The End of An Era? Part II

September 7, 2008

Dear Citizens and Elected Officials:

I’m pleased to present Part II of the essay/book review, “The End of an Era?” Since the format has been to weave contemporary economic events into the work, I felt an obligation to comment on Senator Obama’s economics, reflected in his March speech at the Cooper Union in NY City, the long NY Times Magazine article from the end of August, and his acceptance speech in Denver, all in light of the themes of this essay.

Economic dislocations are gaining in momentum. Fannie and Freddie have been placed in federal “receivership,” in another Sunday announcement, with the tip-off coming from bond king Bill Gross, warning of a financial tsunami if their ills weren’t addressed more forcefully. We consider, in depth, their history and plight, and what it tells us about our passing era. They are symptoms, not cause of our troubles. Unemployment has hit 6.1%, the highest since 2003. Former Federal Reserve Chairman Paul Volcker, commenting on September 5th, said the financial system is broken, and “‘growth in the economy in this decade will be the slowest of any decade since the Great Depression.’” That’s an amazing declaration, and it fits in with our subject line and a theme that is woven through out the essay: that we are facing problems comparable in complexity to those of 1933. Hence the concluding page’s presentation of part of FDR’s Inaugural address from March 4, 1933 -75 years ago. I hope you find it as inspirational as I do. In April, hundreds of people worked very hard to tell you why that 75th Anniversary was so important for today, but you’ve never read a word about it…until now.

Knowing how busy many of my readers are, I’m going to give you a very condensed version of my own findings to describe what is at the core of a “broken” system:

We have built a giant speculative debt pyramid upon “assets,” aka as debts/loans of every type, from the subprime mortgages we have all heard about to boat loans and vacation home times/share leases that you probably haven’t. If there was a debt with an income stream behind it, it was securitized. I wouldn’t be surprised if snow mobiles and jet skis leases are part of the mania. In the grand process called “securitization,” investment instruments or obligations were built on these “assets”/loans/debts, sometimes three or four layers high (bets upon bets upon bets) with the highest returns being generated from those parts most likely to default. This huge edifice has grown higher and higher, while what it ultimately rests upon has not: the ability of the humble consumer to keep the payments coming…at the very time that we all know that we have the greatest maldistribution of income and wealth since the 1920’s, and very stagnant wages and income in the middle and lower sectors of our economy. This pyramid began collapsing before the economy turned down: why do you think the thought of a mere recession strikes so much terror among officials?

Other civilizations, the Egyptians, the Romans, The Chinese, built their great edifices out of material objects - the more solid, the better – the Pyramids, the Apian Way, the Great Wall. We used to do some of that too: canals, railroads, interstates, electric grids...the Internet….Now our Great Edifice is built out of consumer debt upon incomes and jobs that can no longer support it.

The great irony for the anti-egalitarian who managed this “construction project” for 18 years, Alan Greenspan, is that we are being led back to the necessity of full employment and higher wages at the base of the pyramid because without it the entire system may very well collapse. Wasn’t that where the New Deal ended up? But this time we don’t want to do it with military Keynesianism.

Without ever comparing charts, author Robert Kuttner and I have sailed in the same direction. Hence his new book, Obama’s Challenge, is about how our greatest Presidents, including FDR, transformed themselves and led transformative changes in our society. Bob assumes Obama’s election victory. I don’t - and wonder out loud if the deep frame of FDR and 1933 – which I try to show are already on citizen’s minds ahead of the “handlers” ….might not be the necessary one for him to win this crucial election.

With thanks to all my readers….

Bill Neil
Rockville, MD
w.neil@att.net [1]

THE END OF AN ERA?

September 7, 2008
William R. Neil
w.neil@att.net [1]

PART TWO

Introduction

The most worrisome thing about the vulnerability of the U.S. economy circa 2008 is the extent of official understatement and misstatement – the preference for minimizing how many problems there are and how interconnected they are. (Kevin Phillips, Bad Money Preface, p. vii.)

How could leverage get so high?...a relatively small number of institutions, basically the global banks, investment banks, and credit hedge funds, do most of the trading. In effect, they’ve built a huge Yertle the Turtle-like unstable tower of debt by selling it back and forth among themselves, booking profits all along the way. That is the definition of a Ponzi game…So that is the place where a quarter-century of Chicago-school piloting has brought us – to a debacle on at least the scale of the one caused by the liberal crackup of the 1970’s…The American financial sector today is far more powerful than it was in the 1970’s. And to date, its response to the looming crisis has been, overwhelmingly, to downplay and to conceal. That is a path to running a painful debacle into a decades-long tragedy. (Charles Morris, The Trillion Dollar Meltdown, pages 135-136.) {Underline, italics are my emphasis}.

The fecklessness of recent Democratic presidential nominees is often mistakenly understood as merely personal…Weak candidacies and uncertain trumpets are the logical product of muddled ideology. And the faint ideology is, in turn, the product of the immense power of organized business in today’s American politics. (Robert Kuttner, The Squandering of America, page 277).

Obama will be challenged both by hard economic realities and by the constraints of conventional wisdom. In principle, two core premises about the economy, which have governed the economic thinking of both major parties for three decades, have been demolished by the deepening crisis. The first is that markets can accurately price complex financial inventions, with no need for government involvement. The second is that private outlays are invariably superior to public ones. Economic recovery will require the drastic revision of these premises, just as in 1933…Despite the severe economic situation, there is an undertow of stale thinking that discourages transformative policies. ..The new president will need to inspire the American people to demand enactment of bolder measures than either the Congress or Obama himself currently thinks necessary or possible. (Robert Kuttner, Obama’s Challenge, page 2).

I’ve chosen the above quotes from three of the works under review because I think they can quickly help readers grasp the key dynamics and dimensions of what we are facing in the United States in the late summer of 2008, one year into the greatest financial crisis since the Great Depression of the 1930’s. A part of the understatement component of officialdom is historically true to form – and a ritual, really, of central banks and major financial players in times of great turbulence, trying not to panic the public and their own investors. Understood. But the more the same record is played – “existing capital is adequate” - the more diluted and diminished is its effect over time, and the ability to rally citizens to rise to the magnitude of the occasion is lost – and the greater the chances that the “decades long tragedy” that Morris fears – actually happens. Robert Kuttner sees this danger too in The Squandering of America, when he invokes the long, drawn-out decline of Great Britain from 1918-1945. Just to supply a little continuity, remember: Countrywide Financial, Bear Stearns, IndyMac Bancorp Inc., Lehman Brothers…Fannie and Freddie… You can bring yourself up to date with a list of “ten in trouble” thanks to Mike Shedlock’s article from August 22 at http://www.marketoracle.co.uk/Article5972.html [2] As a bonus, he throws in Ford and GM on top of the ten financials named. They’re in trouble on both the manufacturing and finance side.

“Existing Capital is adequate” - that’s a phrase we’ve heard often and will continue to hear, but more and more, it will be caught up in the understatement/misstatement cycle.
The open and discordant disputes as to the true state of balance sheets at the nation’s financial institutions are not building confidence in the system. While Secretary of the Treasury Henry Paulson was insisting in testimony in mid-July that Fannie and Freddie were ok on their current capital levels he was simultaneously lobbying to meet the reality that they probably wouldn’t be very shortly – while a prominent former Federal Reserve official (St. Louis President), William Poole was saying, very publicly, that Freddie Mac was “technically insolvent under fair value accounting” and that Fannie Mae was headed there soon. (Bloomberg.com: “Fannie Plan a ‘Disaster’ to Rogers; Goldman Says Sell,” by Carol Massar and Eric Martin, July 14th). At the same time, Senator Charles Schumer (D, NY) and the federal Office of Thrift Supervision (OTS) were conducting an open feud over who was to blame for the bank run against IndyMac Bancorp, Inc., with Schumer charging that OTS wasn’t doing their job and should have acted sooner than the weekend take-over (July 12-13th), and OTS accusing Schumer of having caused the bank run and failure because of his public letter of June 26th. (See Bloomberg.com article by Ari Levy and David Mildenberg of July 12th, “IndyMac Seized by U.S. Regulators; Schumer Blamed for Failure”). This exchange was nearly as remarkable as President Bush’s press conference of July 15th undercutting the testimony of his own Federal Reserve Chairman.

In the same spirit, on the cause of the dramatic surge in oil prices which peaked on July 11 at $147/barrel, Fed Chair Bernanke was delivering his opinion, on July 15, to Congress, that “…based on the evidence that’s available, I would not estimate that speculation or particularly manipulation is a significant part of the rise in oil prices...” But the Fed Chairman, who is a smart man, gave himself an “out” by also stating that “…my advice would be to go slow…and to take the insights that you get from the CFTC {Commodities Future Trading Commission} and others who are directly – associated …overseeing these activities.” From Frank James’ July 15 article in the Chicago Tribune online at http://www.swamppolitics.com/news/politics/blog/2008/07/bernanke_pricey_... [3]

It’s good he did, because on Thursday, August 21st, The Washington Post ran a front page story by David Cho entitled “A Few Speculators Dominate Vast Market for Oil Trading,” which presented the none-too-reassuring findings of the Commodities Future Trading Commission (CFTC) when it looked into who is doing what in the markets it’s supposed to be regulating. “The CFTC… now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NY-MEX, a far bigger share than had previously been stated by the agency.” The article goes on to point out the importance of “swap dealers,” which it says “primarily invest on behalf of hedge funds, wealthy individuals and pension funds…” Please note that these dealers formerly would have fallen outside the “good” speculators designation that allows farmers, airlines, trucking companies etc., to “hedge” in these markets against dramatic swings in prices crucial to their basic everyday “real economy” activities. And the article – we need more like these from the Washington Post – then goes on to talk about who is benefiting from the exemptions from CFTC regulations. Sure enough, Goldman Sachs’ name pops up prominent among others, in benefiting from an exemption granted in 1991 and from the changes ushered in by the “Commodity Futures Modernization Act of 2000,” aka as the “Enron loophole.”

These findings by the actual commission charged to be on top of the issue of constructive versus detrimental speculative activities were anticipated by economist James K. Galbraith’s August 15th article in Mother Jones online entitled “How to Burn the Speculators.” In it, Galbraith states that “Yes, Virginia, speculators can affect the price – if they are large and relentless enough to dominate a market, and especially if they can store the commodity and keep it off the market as the price rises.” Galbraith reminds readers in a little more detail than the Washington Post article just how indebted we are to former Senator Phil Gramm’s timely craftsmanship in dropping off the Commodity futures Modernization Act of 2000, “a surprise 262-page rider, drafted at the behest of Wall Street and Enron, in an 11,000-page appropriations bill on a Friday evening two days after the Supreme Court handed down its Bush v Gore ruling and as Congress was rushing home for Christmas.” This “rider” and other actions by the CFTC expanded the way “Credit Default Swaps” could be used by new players in oil markets to conduct pure speculation: “According to Senate testimony on June 3 by Michael Greenberger, who used to head the CFTC’s division of trading and markets, if swaps were properly labeled, about 70 percent of the oil futures now traded on the New York exchanges would be deemed speculative, not commercial, and subjected to a high degree of regulatory scrutiny.” See Galbraith’s take at http://www.motherjones.com/news/feature/2008/09/exit-strategy-how-to-bur... [4]

What these examples tell me is that we have a government which has placed markets on such a pedestal as to turn initiatives over to the regulated industries themselves. It’s reached the point where even the basic call of solvency is up in the air, openly disputed and the highest financial authorities in the land are unable to determine to what degree something as crucial as oil prices have been driven by speculation. This is not the result of a few oversights, weakening amendments or regulators being slightly behind the curve of market innovation: this is the culmination of the Age of Market Utopianism. Under the spell of the near religious aura of Markets, and the arguments of private sector players burnished by its glow, caution and critical historical memory have been thrown overboard. Not since the heyday of the railroad empires of the late 19th and early 20th century has the nation seen anything like the arrogance, audacity and aggrandizement displayed in so many spheres of American life by the financial sector and its lobbyists.

Another “Little Shop of Horrors”: Just $200 Billion
While most of the nation is still catching up with the complexities and horror stories of the mortgage calamity, another “little shop of horrors” has been playing nightly, off Broadway. Witness the legal actions from New York State and Massachusetts to restore billions in “frozen investments” from small businesses, charities and individuals, which major broker firms did not want to give back after the complete collapse of their auction rate market in the winter of 2008. In an ongoing saga where the early reports were of the local governments and authorities having their bonding costs driven through the roof by the faltering weekly bond auctions, there was another whole dimension playing out. Individual investors and small businesses had been lured into this arena by active marketing that presented the bond investments as being cash/money market equivalents. Well, maybe on the upside, but not in the rush out of the exits. When the major firms decided to bail in February 2008 on the whole auction market, the little people found out they couldn’t get their money back. For the five firms listed in the settlement here (Citigroup, Inc. UBS AG, JPMorgan Chase & Co., Morgan Stanley and Wachovia Corp.), there were 140,000 investors involved and they will be getting $35 billion back. Please take note that now larger businesses - burned in the same way - are protesting that the state driven legal actions have ignored them – they’re angry that certain Attorneys Generals seem to have forgotten where they stand in the food chain. It’s almost Darwinian. New York AG Andrew Cuomo estimates that the settlement represents just 18 % of the astounding $200 billion outstanding. See Martin Z. Braun’s August 21st story at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avo4fYJjD6rI# [5] and the August 14th story by Karen Freifeld and Michael McDonald at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=axFcO52x_4qk [6] ).

What “Morning in America” Let Loose
Far from having ushered in a peaceful Morning in America, letting the animal spirits of Wall Street roam loose has created “wolf packs” of speculators who now bet, through Credit Default Swaps, and other instruments, on the fate of debtors and all types of securitized debt instruments. It has always been a given that underperforming firms are supposed to be “punished” in market trading – picked off by the wolf packs, if you would prefer. Now, however, the power of speculative forces is so large and swiftly deployed that they are failing to take account of the “tight coupling and interactive complexity” which Richard Bookstaber calls our intention to in his Demon of our own Design. And that “balance of terror” between hedge funds and banks that Charles Morris has highlighted in his Trillion Dollar Meltdown. It isn’t just the old market discipline any more. The old punishment mechanism, still employed but not fully understood under vastly altered markets and relationships, now can quickly pull down the whole market in the attempt to get at the particular firm. Is anyone really on top of this system which has emerged since 1980? I doubt it. Speculation we will always have, and some of it is constructive as noted above. But the size, force and new instruments of the purely speculative tide are now so great that it is surging over regulatory sea walls to be a destabilizing if not destructive force. That’s why the arbitrary and selective emergency ban was imposed in July and August to keep “naked shorting” from crashing the financial system at a very vulnerable time - and it’s a possible explanation as to how Bear Stearns could have collapsed so quickly this March – as presented in an August 11th investigative story by Gary Matsumoto of Bloomberg.com at http://www.bloomberg.com/apps/news?pid=20601109&sid=aGmG_eOp5TjE&refer=h... [7] ).

When former Senator Phil Gramm and then economic advisor to Republican Presidential candidate John McCain got in deep trouble with his July 9th comments (in the Washington Times) on whining Americans caught in a mental recession, much of the country reacted in disbelief and he was quickly ushered off the public campaign stage. Yet his comments had been preceded on June 18th by a front page Washington Post story of similar theme: “Why We’re Gloomier Than the Economy: Consumer Anxiety Outstrips the Data,” by Neil Irwin. Now the thrust of both articles was that the level of consumer pessimism registered in the polls is not supported by all the data on the economy, especially those still showing some GDP growth and unemployment numbers modest compared to other harsh American recessions. Fair enough. The Washington Post article begins to correct its own title with some observations that consumers face-to-face with rising gas pump prices and falling home values might have a right to be worried, but that’s as close to real insight as it gets. Not mentioned was the dramatic rise in level of consumer debt, an aspect of the “middle-class squeeze” which, everything else being equal, means folks are likely to feel less secure even in mild recessionary conditions. But right now, other things are not equal. Our streets are lined with grim reminders: “foreclosure” and “for sale” signs, “for rent” signs, and simply empty houses with no signs at all. There was a falling stock market in June, in retrospect, the worst June on Wall Street since 1930. And a falling dollar abroad. And a large trade deficit. Reductions in holding dollars in some foreign central bank accounts. Perhaps, when you think about it, citizens might just be registering in the polls a better “intuition” of the real structural situation looming over the economy than Mr. Irwin and Mr. Gramm would like to admit. And Kevin Phillips likes to hammer home the point in Bad Money about the vast rise in private debt with his “Great American Debt Bubble chart, showing total credit market debt as a share of GDP peaking in 1933 at 287%, and reaching 335% of GDP in 2006 (page 7).

What Books, What Crisis?
Now when Mr. Gramm posited, in the same article where his infamous quotes came from, that “ ‘We’ve never been more dominant; we’ve never had more natural advantages than we have today…we have benefited greatly’ from the globalization of the economy in the last 30 years,’” it didn’t get much media attention at all. Yet these comments reveal that he doesn’t grasp the implications of the “structural” fault lines running through the American economy, and which Neil Irwin and the Washington Post more generally, don’t seem to want to take into consideration. These deeper questions, the enormous rise in consumer debt, the falling dollar, the constant and substantial trade imbalance, the connection between the rise in oil and commodity prices and the fall of the dollar – and the disproportionate impact of the massive and troubled financial sector on the real economy - these are the very structural issues that our authors, especially Kevin Phillips, Robert Kuttner and George Soros, want to stress. How is it that a reporter like Neil Irwin can write the article he did, without ever mentioning any of our six books under review, even though the three mentioned here were all published this year, and directly address our economic situation? None worthy of a call to the authors for comment on the main question posed in the article? Well, if not this reporter and this article, then surely the Washington Post must have reviewed at least a couple of them, so maybe the perspective I’m seeking is there, in the book reviews? Well, no, it’s not. None of these books have been reviewed, as best as I can determine. I was troubled enough by this rather startling discovery to call Rachel Hartigan Shea, the Deputy Editor of the Washington Post Book World on July 28. No, there are so many books to review, she didn’t think any had been; the closest the Post got was an arrangement to have Kevin Phillips’ Bad Money reviewed, but the deal was not kept and nothing appeared. I gallantly offered my own review on Amazon.com to fill the void, but I’m not sure a failure to have a Bad Money review is quite seen as a crisis at the Post. In further defense, Ms. Hartigan offered that they had reviewed previous Phillips, Kuttner and Soros books, but not these.... Oh well.

Repressed Memories of the Great Depression?
Is it possible, though, that in one of our nation’s flagship papers, there is an institutional leaning towards “downplaying and minimizing” just how “many problems there are and how interconnected they are,” to use the words that Kevin Phillips employed in his Preface? After all, reporter Irwin noted in his very first paragraph that, “On the Internet, comparisons to the Great Depression are widespread.” (My emphasis). Now while it is quite correct to point out the employment situation is nowhere near as dire – 5.7% today versus 25-30% percent in the 1930’s, our financial system has not seen anything so serious or prolonged, since then. And these other structural fault lines, I think it is accurate to say, are actually more complicated (if less acute) than the ones facing us in the Great Depression, in the dilemmas they pose for policy makers. But maybe, just maybe, there’s something else in that Great Depression frame that catches the imagination (and fears, rightly or wrongly felt) of citizens, expressed among the very impolite (and impolitic) emotional ethers of the Internet. And that would be a sense of the great watershed marked by the years 1929-1932, and the election of FDR and the coming of The New Deal – and the hope it represented after the Crash of October 1929 had turned into 1930, and then 1931 and then 1932 with the nation sagging further with each turn of the calendar year. Could it be that no matter how factually imprecise such a frame might be in real world economic parameters, that it accurately captures a psychological mood among citizens today, citizens who are always criticized for their short attention spans, their lack of historical memory? How is it now that in their subconscious as revealed in Internet chatter, they have rediscovered lost memories of the Great Depression? Weren’t these memories banished for good, Depression and New Deal, when the resolute optimism of Reagan presided? Could this be the “return of the repressed,” the sharp bite of the real economy interrupting the illusions of the “virtual” one – of the “new financial instruments.”

But they keep popping up to serve as a frame of reference, uncomfortable as they undoubtedly are to “understaters.” For example, this headline is sure to get under some such skins, from Bloomberg.com reporters Matthew Benjamin and Heidi Przybyia, on July 21st: “Bush Failures May Force McCain, Obama to Make Like FDR in 2009.” Thanks to historian Robert Dallek, the thought is made even more explicit: “‘What a burden the next president is going to confront…It’ll be like Franklin Roosevelt coming in, in 1933.’” What’s next in an article like this, an Ivy League professor raising even more fundamental issues? Yes, I’m afraid, it’s true. Dartmouth College (of all places) political science professor Linda Fowler goes on to observe “‘The country is facing a crisis in capitalism.’” Something was contagious at Bloomberg.com on that day, because reporter Rich Miller chimed in with another story called “Bernanke, Paulson Pressed to Seek Big-Government Bank Bailout.” He went on to note that “trying to envision what steps Washington might have to take, economists hearken back to the last time the country faced nationwide decline in house prices during the Great Depression.”

There must have been something in the national air too during July – (a dust storm, perhaps?) – because a Time/Rockefeller poll reported some very un-Reagan like responses from a nation where 85% of respondents to one poll question “believe the nation is on the wrong track.” Going further, “most also believe that the social contract – the benefits corporations and government once guaranteed – is busted and needs to be rewritten to reflect the realities of economic life in a global marketplace.” A majority of respondents also report a belief “in the power of Big Government to solve the biggest problems of our time. They support major government investments that create jobs – 82% favor public works projects…” A new Social Contract, Big Government, Public Works Projects, what’s gotten into people? “Well,” I imagine some on the Right might ask, “What do you expect from a Time/Rockefeller Foundation poll? That’s why we threw the Rockefellers out of the party!” At http://www.time.com/time/business/article/0,8599,1823668,00.html [8]

Erasing the Memory?
Now I want to make my own contribution to the recovery of national memory. It’s an up close and personal issue for me. While living in Massachusetts earlier in this decade, I helped fight off an attempt to rename state parks and forests for the highest bidder at commercial auctions. I didn’t like the idea of Abigail Adams State Park being renamed for – let’s say Countrywide Financial’s Angelo Mazilo. I saw the issue as one of commercial ideology erasing a “long train of shared memories.” So don’t you just know when I heard about a conference celebrating the 75th Anniversary of the New Deal at the Willard Hotel in Washington, DC on April 9th, I had to be there.

The title of the conference, “Toward a New New Deal: FDR’s Liberalism and the Future of American Democracy” gave the idea even more urgency, as did the advertisement I saw in The Nation, with a poster of a resolute, determined looking Roosevelt holding a stack of papers and looking off into the distance to assess, I would like to imagine, progress on the new “social contract” he was drawing up. There were additional motivations. I had, earlier that spring, embarked on a refresher course in the New Deal, reading old classic’s like William E. Leuchtenburg’s Franklin D. Roosevelt and the New Deal (1963), and new ones, such as David M. Kennedy’s Pulitzer Prize winning Freedom From Fear: The American People in Depression and War, 1929-1945 (1998), and Nick Taylor’s fine work, just out in 2008, American-Made, The Enduring Legacy of the WPA:When FDR Put the Nation to Work.

And I paid my own personal tribute to the physical legacy of the New Deal, by writing a book review of Robert D. Leighninger Jr.’s excellent work, Long Range Public Investment: The Forgotten Legacy of the New Deal (2007). (You can find it online at several locations by typing Still Shining, A Beacon of Hope from The New Deal and my name). You’ll be amazed at some of the famous places we take for granted today, but have forgotten were actually built during the New Deal. Like the terminal building at Washington National Airport, now cruelly renamed for the man who berated big government at every opportunity. As Leighninger points out, “at the time of the renaming, no one seemed to know about the origins of the building, and there was no public comment on the irony of the honor.” (Page 99).

The conference itself was no disappointment. It was well attended, and there was something special in the air, doubtless influenced by the acute outbreak of symptoms on Wall Street just a few weeks earlier in March, when Bear Stearns’ long history vanished in record time and without good explanation, like an episode from the old Twilight Zone. This then, wasn’t just the feel of any old 75th – it was living history with a heightened sense of relevance. There was James Roosevelt Jr. to bring family history to life and a moving, eloquent speech by Professor Leuchtenburg, the best of the day, I thought. At lunch, I had the chance to surprise the author whose book I reviewed with a first hand copy – we had never met or spoken – it was a total surprise – and it produced a big smile when he read it with his wife. Then, after lunch, at one of the panel discussions, I heard something quite remarkable, from the Chairman of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises….someone I had never heard of.

So my apologies to Chairman Paul Kanjorski, Democrat from the 11th District in Pennsylvania. I thought I knew the names of most Chairpersons in Congress. But I certainly know who you are now. Since I had already begun writing in some detail about the financial crisis, I really wanted to hear what he had to say in such a setting. He said he was happy to be back among upbeat people, because he had been listening to a lot of gloom recently, in trips to Wall Street for hearings about the financial crisis. And industry leaders there had been telling their stories to him, and the ones he was telling us were the conversations, the pleas, not the formal testimony, if I remember correctly.

So I leaned a little closer when I heard that. The Chairman said our conference was fitting and timely. The gloom he had been hearing from Wall Street was not about the “R” word – Recession, which was then in early April 2008 still a dangerous enough word. It was an election year, after all, and recessions are the kiss of death to the incumbent party. It’s almost Labor Day now, and recession is still a very sensitive word, though used more often. No, he hadn’t been hearing the “R” word, he related in a straightforward, conversational tone. The gloom he was glad to get away from had been employing the “D” word – Depression, and even worse, the “M” word, for Meltdown. Remarkable. Told with even pitch, no great buildup and no trumpets. There it was. From a Wall Street world famous for its ritual, rigid optimism, glass always half-full at least – don’t ever forget, the 1930’s offered great buying opportunities ( if you had any money to purchase with, that is, like the late John Templeton had). That’s the Wall Street script. Now, however, apparently, The Street had ditched the script. I was so stunned by what I thought I had heard that I later emailed a Maryland state delegate whom I saw in attendance, and asked him whether I had heard correctly. I got a one word answer: “Absolutely.” Months later, when I by chance ran into some folks who had been there as well, they also confirmed what I heard. But you, my readers, are hearing about this, and the conference, for the very first time, unless you were there yourselves. And here’s why.

The very next day, I tore into my delivered Washington Post, looking for the coverage. Nothing. Nada. I went out and bought the New York Times, after finding nothing online, but there was no print coverage either, even though one of the sponsoring organizations, the Franklin and Eleanor Roosevelt Institute, is based in Hyde Park, New York. Apparently, not even the hometown connection gets you any coverage. Surely the Washington Times or the Wall Street Journal, then, would have something to say, even it came from the back of the hand…but they carried nary a word. Thinking that surely there would be some hostile conservative magazine coverage, at least, perhaps weeks down the road, I kept looking…and now, almost five months later, I still haven’t found a single story. Astonishing. Either The Roosevelt Institution and the Franklin and Eleanor Roosevelt Institute are the most incompetent publicists of our time – they seemed pretty competent from what I saw that day – or something else is going on. David Woolner’s and Nate Loewentheil’s Introduction in the conference program didn’t miss the context, and the logic of the moment: “Recent events have made Roosevelt and the New Deal even more relevant than we could have imagined when this conference was first envisioned…Each day, ‘Roosevelt’ hovers on the lips of writers, policy makers and elected officials.” (My emphasis). But not, apparently, on the lips of the press and its editors. They delivered not light coverage, or stilted coverage, or critical coverage. They simply failed one of the basic tests of freedom and information in a democratic republic: to respect its history, like it or not. Senator McCain, in his acceptance speech of September 4th, stated that “We never hide from history. We make history.” But it seems to me that we do a pretty good job of hiding portions of our history at times when it’s too painfully relevant.

Have we located a raw nerve here; a time, a frame, a set of circumstances and events that some very much aware leaders would rather not have you re-visit? Does this amnesia have bi-partisan roots, where Democrats have as much incentive not to bring it up as Republicans? Is that because they believe it to be utterly irrelevant, or the inverse, far too relevant for what William Greider has called “the historical predicament of our country?” That’s why it may be good to take a look at two substantive pieces on the economic views of the Democratic Presidential candidate, Barrack Obama. I’m thinking of his address at the Cooper Union in New York City towards the end of March this year, just about two weeks after the disappearance of Bear Stearns Inc., the transcript of which is available online at http://www.nytimes.com/2008/03/27/us/politics/27text-obama.html [9] The other is the long article which appeared online first on August 20th and later in the NY Times Magazine, by David Leonhardt, “How Obama Reconciles Dueling Views on Economy” at http://www.nytimes.com/2008/08/24/magazine/24Obamanomics-t.html [10] .

Obama’s Cooper Union Speech
The Cooper Union speech, “Renewing the American Economy,” where we get Obama’s words directly, I found much more reassuring than the magazine article. It begins with homage to “the role that the market has played in the development of the American story,” and also begins (and concludes) with the tensions between Alexander Hamilton and Thomas Jefferson on economic priorities for the new nation – and how they were able to find common ground in their belief in the powerful capabilities of the American people. As my readers probably know by now, I’m not sure that’s the period where I would look for the most pertinent historical guidance for what we face in 2008, but that’s where Obama takes us. But what is in-between the references to these founders is pretty good, and tells me that Senator Obama has at least a working grasp of much of the financial crisis, and the recommendations he makes are heading in the right direction. Asserting that “there is no dividing line between Main Street and Wall Street,” he says “it is time for the federal government to revamp the regulatory framework dealing with our financial markets.” He goes on to outline six goals for the new framework. He calls for protecting the taxpayer interest whenever the Federal Reserve extends its authority to new financial institutions, and the new regulations should include “liquidity and capital requirements.”

Although hedge funds were mentioned in an earlier part of the speech, it is not clear whether they would come under the new proposals. I could infer it, but that would be a stretch. However, the calls for “a process that identifies systemic risks to the financial system” and a “financial market oversight commission” are good and welcome, as are the references to excessive leverage and dangerous risks. I believe that leverage limitations need to be made explicit for all the institutions brought under the new framework, and that includes hedge funds. It won’t be easy. On CNBC on Sept. 4th, the day the Dow plunged 344 points and bond king Bill Gross said he wasn’t bailing out any more banks, commentators were stressing just how important “leverage” will be to re-capitalizing them. Senator Obama makes clear that we have gotten to this point from the poor judgement of both Republican and Democratic administrations, and in several places, he conspicuously called attention to the deleterious effects of campaign contributions in enabling these regulatory debacles to unfold over nearly 30 years. I concur with Robert Kuttner’s assessment of this speech, made in the magazine article, that it goes “‘well beyond the current Democratic Party consensus.’”

Although the language Obama uses to criticize the results of the de-regulation of financial markets is bold, he indicates that changes were needed in the old structure in the 1990’s because of the rapid pace of innovation in the markets. But what we got instead of a “21st century regulatory framework” was simply the dismantling the old one. It’s worth noting that Obama injects some historical context, stating that we’ve seen this before: “the concentration of economic power and the failures of our political system to protect the American economy and American consumers from its worst excesses have been a staple of our past: most famously in the 1920’s, when such excesses ultimately plunged the country into the Great Depression…” After noting a couple of the prominent features put in to remedy these excesses of the 1920’s, it’s on to the reaction of the 1980’s and 1990’s, pushing against “some of the outmoded structures of the New Deal…” FDR is never mentioned. Nor is Ronald Reagan. This was, again, a speech in late March, 2008.

Obama’s Economics: Straddling the End of an Era?
Now, at the end of August, comes Obama’s economic views primarily through someone else’s lens, economic reporter David Leonhardt, although there are enough quoted passages to give some weight to Obama’s own words. Here’s my take on the article, “How Obama Reconciles Dueling Views on Economy.” First is the reporter’s presentation of events: the IMF, solid, conservative body that it is, thinks the crisis in financial markets is the worst “since the Great Depression.” But Leonhardt, like Paul Krugman and so many others, states that “the details are too technical for most of us to understand.” Already, and this is just the first paragraph, and the problem can’t be grasped by the average citizen in a democratic republic. All the better, perhaps, later on, to let Leonhardt tell you what the boundaries of the possible are, as set by the economic experts. The rest of the setting described is decently accurate: debt that will not be repaid, income stagnation, the private sector health insurance picture “unraveling.” The progressive economists I read, like Dean Baker, however, would disagree about the Social Security crisis, and think that the Medicare cost explosion should, and can be, dealt with by sufficiently ambitious health insurance reforms.

Leonhardt claims that Obama does have an economic ideology (Obama says he’s a pragmatist, steering between Robert Rubin and Robert Reich), it’s just not a familiar one, and I’m afraid the total effect of the piece summons up Robert Kuttner’s “weak candidates and uncertain trumpets” quote (the third one) that we began this Introduction to Part II with. The harsh term of judgement on Obama’s ideology might be “muddled,” the more generous one would be “hybrid.” Writing with my readings about FDR and the first part of the New Deal, 1933-1934, in mind, it’s understandable that leaders who happen to exactly straddle the passage from one era to another are likely to carry over substantial parts of the old. For FDR, and the purposes at hand here, it was the ongoing tension between the need to put people to work, and get incomes flowing through public work projects, and the worries over a balanced federal budget/deficit spending which characterized the struggle between eras. The compulsion of balanced budgets was one of the chief orthodoxies inherited from the old economic order, along with the gold standard, which was abandoned in April of 1933, to give the US the flexibility to re-inflate the economy. This horrified many conservatives. So I am trying to measure Obama in the way someone listening to FDR’s campaign in 1932 might have been doing: it was not so easy to predict where FDR’s future policies would come out, he was something of a “hybrid” on the major fault line of the day too.

In this 13 page article, the combined references by the author and Obama to Reagan, the Age of Reagan, and Reaganism, is 15, and if we throw in references to Milton Friedman and the University of Chicago School, very close relatives, it would be over 20. FDR gets mentioned once, in passing, as does the New Deal. When the New Deal gets elevated to the title of Section VII, “The New New Deal, we find that Harold Ickes, Harry Hopkins and Frances Perkins have come back, reincarnated as Governor Tim Kaine of Virginia, and his efforts to bring modern high tech jobs to the de-industrialized portions of the state. Those efforts, however worthy in direction, are more like pilot programs in scale than a full blown Apollo new energy/efficiency “WPA” or “CCC.” The Obama infrastructure spending proposals, $50 billion annually, is also so modest in scale compared to what other progressives have suggested, like James K. Galbraith’s national infrastructure bank proposal for $290 billion per year…that it is in reality a modest gesture. (See Galbraith’s proposal at http://www.newamerica.net/publications/policy/macroeconomic_consideratio... [11] ). Galbraith’s in turn, is made to seem unequal to the full economic task as presented by Robert Kuttner’s Obama’s Challenge, who calls for new investments and public spending on the order of $600-700 billion per year. We’ll be dealing with this book and its recommendations in future postings.

What I find most interesting about the article, and what it portrays as Obama’s vantage point on economics, is how it starts “history” from Reagan’s viewpoint in 1980, and we could say in fairness that this is also the view of Milton Friedman and the Chicago School of thought: quoting from his book The Audacity of Hope, Obama says “ ‘Reagan’s central insight – that the liberal welfare state had grown complacent and overly bureaucratic, with Democratic policy makers more obsessed with slicing the economic pie than with growing that pie – contained a good deal of truth.’” Towards the end of the article, in a conversation on a plane, trying to answer the worry that Republicans still have a simple and coherent story to tell on economics, and that he and the Democrats don’t, Obama again starts with the Reagan frame: “ ‘Ronald Reagan ushered in an era that reasserted the marketplace and freedom. He made people aware of the cost involved of government regulation or at least a command-and-control-style regulation regime. Bill Clinton to some extent continued that pattern…and George Bush took Ronald Reagan’s insight and ran it over a cliff.’”

Now based on what I found from Obama’s March Cooper Union speech, and the details and qualifications offered about markets in this NY Times article, it is clear that Obama has a much more guarded, and less utopian view of markets than either Friedman or Reagan. That’s good, and I come away somewhat reassured. But the frame and starting point from Reagan is a bit worrisome on two counts for me. Some of that may be the viewpoint of Leonhardt, and some could be from Obama himself, it’s a little difficult to judge in a piece like this as compared to his own speech.

First, remember that both Ronald Reagan and Milton Friedman had extreme views of the role of free markets and strong antipathy to government intervention into markets, something that may be hard to appreciate given how far political and economic thought in the US had shifted to the right by the middle of the 1990’s. (Paul Krugman had a fine article on Friedman in the February 15, 2007 edition of The New York Review of Books, which carefully distinguishes his technical, professional work from his ideological, polemical role: “Who Was Milton Friedman,” pages 27-30). Step out of the US, look around the world with clear eyes, especially in Asia, and you will begin to realize how “managed” other economies are. Leonhardt’s view of the role of markets in Asian success stories under-appreciates the degree to which they have managed trade, currencies and capital markets – to develop what both Kevin Phillips and Robert Kuttner view as a form of modern “mercantilism.” Leonhardt, along with most U.S. observers, completely missed their angry and determined reaction to the crisis of 1997-1998. After having the Western electronic “investment herd” run in and run out, many Asian governments vowed to cut their dependence on foreign investment – and they’ve kept it and kept going, hence the rise of sovereign wealth funds there and in other countries that don’t want to repeat the very harsh lessons of unregulated capital flows learned from those years.

To really put the political economy of Reagan and Friedman in historical context – and to reveal how distorted they are – I recommend John Gray’s False Dawn, published in 1998.Gray teaches intellectual history at the London School of Economics, and he has won praise from even The Economist magazine for his deep insights into the cult of free markets and the distortions of globalization. You’ll also get a “bonus” insight into Karl Polanyi’s The Great Transformation (1944), without having to tackle that very tough book on your own. Polanyi is the “other” economist from Vienna – the left counter point to the more famous intellectual fathers of Milton Friedman: Ludwig von Mises and F.A. Hayek. Gray gives the readers a graceful summary of the main ideas of Polanyi – and just how much resistance the world has always offered to the harsh realities of pure free markets, whether in trade or finance. I led a group discussion on Gray in a progressive book club I belonged to and after folks stopped complaining about how tough he was to read, the consensus was that he was the best and most enlightening work they had encountered on globalization. Remembering that he wrote “way back in 1998,” try this brief passage on financial markets on for insight and predictive power: “Global laissez-faire may break down in an unmanageable crisis of the world’s stock markets and financial institutions. The enormous, practically unknowable virtual economy of financial derivatives enhances the risks of a systemic crash.” (Page 198, my emphasis.)

By squinting through a telescope mainly focused on the orbit of economists still in thrall to Friedman and Reagan, Leonhardt and perhaps Obama too may not be seeing clearly at “the end of an era.” The consensus view of professional economists in 1928 was not very enlightening about what was coming, and neither was the consensus in 2007. True, the article points out that the focus now is off the Clinton/ Rubin obsession with the federal budget deficit, which is not as great relative to GNP now as it was in the early 1990’s, but what Leonhardt doesn’t mention are the works by Kuttner (The Squandering…), Dean Baker and Nobel Prize winner Joseph Stiglitz (The Roaring Nineties, 2003) which all seriously reassess what the Clinton achievements were, and down play the importance of deficit reduction, and instead emphasize the powerful but fleeting wealth effect from the stock market bubble (especially Baker and Kuttner). Also missing from this article is a consideration of the serious trade deficit and the related decline of the dollar, important considerations that make our current situation much more difficult to deal with. We’ll see later how important they are to Phillips, Kuttner and Soros. (We do know, however, that Obama does talk to economists on the left, especially Jared Bernstein, James Galbraith, and William Spriggs, as Robert Kuttner points out in Obama’s Challenge.)

My other worry about where Obama’s pivot point leaves him – pivoting off a fading liberal era, citing Reagan’s critique, and the Right’s, which was powerful in the confusion of the mid-1970’s, is that those years may not have much to tell us – or him, about how to deal with the intellectual exhaustion of conservative economics in 2007-2008, the end of the era of Market Utopianism, The Age of Reagan, or Market Fundamentalism – whichever you prefer. Despite the very real costs imposed on family budgets by food and energy costs, the most serious threat now, as Bill Greider rightly points out, is generalized deflation, led by, but not limited to, housing. The great crisis in our financial markets will feed off all types of securitized debt, and if unemployment rises into the 6-8% range, the debt defaults and plunges in related asset values will only intensify. (Friday Sept. 5th saw the employment rate rise to 6.1%, the highest since 2003). From his Cooper Union speech we know Senator Obama knows that we are going to be on an increasing curve of re-regulation. What we don’t know is whether he fully understands the deep interconnectedness of the new financial world, illustrated by the predatory speculation against Fannie and Freddie stocks and bonds. Some of the shorting efforts are ideological warfare: drive them into distress, so eventually the best parts are re-privatized, even if they have to go through “nationalization,” temporarily, to get there. (Looks like it is happening the weekend of Sept. 6-7th). But do the “wolves,” those shorting the shares – fended off briefly by that emergency regulation during the July-August crisis, realize that some of the “preferred” debt they are hammering is also used to meet capital requirements in a substantial number of American banks, so that they are potentially going to set off bank runs and solvency crises, and threaten the resources of the FDIC itself? Or how much of that subordinated debt is wrapped up in Credit Default Swaps? In 2008, the line between constructive traditional speculation and systemically destructive speculation is very different than what the Chicago school imagined from pure free markets back in the mid-1970’s. I know Mark C. Taylor and Richard Bookstaber know (and Kuttner and Charles Morris) how dangerous the new financial markets have become; I don’t know if David Leonhardt or Jason Furman or Austan Goolsbee know the power and speed of the dangerous currents we are now caught in. We’re going to need new “navigation charts,” and economic models, to get us through this safely. And do they realize the scale of the investment/infrastructure job creation response that might be necessary to fend off the worst? Paying homage to Reagan as an act of political inclusiveness is one thing; asking Milton Friedman’s ideas to get us out of this mess – is to risk being intellectually trapped in the wrong era – at precisely the wrong time.

Flashback to 1932-33:
Interviewed by journalist George Creel shortly after his 1932 nomination, FDR left no doubt that he understood what 1929 meant: “‘The debacle of 1929…was no mere panic, but the end of an era.’” (Page Smith, Redeeming the Time: A People’s History of 1920’s and the New Deal, McGraw-Hill, New York, 1987, page 335.) That didn’t supply FDR or the New Deal with a formula; above all else the government then was experimental, and a pragmatic path was followed. FDR was always looking over his shoulder at the deficits, as events in 1937 so sadly demonstrated, tempered by a deep commitment not to sacrifice people to the old economic ideology, and that’s how public policy evolved.

While I am glad to read in the Obama article that there is a shift in Democratic focus away from the old obsessions with the federal budget deficit, which is now far smaller in proportion to the GDP than it was during the early Clinton years (2.5% now, 4.7% then) there is still too much space devoted to the fine details of tax-cuts, and a stress on Pay-Go for any new programs, points that speak to continued Republican domination of “the frame” and not the actual nature of the broader economic disaster seen looming by Kuttner and others. (Those others include former Fed. Reserve Chairman Paul Volker, who said “the U.S. financial system, dependent upon securitization rather than traditional bank loans, is broken, and may contribute to the weakest expansion since the 1930’s,” in an article from Sept. 5, Bloomberg.com at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aw4J8Ty2h3fE [12] ) And Leonhardt, in addition to questioning the ability to convey Obama economics to the public, has a revealing “resignation” paragraph towards the end of the article. He asks: what else is there besides this or the Republican staple ideology of lower taxes and smaller government – since populism allegedly has done so poorly and a left wing agenda is dismissed in just two sentences – “disliked by both voters and experts alike?” I guess he must have missed the Time/Rockefeller poll we cited earlier. When Robert Kuttner talks about stale and conventional thinking and its “undertow,” this is a pretty good example of what he means in Obama’s Challenge.

There is one more thing missing from Leonhardt’s article. We get a discussion about how the “Chicago School” may have shaped Obama’s thinking with some commentary from the prolific professor and writer Cass Sunstein, who spent some down time with the Senator when he taught law at the University of Chicago. Now readers may be unaware, and maybe even Sunstein has forgotten, he publishes so much, that he wrote a book in 2004 called The Second Bill of Rights: FDR’s Unfinished Revolution and Why We Need It More Than Ever. The Second Bill of Rights comes from an almost now forgotten January 11, 1944 speech, Roosevelt’s last State of the Union address, which he could not deliver in person because he was ill. This is how Sunstein introduces it: “His speech wasn’t elegant. It was messy, sprawling, unruly, a bit of a pastiche, and not at all literary…But because of what it said, it has a strong claim to being the greatest speech of the twentieth century.” (My emphasis.) Here, published on a separate page between the Table of Contents and The Introduction, is The Second Bill of Rights:

Every American Is Entitled To:

The right to a useful and remunerative job in the industries or shops or farms or mines of the nation;

The right to earn enough to provide adequate food and clothing and recreation;

The right of every farmer to raise and sell his products at a return which will give him and his family a decent living;

The right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad;

The right of every family to a decent home;

The right to adequate medical care and the opportunity to achieve and enjoy good health;

The right to adequate protection from the economic fears of old age, sickness, accident, and unemployment;

The right to a good education.

Now maybe Sunstein never brought this up in the interview, and maybe he never even discussed it with Obama, and perhaps David Leonhardt is unaware of its existence. But given what I am writing about, and some of the other omissions I’ve mentioned, I thought you, my readers, should be aware of it. I’m not sure that if Obama is ever so inclined to discover and invoke FDR’s legacy, that this is where he should start; I tend to think the most immediate lessons are in the early days of the New Deal, and perhaps the historic physical contribution of the well managed public works…yet there it is…another part of our legacy, one rarely invoked in the fading twilight of the conservative era.

The Convention Speech and Obama’s Challenge
Like 38 million other Americans, I paid close attention to Senator Obama’s acceptance speech on Thursday evening, August 28. The 85,000 or so in attendance at the stadium was eclipsed only by the 100,000 citizens who heard Roosevelt’s 1936 acceptance speech in the intermittent rain falling at Franklin Field, Philadelphia. I also printed out a copy and read it the next day, several times. If the public had any doubts about Senator Obama’s poise or charisma, his leadership abilities, they should now be put to rest. I was very impressed. The speech was very good. It brought the Senator right to the kitchen table of American’s economic worries. Waitresses were pleased, I would think. Yet the lack of depth – as opposed to detail – of the diagnosis and remedies of our economic troubles – I thought had a lot in common with the magazine article – more so than the good Cooper Union speech. On Foreign Policy, I’m still a bit stunned. For someone who built his candidacy on his early insights into the traps of Iraq, he has now upped the ante in Afghanistan where the historical record of foreign interventions, British and Russian, is even bleaker. Since part of his fiscal game plan is built on savings from leaving Iraq, aren’t those funds going to be diverted right into Kabul – or discord with Iran, or the new cold war with Russia, once again, hauntingly, confrontations of choice where we frame the traps ourselves? Sure it makes the Dems sound tough; but we must be looking at entirely different budget sheets on what it will take to get out of the economic mess I see, the one that formed such a large part of the speech’s dynamics. There are weapons of mass destruction at work here, but not the Iranian ones being conjured up; rather, they’re the ones that Warren Buffet called “financial weapons of mass destruction,” – derivatives.

Is the historical frame here deep enough to carry the burden of the changes candidate Obama constantly evokes? By putting so much of the emphasis on Bush’s eight years – but not on the conservative era’s thrust over three decades – Obama is perhaps being tactically shrewd but cutting his leverage for the transformations it will take to achieve even what he has put on the table for now, which is much, much less than the situation will come to demand. I read the major addresses of the week to see how often 1932-1933 came up, or FDR was mentioned. Joe Biden mentioned him in passing from Lincoln to Kennedy, but there was no real context. And Senator Obama mentioned him alongside Kennedy, in a “defend the country” passage. But not Roosevelt as sitting astride a great transition from one economic era to another, and I think that the forces he had to deal with, including a comparison of the 1920’s to the 1990’s, have much more in common with our crisis, and its solutions, than other more recent comparisons.

As I mentioned before, Robert Kuttner’s Obama’s Challenge: America’s Economic Crisis and the Power of a Transformative Presidency came out just in time with the intention to be distributed at the Denver convention itself. My copy arrived the day after Obama’s speech. Without any communication between us, Kuttner and I are reading this moment from nearly the same historical page. He senses Obama can be one of the great transformative Presidents, on the order of Lincoln, FDR, and LBJ (leaving out Vietnam, which is a lot to set aside, admittedly). The material on FDR’s own transformation, and how it unfolded, is first rate, and shatters the New Deal myths of Right Wing talk radio. But right now, Kuttner is assuming Obama wins the Presidency and then has to face problems he’s currently understating. My question to Kuttner is this: even with that powerful speech, Obama only got a slight bump in the polls and the race looks very close under circumstances where it should be a landslide. Can Obama get there without deepening the frame, without going to the power that 1929-1933 evokes, and using that setting to educate the American people on the scope of what we face, similarities (there are so many) and differences (there are significant ones, but not ones that negate its force)? Kuttner worries that after he’s elected, Obama has to break the bonds of conventional economic thinking. I’m thinking he might have to break them to get elected. There will be more to come. (Take a look at the Washington Post Op-ed article’s by Michael Gerson “Obama the Orthodox,” from August 30, and David S. Broder’s “Small Change From Obama” from Sunday, August 31, both of which want to frame the policy substance of Obama in old Democratic footprints. Broder says his “…long list of domestic promises could have been delivered by any Democratic nominee from Walter Mondale to John Kerry.”).

Not only didn’t I hear what I was hoping to about FDR and 1932-1933 at the convention, I also didn’t hear the deeper insights which our authors offer the public, and the candidates, at “the end of an era.” Let’s look at what they mean by this term, the “era” which has no accepted “name,” like the Gilded Age, or the Roaring Twenties, or The Great Depression, a fact which was noticed by several progressive organizations, which are having a contest to name it, a little belatedly, I think.

So What Do We Mean, “The End of an Era?”
It is Kevin Phillips in Bad Money who presents the boldest and most historically rooted meanings of the term “The End of an Era.” Certainly his have the most explosive political meanings, and he recognizes that a candid discussion of the decline of America from the perch of the world’s leading economic power will most likely be off the table in a Presidential election year. Yet it shouldn’t have been too hard to riff off the many layers of Phillips’ arguments, to use the worries about “decline” as a rallying point to turn the nation around. Instead, it’s too tempting to leave it as “the mess Bush has created” however much Phillips’ insights reach back far beyond his disastrous eight years.

The more I hear and read about Barack Obama, Bad Money seems open for him to mine, especially by a tactful route, one of focusing on British decline as the path to be avoided. After all, Obama presents himself as a post-partisan figure, pivoting off what he sees as Reagan’s good insights, and Phillips is a former Republican theoretician now “statesman” worried about the fate of our nation, the nation where “so much work” remains “to be done.” So try this on for contemporary fit: “…a fair part of what blocked British reform between 1914 and 1939 was a politics – and crumbling party system – that…precluded any far-reaching policy transformation. For Americans, this idea is especially worth pursuing, because of the partial analogies to the entrenchments and incapacities in contemporary Washington.” (Page 167).

For decades now Phillips has been studying the patterns of other former world leading economic powers in decline, focused on Spain in the 17th century, Holland in 18th, and Great Britain in the 20th. The most powerful connection he sees to current US economic troubles is that all the former powers descended into a phase where finance came to dominate over other more fundamental economic activities and beyond that, where growing debt ushered in the unhappy final act. For short American historical memories, the eclipse of British manufacturing by its financial sector may be the easiest to grasp, with the slow decline of the pound sterling as the world’s leading currency playing out between 1918 and 1949, as the two world wars and the Great Depression humbled the once proud Empire.

For the “end of the era” that Phillips is talking about is nothing less than the eclipse of the “American Century” by new economic powers, led by China, Japan, Malaysia Indonesia, Singapore, Korea, Taiwan and others, the rise of India and Brazil, and the resurgence of Russia. The chief culprit in the complex saga of American economic decline is the rise and nurturance of our financial sector, FIRE: Finance, Insurance and Real Estate, and neglect of the American manufacturing sector. While the American political and economic establishment is still largely living under the spell of the Chicago School’s free markets, the world has moved on to various flavors of mercantilism. The US practices it too, for our FIRE sector, with heavy doses of denial and illusion. Phillips comments that “this is less a market-based Adam Smith brand of triumph than a mercantilist joint venture with U.S. government authority, strategic direction, funding support, and periodic Federal Reserve or U.S. Treasury bailouts of overextended financial institutions.” (Page xiii.) If anyone doubts that there is something to this line of explanation, a review of the shifting roles of Goldman Sachs’ leaders on Wall Street and in government is a recommended line of inquiry. Maybe this wouldn’t be working out so badly, if this newly dominant sector rested on a stable foundation. But it doesn’t. Here’s Phillips powerful summation of where the dependence on this sector has led the nation:

…American financial capitalism, at a pivotal period in the nation’s history, cavalierly ventured a multiple gamble: first, financializing a hitherto more diversified U.S. economy; second, using massive quantities of debt and leverage to do so; third, following up a stock market bubble with an even larger housing and mortgage credit bubble; forth, roughly quadrupling U.S. credit-market debt between 1987-2007, a scale of excess that historically unwinds; and fifth, consummating these events with a mixed performance of dishonesty, incompetence, and quantitative negligence. (Page 207).

This essay opened with the quote from Phillips calling our attention to the level of “official understatement and misstatement” and that theme is woven throughout. And it is nowhere more apparent than the absence of a discussion of the decline of the dollar in the political arena in a presidential election year. Talk about understatement and misstatement. While the superficial rhetoric is trotted out on occasion when absolutely necessary – Treasury is always for a “strong dollar,” after all, it is still the world’s “reserve currency - anyone who ever took a basic economics course knows that the major mechanism in international trade to correct huge trade imbalances – which are not exactly at the center of discussion of the Presidential race either – is to have the deficit- running nation’s currency depreciate (preferably, slowly and steadily). Which is exactly what the dollar has done since 2002. Phillips is sharp and a real official irritant on this point, because he insists on writing about the connection between the fate of the dollar and the price of oil. Once a happier dynamic existed: when oil prices were high, the dollar was strong too; now, with a weaker dollar, the oil producers have every incentive to try to make up for their lost purchasing power by biasing in the direction of higher prices, so there is an inverse relationship between the two. Although the dynamics have shifted since the peak price of oil at $147 a barrel in July, it is the alarming, and once again, unanticipated (especially in Europe) nearly global slowdown in economic growth that has given the dollar a slight bump up. Since our exports under a weak dollar had been a bright spot, it’s hard to be buoyed by this turn of events.

The great worry that runs through Phillips’ Bad Money, as the U.S. international economic situation deteriorates further, is that at a crucial moment, the US dollar will cease to be the world’s reserve currency, the one oil sales are denominated in. Everyone hopes, and Phillips does too, that if this is the inevitable trend, that it occurs slowly and orderly, the way it did when the British pound faded between 1918 and 1949. In recent writings (August 14th), we have called attention to a similar theme, the possible unwillingness of other nations, with great trade surpluses with the US, to hold other forms of our debt, especially US Treasury instruments, and just now, the debt of Fannie and Freddie, the mortgage market giants. Unfortunately, however, the world has no Bretton Woods like agreement to give the vast international currency markets the guidance and stability they enjoyed from 1944 until 1971. And this is a world which is much more closely networked than it was then. And much more volatile. During the last weeks of August, a story was making the rounds on Internet financial sites, and it had everyone who pays close attention wondering just how “official” the signal was. That’s because Chinese economic pronouncements tend to be even more understated and subtle than those uttered by the Federal Reserve. Here’s what got my attention: Yu Yongding, a “former adviser to China’s central bank” and someone who has access to Chinese Premier Wen Jiabao, is quoted as saying that “‘If the U.S. Government allows Fannie an Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic….if it is not the end of the world, it is the end of the current international financial system.’” From Kevin Hamlin’s August 22 Bloomberg.com story at http://www.bloomberg.com/apps/news?pid=20601080&sid=aslo2E01QVFI&refer=a... [13]

More recent accounts of these worries by the Financial Times indicate that the Bank of China has reduced its holdings of these GSE securities by 25% since the end of June of 2008. See the story at http://www.ft.com/cms/s/0/74c5cf58-7535-11dd-ab30-0000779fd18c.html [14] .

And so that gives us some timely and real world punctuation marks to the text of where Kevin Phillips leaves us in his concluding chapter of Bad Money, entitled “The Global Crisis of American Capitalism.” At least one Chinese expert then, apparently, doesn’t think Phillips was exaggerating the stakes here, when he wrote that “the underlying question before us in this last chapter is whether the housing and credit crisis expected to span the 2007-10 period constitutes the global crisis of American capitalism, in the sense of being the one that signals the Great Transferal to Asia.” (Page 200, my emphasis).

George Soros does not waste any time in his new book The New Paradigm for Financial Markets, in telling us what constitutes his “End of an Era” formulation. On the very first page of the Introduction, he notes that the worst financial crisis since the Great Depression “in some ways …resembles other crises that have occurred over the last twenty-five years, but there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process; the current crisis is the culmination of a super-boom that has lasted for more than twenty-five years.” Just in case this sounds too dryly put, Soros sharpens the edge a bit towards the end of the book, sounding a good deal like Yu Yongding above: “The decline of the dollar as the generally accepted reserve currency will have far-reaching political consequences and raise the specter of a breakdown in the prevailing world order. Generally speaking, we are liable to pass through a period of great uncertainty and destruction of financial wealth before a new order emerges.” (Pages 124-125).

Charles Morris, the banker/lawyer author of The Trillion Dollar Meltdown is a writer with a solid command of the financial wreckage, and most of the time his tone is restrained, if biting in the necessary places. His mild version of “the end of an era” is conveyed by reference to the great cycles of American politics put forth by Arthur Schlesinger Sr.: “…we are witnessing the final days of another quarter-century political/ideological cycle – the last gaspings of the raw-market, Chicago-school brand of financial capitalism that moved into the vacuum created by the 1970’s collapse of the Keynesian/liberal paradigm.” (Page 156-157). Now that’s softened a bit in other passages where Morris, like Senator Obama, defends the necessary shake-ups delivered by some of the conservative initiatives of the 1980’s, leading to economic gains later in that decade and the 1990’s.

Yet he has a deeper reading, one that echoes Phillips’ focus on the decline of the British Empire, and both Phillips’ and Soros’ fears for the status of the US dollar as the world’s reserve currency. Hence his reference to one of Anthony Trollope’s “greatest and most sour, novels, The Way We Live Now,” which would push the premonition of British decline back to about 1875, a lot earlier than Phillips posits. In language that is far too Wilkinson-sworded for me to paraphrase without losing its cutting edge, I’ll let Mr. Morris take you on a ride on the harsher side of his prose:

It’s conceivable that America is now at just such a place. For most of the past decade, business and government have offered a depressing spectacle. The massive frauds of the Enrons and the WorldComs. The eager self-delusions and conscious deceits that underlay absurdly misrated CDOs. The shameless selling of the government, as epitomized by the Republican “K Street Project” and executed through one Sallie Mae-type tale after another. The monetary helium from the Federal Reserve that fed asset bubbles, fueled a bread-and-circuses consumer binge, floated Wall Streeters into the financial stratosphere, and perhaps irrevocably debased the dollar.” (Page 156, my emphasis).

I’m going to finish this concluding section of Part II of “The End of an Era?” with some difficult material. So if you are tired and want to quit now while you are still ahead on Morris’ metaphors, please feel free to do so. However, if you do chose to travel along, I can promise you a glimpse of the Utopian Markets, and models, and premonitions of calamity, that have taken our nation to the financial brink. So on to “monetary helium,” and a vision of “zero capital and infinite leverage.” As Mark Taylor puts it, the financial world, that even gifted economists like Paul Krugman cannot figure out how to describe for you, was, “in the final analysis…a religious vision in which the market is a reasonable God providentially guiding the world to the Promised Land where redemption finally becomes possible.” (Page 301).

The Models Which Took us “To the Promised Land”
One of the sure signs, to me at least, that we are at the end of an era, is the rise in the level of attacks on the dominant models which have guided the economics of the era passing away. That would be the rational expectations school, Efficient Market Hypothesis/One Price Law, and market equilibrium theories that lay at the core of the revival of neo-classical economics. These are fancy names for more modern variations on the same ideas that guided the economic outlook of Presidents Warren Harding, Calvin Coolidge and Herbert Hoover through the 1920’s, right up to the point where they could not explain why the markets stopped “clearing” 1929-1933. Or, to put it another way, by 1933 the market had found an equilibrium, of sorts, that left between one-quarter to one-third of the nation unemployed. You’ll be happy to know that these are very much the same neo-classical ideas that underwent a great revival with the triumph of the Austrian economists (Ludwig von Mises and F.A. Hayek) the intellectual mentors of the Chicago School that emerged in the 1970’s and which is still the dominant flavor. There are many complexities being left out of this oversimplified tale, however. Milton Friedman, who was wise enough to predict the stagflation of the 1970’s, had his monetarism found wanting in the reality tests of Paul Volker during the 1980’s. And Keynesianism, supposedly the losing side in the battle with the Chicago school, sure looks like it was the unspoken guiding force in dealing with the recession of 2000-2001: low interest rates, massive tax cuts and heavy deficit public spending, (military Keynesianism would be more accurate). However, the nature of the tax cuts and direction of the public spending drove many “classical” Keynesians” up the wall, where they converged with monetarists “beside themselves” over the bubble-creating Federal Reserve directions from the Greenspan reign.

All this can become very complex. But if you remember that under the Chicago School and in the conservative era, free markets have been worshipped and government regulatory interventions (in theory and most practice) have been despised, you’ll have the sense of it. It was all working out towards a happy ending. If it were not FDR’s theme song, we could sing “Happy Days Are Here Again” to celebrate these Chicago theories: markets are efficient (a word of very high utility and praise, is it not?), prices always converging (towards One Price That Is Right), supply and demand always striving towards a soothing equilibrium (implying full employment and stable prices – little inflation). You can have some fun with these ideas like the One Price Law, for example. Readers may remember the important term “arbitrage” – the investment activity that strives to make money from betting on divergent prices of different instruments, or different prices for the same asset in different markets. But how could that be in the world of the One Price Law? Well, small wrinkles in a smooth theory are not a problem; those divergent prices are heading towards one price, very quickly, and the more market players that spot the divergence the faster they will move towards one price – so you better, if you are a hedge fund, leverage up and act with speed, which the highly automated, model driven financial world of the late 1990’s was designed to deliver. (Careful readers of the financial news in early September will note that the “spreads” – the differences - between crucial indicators used to price financial assets are widening, not narrowing…a measure of distress and oops…a slight “divergence” from Efficient Market Theory/One Price Law).

This brief background is my way of introducing you to the amazing work of Mark C. Taylor’s Confidence Games: Money and Markets in a World Without Redemption (2004). It’s easily the most difficult of the six books under review, but perhaps the most rewarding in both its explanatory power – and predictive success - because, as noted in earlier postings, Taylor described with precision what has unfolded in the collapse of our financial markets starting in August of 2007. I don’t know if he would be interested, but he should be considered for the “financial market oversight commission” that Senator Obama recommended in his Cooper Union Speech, as well as our other authors. I’m going to use Professor Taylor’s (he’s now head of the Religion Department of Columbia Univ. in New York) book as the basis for giving you a sense of how the financial models of the 1990’s, which have helped drive us to our current market predicament, failed, and what newer models, based on some not-so-utopian assumptions, deliver: which is not good news for the old market “happy” equilibrium theories. We’re going to look more closely at the model Long-Term Capital Management (LTCM) used, and what it signified, from 1994 until its collapse in August of 1998. LTCM was the giant hedge fund founded by the famous John Meriwether, a pioneer in mathematical models for risk and arbitrage, and advised by two Nobel Prize winners in economics (awarded in December,1997), Myron Scholes and Robert Merton. They were awarded the prizes for their “discovery of ‘a new method to determine the value of derivatives.’”(Taylor, Page 250).

Led and nurtured by three of the most brilliant economic minds of the “era,” what could have gone wrong with LTCM’s models? {As we describe what happened, and its meaning for the broader markets, please note that Taylor is relying on two books written about LTCM: Nicholas Dunbar’s Inventing Money: The Story of Long-Term Capital Management and the Legends behind it (New York, Wiley, 2000) and Roger Lowenstein’s When Genius Failed: The rise and Fall of Long-Term Capital Management (New York: Random House, 2000)}.

“Zero Capital and Infinite Leverage”
Taylor reminds us that the familiar basic ideas behind the market fundamentalism of the Chicago School are the same ones, along with related assumptions, that were at the core of the mathematical models that drove LTCM. Now add in a couple more: “Risk can be quantified and therefore uncertainty eliminated through probalistic statistical analysis. Volatility follows a Normal distribution…Liquidity is always available….Prices move in a continuous curve and are not subject to major leaps up or down. Seismic market shifts, sometimes called outliers, are so rare that they can for all practical purposes be disregarded.” (Page 258).

While the conventional economic narrative of the times portrayed the collapse and damage containment from LTCM as a skillful “just in time” emergency room operation for the whole system, I read the autopsy report as a blueprint for today’s broad financial collapse. Lowenstein is quoted as saying that one of their large trades, for $2 billion, was made “without using a dime of its own cash.” (Page 259). By 1997, Taylor, citing Dunbar’s Inventing Money, says LTCM had “‘$120 billion of borrowed bonds and $1.25 trillion of derivatives.’” (Page 259). As Dunbar describes where this was all leading, please listen to the rising Utopian/Faustian notes: “‘the interlocking parts were now so perfectly engineered that these devices were virtually capable of perpetual motion. As the technology of risk management continued to improve, the tiny sliver of equity underneath the inverted pyramid would vanish completely. ..At LTCM’s zenith, they had a vision of zero capital and infinite leverage.’” (Page 259).

In August of 1997, after three years of very high returns, things started to unravel. Russia defaulted on its bonds, an “outlier” that caught the investing world by surprise. And no IMF bail-out followed an earlier one in July. Markets were thrown into turmoil. Hedge fund competitors were already putting pressure on LTCM’s earnings by following similar investing models, and so Meriwether’s hedge fund took some risks that were not well-hedged, based on their confidence in projecting that other market players were “overestimating” market volatility…But spreads were widening and not converging…their model was failing and they were losing money at a rapid rate….: “Most of their assets were held by creditors as collateral for loans that had been made to purchase additional assets. In the absence of buyers, the only thing LTCM could do was sell their holdings to raise the capital they needed. However, because these positions were so large, when they sold assets, their actions depressed prices still more, thereby creating the need to sell additional holdings…The situation was all the more alarming because some of the major banks and financial institutions at home and abroad were deeply invested in LTCM.” (Page 262).

The situation was resolved by the Federal Reserve acting as a convener for major banks and brokerages which came up with $3.625 billion to salvage the situation. LTCM was dissolved in 1999. Readers will recall from our June 17 posting the descriptions given in Charles Morris’ Trillion Dollar Meltdown of the “balance of terror” which exists between “banks and their hedge fund clients.” This 1998 episode was the full dress rehearsal for the broader, deeper calamity that we are still trying to avoid today, almost exactly a decade later. There are now between 6,000-8,000 hedge funds. While we don’t know how many have the Faustian drive of LTCM, their numbers and known appetite for risk, desire for leverage, and lack of transparency and regulation leave many feeling very uneasy, including this writer.

Even though we are hearing charges of “elitism” tossed about in the presidential race, we haven’t yet heard anyone call hedge funds elitist. They are. You need big money to play, and the government is not allowed to regulate them because they are descended, partly god-like, from the region of The Market mountain tops. The mortal closest to “The Market,” the Chairman of the Federal Reserve, is allowed, just recently, under conditions of great secrecy, to peer into their books, to see if their closely guarded “positions” might pull down the whole system. On Sept. 4th, the day the market dropped 344 points, there was speculation that several large hedge funds were “unwinding,” something akin to Atlas shrugging, I guess.

Order Emerges…Far From Equilibrium
Since Mark Taylor was writing in 2004, Confidence Games does not have the direct “end of an era” coloration that Phillips’, Morris’ and Soros’ books do. His broader purpose is a description of what the “postmodern era” means in economics, philosophy, religion, architecture and the interaction between culture and the marketplace. Writing in the wake of the dot.com bust and stock market shocks of 2000-2002 and the major accounting scandals, his stress is on the obsolete financial models that Wall Street was using and the need to develop better ones. Yet what isn’t clear is the extent to which these old models have been replaced by newer ones that more accurately capture the extensively networked modern economy. We do know, however, that whatever the quants were employing heading into the crisis of 2007, the models failed, and failed miserably, to foresee and forestall the systemic problems of a financial world built on derivatives. Presumably, Wall Street was not employing the new models described by Taylor, because these new models don’t have the happy endings and certainties which the old equilibrium models did. If heeded, they might have led to higher margins, more collateral, and less risk taking.

The key words used to describe the new models are “complex adaptive systems with self organized criticality, also known as tipping points,” drawing on work in physics, evolutionary biology, landscape dynamics, neural activity and, something which should really get your attention, natural phenomena like “avalanches.” Peter Bak, who formerly was a physicist at Brookhaven National Laboratories, has done much work in these areas, and the findings lead to comparisons to the way markets behave in the new economy, with increasing volatility and repeated, sharp shocks. Here’s what Bak has to say:

‘Complex behavior in nature... reflects the tendency of large systems with many components to evolve into a poised, critical state, way out of balance, where minor disturbances may lead to events, called avalanches of all sizes. Most of the changes take place through catastrophic events rather than by following a smooth gradual path. The evolution of this very delicate state occurs without design from any outside agent…the critical state is self-organized. Self-organized criticality is so far the only known general mechanism of complexity.’ (Page 291).

Now this is fascinating and scary stuff. Does anyone else hear echoes of Chicago School themes in the emphasis on self-organization and evolution “without design from any outside agent” – like maybe the SEC or Commodities Future Trading Commission? It’s not a surprise then to see that the conservative patriarch, F.A. Hayek, was exploring some of these same pathways to draw macro-principles from two systems of ordering, one with “exogenous” traits – order imposed from the outside, and the endogenous kind, the self-generating or spontaneous types, in his 1973 work Rules and Orders. Got the message? Don’t impose economic regulations on the spontaneous order that will emerge from the hidden hand of the marketplace. Yet there is a terrible tooth and claw coloration to Hayek’s view here, Hobbesian in its very language: “ ‘Neither his reason nor his innate ‘natural goodness,’ leads man this way, only the bitter necessity of submitting to rules he does not like in order to maintain himself against competing groups…’” (Taylor, Page 295). Of course, one also hears clear echoes of Calvin and Smith’s Hidden Hand in these self-regulating features. But Mark Taylor is a complex interpreter of modern complexity. We’re not heading for a happy equilibrium here, citizens:

By the end of the twentieth century, this network was embodied in realities that were becoming increasingly virtual. In those complex networks, the invisible hand is no longer omniscient and omnipotent. To the contrary, the order governing the network economy emerges from the internal relations of human and machinic agents whose knowledge is always mistaken and memories as well as expectations are inescapably incomplete…recent developments in a new field known as artificial life also suggest that the principle of equilibrium, which lies at the foundation of classical economics, has severe limits. …in self-organizing systems, order invariably emerges far from equilibrium, between too much and too little order… (Page 295, my emphasis).

Well, my apologies to Professor Hayek here, but isn’t that exactly where Keynes had left us in 1936, dealing with the wonderful “order” of the Depression, where “equilibrium” had set in at unemployment levels of 20-30%? That was an intolerable situation for our nation, and our people, who had to eat and keep a roof over their heads by employment, theories be damned, and the New Deal was not about to sit around and “submit out of bitter necessity” if the “self-organizing” economic features of the 1920’s led them into such an tragic “equilibrium.”

I have worries about the resignation and passivity implied by where Mark Taylor’s amazing book leads. It is not a book of political economy or prescriptions, other than showing some exploratory paths to get better models of economic reality. It is really a book of descriptions and insights into our new networked, high-speed, semi-virtual modern landscape, where Las Vegas may have more to tell us about financial reality than University of Chicago lecture halls. Yet the subtitle – Money and Markets in a World Without Redemption – clearly expresses a message: learn to live with uncertainty, insecurity and market volatility. Could it be that the author who has left us such a prophetic description of the “house of cards” financial system built upon higher and higher levels of derivative bets upon a shrinking collateral base in his chapter entitled “Specters of Capital” – more specific and more penetrating in advance than any of our other authors – perhaps underestimated where the “real economy” would be left after a year of financial crisis in the spectral one?

“…Collateral Damage Is Difficult to Contain…”
After all, Professor Taylor raised the issue himself with warnings about an economic world where the virtual financial one has triumphed, seemingly, over “what was once called the ‘real’ economy: “The spectral economy continues to be haunted by the real economy, which hides but does not vanish. When the repressed finally returns, collateral damage is difficult to contain.” (Page 180). Now when he wrote that, Taylor had in mind the collapse of the dot.com world at the turn of the 20th century, when we came to realize that high-tech start ups needed day-to-day profits after the initial fireworks of their IPO launchings. Now, in 2007-2008, we are facing the collapsing world of financial derivatives – investment instruments built, layer upon layer, on the “foundation” of the greatest consumer debt levels ever seen since the 1920’s: ….anything that could be securitized was. Who could ever have dreamed of a financial world where the underlying “assets” were the debts themselves? The smart people on Wall Street knew, when marketing them, that “Asset Backed Securities” (ABS) sounded better than Debt Backed Securities. (Taylor wasn’t buying any: a key chapter is called In-Securities). Any debt/loan with a payment stream behind it was fair game for this. You’ve heard about sub-prime mortgages, credit card debt, auto loan debt, auto leases. How about the securitizing of mobile home loans, boat loans, airline ticket sales, aircraft leasing, railroad rolling stock, tax liens, vacation home time-share leases? I think snow-mobile and jet ski leases were in there, too, but I could be mistaken. Language fails at describing the breadth of imagination displayed in this mania. So what does “the return of the repressed” and “collateral damage” mean in this context?

“Creation Out of Nothing”
Readers, citizens and elected officials, all of us, will be likely to hear more about the fate of our hybrid mortgage giants, Fannie and Freddie. It’s unfolding the weekend I’m proof-reading this essay, Sept. 6-7th. Even as many in the private sector say they don’t have adequate capital – a Lehman Brothers Holdings Inc. report released in early July said they might have to raise another $75 billion in new capital (appreciate the irony of this as Lehman Brothers itself was under severe pressure on similar capital shortage grounds) intensifying an ongoing drop in their share prices. Henry C. K. Liu, a chairman of a NY based private investment group and a prolific essayist at Asia Times Online, wrote what I thought was a first rate piece on the history and troubles of these mortgage giants, entitled Debt Capitalism Self-Destructs. But rather than being the cause of the crisis, he presents them as the logical conclusion and giant illustration of what has been going on in the age of market fundamentalism, which he often calls the reign of neo-liberalism, hearkening back to the original free market “liberalism” of 19th century Britain. He reminds readers just what getting a mortgage was like before the interventions of the New Deal. In the 1920’s it was 40% down, to be paid off in 3-5 years, interest only, until a big balloon payment at the end. “Lenders could demand full payment of the outstanding loan at any time they wanted…this allowed lenders to use foreclosures as a means to take over desirable properties.” Weren’t the Roaring Twenties great? I don’t remember Ronald Reagan talking much about the New Deal which brought in federally guaranteed long-term (30 year) mortgages with the National Housing Act of 1934.

As the decades wore on the program evolved – still relying on significant tax advantages and lower capital raising costs – but now partly privatized so that private financial investors would benefit. Fannie and Freddie pioneered in the use of some of the new derivative products, mortgage backed securities, and over time, increasingly took on the characteristics of hedge funds as they acted not only to hedge against the great fear of long-term mortgage players – a sharp or steady rise in interest rates – but to generate more and more profits for their investors and Wall Street scale perks and salaries for their executives, and “to enrich debt securitizers and brokers.” Liu asserts that they became prime enablers in the housing bubble, drifting far from their original mission to aid low and middle income families struggling at the edge of home ownership. Of course that was still part of the public rationale, but Liu reminds us of the vast and powerful constituency that the GSE’s (Government Sponsored Enterprises) also served: “The liberals who wanted to help low-income households, real estate developers that wanted guaranteed demand, home builders that wanted a guaranteed market, local politicians who wanted tax revenue from redevelopment, banks that wanted lucrative risk-free loan proceeds and congressmen who wanted campaign contributions from mortgage lenders.” (My emphasis). The GSE’s also became enmeshed in the ideological politics of the era, being attacked by Wall Street Journal editorials and Republicans in Congress for being like “poorly run hedge funds,” the irony of which Robert Kuttner points out – because hedge funs themselves were not under attack by either the WSJ or Republicans in Congress – presumably because they were well run – as we all know by now. Kuttner also noticed that the attacks occurred when the executives of the GSE’s had a slightly Democratic Party flavor (See The Squandering of America, pages 116-117).

Liu denies that the GSE’s have really lowered mortgage costs for their original target audience, and he says they – and everyone else -would have been better off if they stayed public and non-profit in their orientation, fulfilling their mission by using government credit for their funds to directly to purchase mortgages from private lenders and insure them. Here is the awful cycle that we got instead, in Liu’s own words:

The profit from housing price appreciation went mostly to mortgage originators and banks that bought and sold MBSs to investors who also profited from buying debt with debt collateralized with the debt they bought. Capital suddenly became only a notional value in the market of debt derivatives. Homebuyers bought mortgages with no down payment, banks and mortgage brokers sold the debt to securitizers who sold it to institutional investors who borrowed using the securities as collateral. The GSEs also became very profitable, leaving
homeowners to default on their mortgages as the market turned on them. The whole transaction cycle did not require any capital.

That is Henry C. K. Liu writing in Asian Times Online on July 22, 2008. Now let’s flash back to Mark C. Taylor writing in Confidence Games, in 2004, at a higher level of generalization, about the trends in the financial economy in general:

…throughout the 1980’s and 1990’s, new financial products made possible by computers and networks vastly increased the opportunity for leverage and thereby created a collateral crisis. More and more money was being borrowed on the same collateral base. In addition to this, the nature of collateral changed in ways that allowed investors to use securities and derivatives as collateral for additional loans, which in turn were used for yet further investments. This led to faster growth in the financial sector than in the real economy and therefore to a shrinkage of the latter relative to the former. The result of these developments was an inverted pyramiding process in which the foundation of financial markets was virtually disappearing…investments became more and more abstract until they appear to have little to do with actual companies and processes in the productive economy. As the signs of finance proliferated, quants became invisible gods who seemed to allow traders to realize the ancient dream of creation out of nothing. (Taylor, pages 253-254).

Just Streams of Hoped for Payments…
Now what, you ask, lies at the very shrinking base of this grand pyramid of debt-based investments? The answer is debt “assets,” which are really just streams of hoped for payments on the debts or loans, be they mortgages, auto loans, credit card debt….or vacation home time-share properties. And what is behind the hoped for payment streams? Humble citizens and their incomes, the very ones suffering from higher and higher debt levels in all phases of their lives. It’s called the “middle class squeeze” in its milder versions, but it’s much more than a squeeze for many at even lower income levels. Now we all know that some of the great characteristics of this “era,” are the decline/stagnation of wage income at the middle and lower end of the spectrum, and the greatest maldistribution of wealth since the 1920’s. So, as the contemporary phrasing goes, “what were they thinking” to build this pyramid of great debt upon these very stressed foundations? No wonder that some of the risk managers at major Wall Street firms, standing at the base of the vast pyramid in 2005-2006, were worried how it would hold up under recessionary conditions, when those “streams of hoped for payments” would be bound to decline…even without the greatest collapse in house prices since the Great Depression. Now do my readers understand why contemplation of a mere “price of mortality” recession is so unnerving?

Well, we have come nearly full circle now, since the lessons of 1929-1939. Part of the diagnosis of the New Deal was that what was missing in an economy that could not sustain any momentum was adequate purchasing power: among the farmers who still represented nearly a third of the workforce, among the vast number of blue collar workers on the assembly lines, and among the demoralized middle classes, white collar workers of all sorts. Full employment at decent wages was the prescribed remedy, tried at too modest a scale in the years mentioned here, finally backed into, from 1939-1945, as we denied what was happening and embraced a win-the-war version of Keynes.

And so it is that a writer for Asian Times, not the Washington Post or the New York Times, who strikes at the heart of the problem: “The problem was that financial manipulation cannot replace the need for adequate income growth. The mismatch of income with asset price is the definition of a financial bubble…Yet in all the current talk about finding ways to deal with the crisis, not one single voice is heard from official circles about the need to increase worker incomes. Instead, false hopes on one-time stimulant tax rebates are hailed as the magic bullet.” You can read the full article at http://www.atimes.com/atimes/Global_Economy/JG22Dj06.html [15]

The great irony here is that there may be no sound way to work ourselves out of the “great de-leveraging,” to save the very financial system itself, without expanding the income behind the “hoped for streams of payment” at the very bottom of the debt pyramid. At the same time we have to reduce the height and strain of the edifice so that we never again structure our very economy on such a ridiculously utopian set of assumptions. And that is how the “return of the repressed,” from the neglected real economy, comes back to cause enormous collateral damage. The new financial engineers repressed a key, perhaps the key fundamental: the basic need for broadly distributed good paying jobs from a productive economy that actually makes things that we need and that others around the world want to buy. And if these missing investments are made in the right industries, they will create the very products that cut our vast trade imbalance by moving us away from the old carbon energy sources.

“This Nation Asks for Action, And Action Now”
My readers have been very patient so far in following a very complex description, and diagnosis, of our crisis, from many sources. As we have seen in Part II here, an increasing number of observers see the new President in 2008 facing problems on a scale not seen since 1933. I have steered in the direction of FDR and the New Deal, not for a detailed blueprint of the way out, but as a story of determined optimism in the face of daunting economic disaster. We can, however, discern a general compass direction. And without ever comparing notes with each other, Robert Kuttner has headed in this same direction with his book Obama’s Challenge. It offer’s perhaps the boldest and most detailed outline of where we should head to begin “to redeem our time,” and we’ll have more to say about it in “The End of an Era?” Part III.

I would like to close on an inspirational note, from a source that has been out of favor for a long time. We opened this essay with a quote from Kevin Phillips, lamenting the level of official “understatement and misstatement” in 2008. In direct answer to these worries, I offer you a selection from Roosevelt’s Inaugural speech of March 4, 1933, 75 years ago. It’s taken from Page Smith’s Redeeming the Time, the eighth and final book of the last great multi-volume history of our nation written by one author. As I did with the concluding paragraph from Part I, from NY Federal Reserve Chairman Timothy Geithner’s “celebration of the benefits of derivatives,” I’ll leave it to you to read FDR’s national exhortation, and to use it to measure the speech, and directions, of our 2008 Presidential candidates. It’s not gospel, even though he drew heavily on biblical metaphors, but for us today it can be something of a measuring rod. Now here is FDR, from page 430 of Smith’s work:

At the inauguration Roosevelt used his old family Bible in Dutch for the swearing-in ceremony. He then moved forward to deliver his address. ‘This is a day of national consecration,’ he began. ‘I am certain that my fellow Americans expect that on my induction into the Presidency I will address them with a candor and a decision which the present situation of our Nation impels. This is preeminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing conditions in our county today. This great Nation will endure as it has endured, will revive and will prosper…So, first of all let me assert my firm belief that the only thing we have to fear is fear itself…
Our distress comes from no failure of substance…Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply. Primarily this is because rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence, have admitted their failure, and have abdicated…True they have tried, but their efforts have been cast in the pattern of an outworn tradition…They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish.
The money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. The measure of the restoration lies in the extent to which we apply social values more noble than mere monetary profit…Restoration calls, however, not for changes in ethics alone. This Nation asks for action, and action now.’

Bill Neil
Rockville, MD