. The branches of our gov't hardly make an effort to even appear to be functioning as required by our Constitution.
Messy indeed!
April 16, 2008 11:31 PM | Reply | Permalink
I appreciate the comments about Bad Money by Tom Ferguson and Jeff Faux. They have both also worked these vineyards for many years. I agree with Tom that the Democrats have gotten so much money from the financial sector that they are unlikely to do much by way of tough regulation unless the next ten months are so disturbing in economics and finance that a crisis is so clear -- and blameable on the GOP -- that the Dems will be unable not to act. Jeff has watched the two party system put the U.S. political economy in hock as long as I have, and the Ponzi scheme rolls on. I sometimes entertain that there should be a sign on the DC line: "You are leaving Washington, D.C. Care to think about investing in Canada?" Kevin Phillips
April 20, 2008 1:26 PM | Reply | Permalink