November 28, 2008
Dear Citizens and Elected Officials:
So much has happened since the last posting of October 1st that it seems like a year has gone by, and not just two months. America now has an intelligent, articulate new President-elect. He will need all his considerable leadership skills, and then some, to become a “transformational” President equal to our problems. A new book poses the challenge in startling terms by entitling its first chapter “A Great President or a Failed One.” The book, by Robert Kuttner, called Obama’s Challenge, is really a must read for progressives and all who wish President-elect Obama well. Later on, we’ll tell you why this book captures the moment so well.
The long essay which follows has been written as events have unfolded in October and November. It is, in some respects, a series of shorter essays on the pressing problems of the day so I’m going to give you the topics right now, upfront, and you can head to the problem area that worries you the most, and get right at it. But also, hopefully, you’ll see it as one long essay too, connected both to the pressing events of November, our new President’s appointments, and the broader themes covered in “The End of an Era, Parts I & II.” So here’s the layout:
1. Market Volatility and “The Bottom.”
2. How Bad Can It Get? Roubini & The Worldwide Panic Week of Oct. 20-24th
3. Cures for Plunging House Prices and Foreclosures: No Consensus
4. Paulson and The Bailout
5. Who Could Have Known? The Unsung Resistance
6. A Full Accounting for the American People
7. Preparing Progressives: Kuttner’s Obama’s Challenge, Galbraith’s The Predator State, and Fraser’s Everyman a Speculator
The financial crisis blazed across the front pages in October, and seared itself, with the re-entry heat of plunging stock market and commodity prices, into every citizen’s memory. September and October 2008 have guaranteed that this financial crisis will take its place in economic history as marking the collapse of the greatest speculative bubble of all time. A massive second phase is now about to unfold: a world wide recession. The ongoing interaction of the two is what worries our best economic minds. It may not be much consolation for us after opening our account statements, but we can be sure we are witnessing something that will far outlive us, that future generations will think about in the same way we now do of The Crash of 1929 and the Great Depression.
The bailout, pushed with so much urgency in early October that our Congressional leaders felt they didn’t have time for a genuine democratic process, seemed almost immediately irrelevant, as the stock indexes followed with a run of more than a week of steady losses, and the Dow hit its monthly low on October 10th. Then, later in the month, European markets, Asian markets and emerging markets around the world were stricken with selling panics, and the threat of governmental default hung over Argentina, Ukraine, Belarus, Hungary and Turkey. Iceland melted in a banking and foreign debt debacle. As George Soros has pointed out, when western European governments enacted bank account guarantees, it had the unintended effect – a phrase we’re going to hear again and again over the next couple of years – of undermining weaker economies that couldn’t afford the protections. Governments and central banks nonetheless pulled out all the stops to stem the panic, and by Halloween, some sense of stability had been restored – for how long no one knew. But some 9.5 trillion in stock equity had been lost worldwide.
For the month, the Dow was down 27%, the S & P 17%, its largest one month drop ever.
People have asked me, by Email, and in person, what they should do about their investments. Since I’m not a trained financial advisor, I have only offered my sense of the new market dynamics, centered on the questions of whether they have hit bottom, and, if not, how low they could go, and my own explanations of the causes of the extreme volatility we’ve seen over the past year, and especially over the last 60 days or so. So here’s my take.
1. Market Volatility and “The Bottom”
I’m sure many in my reading audience are familiar with the traditional advice of investing professionals, ideas and phrases that one hears, almost obsessively, on CNBC’s daily coverage: don’t be a market timer, invest for the long term, and when everyone else is gripped by fear, that’s the time to buy – at the bottom of a market downturn, of course. And, how could we forget: aren’t many stocks trading way below fair valuations?
Readers who have digested our postings over the past year might have some good insights as to why most of this conventional think might not be much help in our “contemporary markets.” Now here’s a refresher course as to why.
This has been the greatest speculative bubble in economic history. It has now burst, and “deleveraging” has been going full flood in October. That means a sizeable proportion of the trillions of dollars of derivative bets of all types have gone bad, and the small pool of collateral at the base of the giant pyramid is now under tremendous pressure – under call by the counter parties to the bets or the banks or brokers themselves, who want more cash or more near equivalents to cover the fall in value of – well – nearly every asset class. But what is the nature of that collateral? It was most often stocks or bonds, and the only way the players under pressure could meet the calls was to sell the asset. The 8,000-12,000 hedge funds, unregulated, some highly leveraged, faced pressure on two fronts: as they experienced their worst returns ever in September, their investors wanted out, ASAP. Their brokers/counter parties (often banks who were in tremendous trouble for their own reasons – toxic mortgage bonds, other derivatives gone bad - wanted more collateral at the same time.) Many hedge funds were “shorting” the financials (leveraged bets that they would decline in price) – until shorting was banned in September to save the system. Many hedge funds were also “long” (betting on a rise in price) on commodities, like oil, and were betting against the dollar. We are all aware of the tremendous plunge in oil prices from the July $147/barrel price to around $54 now (Nov. 26th). Commodities across the board have plunged, driven by their own bursting bubbles, and the 180 degree change in macro-economic forecasts to now read: global recession coming (it’s here already in many places). The more conservative institutional investors have fled the markets, pulling out hundreds of billions of dollars from stocks and indexes. This would all be bad enough. High leverage – multiplying one’s bets with borrowed money - so rewarding on the way up - is a killer on the way down. Not just for the firms doing the leveraging. For everyone, as we will see. This is an old, often repeated financial tale if one’s historical memory had an adequate span. The mindset of the Age of Market Utopianism was not just short on historical memory, however. It was also long on hubris, even those on the left who should have known better: they felt an all knowing, all-seeing Fed would never let another 1929-1933 happen, because it knew what to do to avoid it. But that is not all.
Remember all the worries we’ve documented about Credit Default Swaps, those derivatives constructed on the likelihood of corporate bankruptcy (or not), which started as simple insurance policies but have grown into nasty complex bets that firms and funds will go under (including Uncle Sam – the likelihood that US Treasuries won’t be acceptable to other countries for investing). The CDSs run into the tens of trillions of dollars. But our worries don’t stop there. A substantial number of hedge funds and other investors make currency and interest rate bets – directional bets. If you’ve been following the news recently, the dollar and the yen have turned on a dime and broken form, and emerging market nations have seen wild gyrations in the value of their currencies and now interest rates as they try to cope with fleeing foreign investment money. So speculative bets with derivatives are going bad in spades.
What this means for the poor average investor worrying how low the S&P and Dow could go is this: forget the fundamental value of the components of your stock portfolio. If your “basket” owns the stocks, bonds or indexes that the hedges and other large players owned and they are unloading - then fundamental value gets thrown out the window in the desperate race for the exit that can push prices out of the orbit of normal valuations.
You may have heard of “technical trading,” where historical stock and index patterns going back to the 1920’s are mapped and graphed to show every twist and turn in historical market valuations. The point: in repeat patterns we will find our predictions. Given the shadow banking and investing world, based on unregulated derivatives we have ushered into existence since we went off gold in the early 1970’s – and especially since the 1990’s …and the nagging fear that the risk managers had in good times of how the new financial system might behave in a recession…well… now we are looking at worldwide recession and perhaps a very severe one of 24 months duration – some say U or L shaped, not V shaped (and we’ll explain that in another section)… So all the historical graphs and charts of the technical traders looking to call a bottom, based on the past ten or twenty year patterns, have lost their predictive power because the patterns they’ve mapped have nothing to do with the new speculative world that is coming apart at the seams now.
As a matter of fact, given the height of the world’s largest speculative bubble – and the possibilities contained in hundreds of trillions of dollars worth of derivative bets – I’ve told some folks that as a theoretical matter I can conceive of no short term floor at all for the DJIA….in other words, in sheer market panic mode given the size of bets going bad and forced selling as described above, sound fundamental prices of assets not in distress could be pushed to unbelievably low prices – at least temporarily. Now I don’t believe that will happen, and as we look at the reasons for the extreme volatility – the wide swings in daily market prices – we will see that there are other forces working in the opposite direction. But because so much of the speculative world we built is completely unregulated, no one can be sure that the number of buyers can match the vast tsunami of sellers built up under present calamity conditions.
The average citizen investor needs to remember that despite the vast damage wrought by the down markets – trillions of dollars already lost – there are many sophisticated traders who are still very wealthy. They can set 70-90% of their assets aside in cash or near equivalents and still have tens of millions or more to swoop in with and buy after some of these tremendous 400-700 point drops we’ve seen. Traders like this are not in for the long haul under these circumstances – they’re nimble and will do quite well with quick turn-arounds over a 24-72 hour cycle – or less. Those remaining hedge funds with nerves of steel can take advantage of the volatility too. Under these circumstances, total volume in the markets is down, and the volatility is caused by a struggle between the deleveraging of forced sellers and the short-run opportunism of the traders, with the more conservative institutional investors in the big equity funds and pension funds having headed to the sidelines, licking their wounds and kicking themselves to the extent that they got caught up in the hedge fund mania.
So this is no market for amateurs. Even the hardened pros on CNBC’s “Fast Money” shake their heads and just recently debated the grand question “of whether long term investing” was down for the count, noting that even Warren Buffett, the classic long-term hold/value investor was now hopping in and out of the market to ride some of the short term volatility waves.
This writer can’t see a bottom yet. (This section was written in early November; not many revisions even at Nov. 26th). The economic news on corporate earnings, consumer spending, and other leading indicators is bleak, and alarming. We’ll talk about it further in the next section. For now, in looking for that bottom and the long climb up, remember that this is a once-in-a-century economic event. In the 1987 crash, it took the Dow 15 months from October 19th to get back to its August 25th high of 2722. And that was not a systemic event of the magnitude we are now living through. In the Great Crash of September of 1929, the Dow fell from its Sept. 1st high of 381, down to 41 on Aug. 8, 1932, a drop of 89.2%, and did not reach that Sept. ’29 high again until November 23, 1954. Yes that’s right, 1954, 25 years later. (Associated Press article, “Wall Street Recovery Could Take Years,” October 4, 2008).
The New York Times’ David Leonhardt had a useful story for investors on October 29th: “Are Stocks the Bargain You Think?” Leonhardt uses a classic investor’s yardstick, stock price/earnings ratios; however, his favorite is based on a 10 year record of earnings. The century average under that lens is “16” – and stocks are just below that mark today. Yet when there is terrible market trauma, as in 1929, the ratio goes way down – to 6, for example, in 1932. So the implication is that we can still go way below today’s average of near 16. Here’s the link: (http://www.nytimes.com/2008/10/29/business/economy/29leonhardt.html?_r=1... [1] ).
It is important to keep in mind that we are now entering a new phase of the crisis. Up until mid-September, it has been events inside the financial system, especially the bursting of the housing bubble and the collapsing bond values intertwined with it, that have driven market reactions. The combined shock effect of the stock market price and housing value plunges in September and October have traumatized consumers, who have pulled back from all forms of discretionary spending – retail, autos, electronics….Layoffs are mounting and businesses are now making future spending plans based on the reality of a worldwide recession. The impact of a major change in US consumer spending habits spells deep trouble for China, Japan, and much of the rest of Asia. And now the negative “feedback loops” between the “real economy” and the financial system will come into greater destructive play. Don’t forget: investments have been built, through the process of “securitization,” on many forms of consumer loans, not just mortgages: credit card debt, auto loans and leasing…any consumer debt with a payment stream likely has some form of speculative investment built upon it. This fall, consumers are losing jobs in dramatic numbers, as well as the easy ability to borrow against their homes (18-20% of mortgages are now underwater/upside-down, meaning the mortgage loan is larger than the market value of the house – no borrowing in these situations.). No wonder Secretary of the Treasury Paulson announced at his press conference of Wednesday, November 12th that Treasury and the Federal Reserve are looking at ways to use some of the bailout money to inject more funds into the credit markets built on student, auto and credit card loans – and their securitization. This merits very close scrutiny. (This has been put into effect just before Thanksgiving).
However, under the impacts of recession, the consumer payments behind these loans will falter and fail in even greater numbers, meaning there will be ongoing losses, then write downs of the value of securities built upon them. This is a dynamic loss process, not a static one, another good reason why no one can call a certain bottom in stock markets. And, stepping back a bit from that “financial world/real economy” dichotomy, the truth is that they are more interconnected than we realize. The hidden connective wiring kept out of sight during the good times, will be sparking and shorting and revealing those connections as the recession deepens. The troubles in the credit market have quickly revealed one of these connections to “the real economy.” Our big three auto makers, already in deep trouble before the financial crisis, have seen auto sales plunge as auto loans vaporize in the credit contraction.
It is also a system where the lack of transparency, extreme complexity, and inability to price assets gone bad can lead to a credit freeze and a complete lack of trust between private lending institutions. Readers with great memories may recall that in our original essay from Feb. of 2007, Fiscally Responsible or Ingredients for an Economic Katrina, we noted that when derivative adverse Warren Buffet’s Berkshire Hathaway closed out the derivatives “book” on a recent acquisition – General RE in 1998 – there were some 14,384 contracts and 672 counterparties to deal with. Compare that with Henry CK Liu’s October 23, 2008 article in Asian Times (“US Government throws oil on fire”) that in the Lehman bankruptcy hearings “Lehman needs to unravel more than 1.5 million contracts, mostly derivative swaps before it can even begin dealing with creditor requests for information on the bank’s financial situation. Lehman’s restructuring advisor is hiring 300 financial specialists for the challenging task, which will take between 45-60 days for Lehman merely to get its records in order. It is not clear if the final value of these contracts can be determined before they work themselves out at maturity.” Business Week’s October 8th article by Matthew Goldstein and David Henry headlined “Lehman: One Big Derivative Mess.” It said those 1.5 million contracts were held by 8,000 different firms and were worth 735 billion dollars, compared to Enron’s which were worth 226 billion. (All my emphasis.)
Perhaps to dampen the sense of alarm generated by these numbers, the Depository Trust & Clearing Corporation (DTCC) came out with a report covered by Bloomberg.com on November 4, which said that the Lehman Brothers Holdings Inc. collapse had derivative contracts worth just $72 billion, and that “after subtracting redundant trades, only $5.2 billion actually changed hands…” (“Credit Swaps Top $33 Trillion, Depository Trust Says,” by Shannon D. Harrington). The DTCC oversees a “central registry of credit swap trades” and includes “JP Morgan Chase & Co and Goldman Sachs Group, Inc” on its board. This article contains a number of reassuring comments by derivative market players who praised the notion of getting the information out to the public. For future reference, the DTCC said there was a total of $33.6 trillion credit default swaps outstanding “on governments, companies and asset-backed securities worldwide…Turkey, Brazil, Russia, GMAC LLLC, and Merrill Lynch & Co. had the biggest dollar amount of contracts outstanding on their debt as of Oct. 31…Turkey alone had $188.6 billion of default swaps written against its debt.” (My emphasis.)
I had a saying during the Iraq War, that if a major news event didn’t make sense, or seemed too good to be true, just wait a week, and the story was bound to change -dramatically. That’s the case here in this “fog of uncertainty” shadow banking system of derivatives. Just two days after the Nov. 4th Bloomberg story, the new headline read “Credit Swap Disclosure Obscures True Financial Risk” (by Shannon D. Harrington and Abigail Moses, on Nov. 6th). Here’s how the new story turned the “2 day old one” upside down: “The most comprehensive report on unregulated credit-default swaps didn’t disclose bets in the section of the more than $47 trillion market that helped destroy American International Group, Inc, once the world’s biggest insurer…a report by the Depository Trust and Clearing Corp. doesn’t include privately negotiated credit-default swaps that insurers such as AIG, MBIA Inc. and Ambac Financial Group Inc. sold to guarantee securities known as collateralized debt obligations. It includes only a ‘small fraction’ of contracts linked to mortgage securities, according to Andrea Cicione at BNP Paribas SA in London.” This is no way to deliver “transparency,” and is only bound to increase the fear and uncertainty of citizens, and of investors. (My emphasis.)
If citizens wanted a surer guide, well ahead of events and spot-on correct for more than two years, and ready to give them the bad news without any sugar coating, they couldn’t do better than to tune in to economist Nouriel Roubini, of the Stern School of Business at NYU, who has his own consulting firm, and a website called RGEmonitor at http://www.rgemonitor.com/ [2] This writer has followed him closely since early 2008, and was citing him before the New York Times did their magazine article, “Dr. Doom,” on August 15 (by Stephen Mihm, at http://www.nytimes.com/2008/08/17/magazine/17pessimist-t.html [3] if you missed it.).
2. How Bad Can it Get? Roubini & the Worldwide Panic Week of Oct. 20-24th.
This writer doesn’t ever want to see the world’s financial system come any closer to the complete collapse that it almost suffered the third full week in October, 2008. I watched a 47 minute video of Roubini, of a talk he gave at a hedge fund conference in London on Oct. 23rd, at the peak of the crisis. You can still find it at Bloomberg.com at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=anyWls2bwwQs [4] under the title “Roubini sees Crisis Worsening, Hurting Emerging Markets.”
He speaks without notes, teleprompter or Power Point in a steady, non-sensational voice, in remarkable command of a bewildering series of events from this fall, and going back to the origin of the crisis. I take note of these details because readers who have caught one of the many of our Treasury Secretary’s press conferences might want to compare the knowledge, command and predictive ability of Sec. Paulson to Roubini’s. Here’s what struck me as important: He noted that the positive responses of markets to official US actions going back more than a year were shrinking in their duration – from months to weeks to days - culminating in the October market plunge abruptly after Congress passed the bailout bill for Secretary Paulson on October 3rd. He noted that the spread of the crisis to a dozen or more emerging market countries was very alarming and de-stabilizing because of their foreign indebtedness and likely currency gyrations. Even he was surprised at the speed and power of the crisis that week. He predicted a continued run on hedge funds: caused by investors fleeing and their own deleveraging …and massive negative surprises on corporate earnings… (and sure enough, that’s coming true in mid-November, from “Best Buy,” to Intel)…there will be a surge in corporate defaults, speculative bonds going under and more credit default swap (CDSs) problems in related and increasingly negative feedback loops. Later – six months to a year, he expects trouble in the private equity sector, whose big buy-out deals were highly leveraged with debt (Mitt Romney, are you listening?) He noted the pull-out-all-the-stops actions of central banks around the world, guaranteeing deposits, bank loans and commercial lending…and that they were running out of options. (True here at home also). At the time he gave the talk it wasn’t clear that these exhaustive interventions were going to be enough, and he thought that stock exchanges might have to be closed – an idea that former SEC. Chairmen Arthur Levitt Jr. said was a bad idea on another Bloomberg.com. video. He noted that Iceland, which is really now suffering under 1930 type Depression conditions, had been run “like a giant hedge fund” with fully disastrous consequences. (Iceland, by the way, bought the neo-liberal formula for banking and markets hook, line and sinker, setting itself apart from much of Scandinavia. I understand their Prime Minister urged citizens to go back to fishing.) He noted 25 housing bubble markets around the world, and said that the US faced major trouble down the road, after we deal with the deflationary present crisis condition and expected 9% unemployment here. The distant trouble would come from difficulty in marketing more than a trillion dollars (some say two trillion) of treasury bonds to foreign buyers to fund all the Fed and Treasury interventions and programs. Roubini phrased it this way: the US would then be “…subject to the kindness of strangers,” a powerful, ominous characterization that we would do well to remember.
At the end of his Q & A session, a moderator, off camera but not off mike, kidded him about the gloom of the presentation, and noted that he was assigned a conference room on a lower floor for the well being of the audience. I did see that the Washington Post ran an article that Saturday, Oct. 25th, on the conference, but failed to mention Roubini. (See “Gloomy Forecast on Hedge Funds,” by Kevin Sullivan and Neil Irwin, page B1.)
I highly recommend Roubini’s website, RGEmonitor at http://www.rgemonitor.com/ [2]. It has been getting better over time, with more postings and better lay-out, showing signs that he is growing in influence and readership. His seven page paper from Feb. of 2008, “The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster,” was an early road map of what has unfolded since then. You can go directly to it at http://media.rgemonitor.com/papers/0/12_steps_NR [5] and see for yourself what a sound grasp he has had of the key dynamics of the crisis.
Before we leave Dr. Roubini, it’s important to give you a better sense of what he means when he says we are going to have a severe 24 month recession, and the question is whether it is going to be “U-shaped or L-shaped” because these terms, along with “V-shaped” are going to be tossed about in many quarters in forthcoming discussions of how bad things will or won’t get. A mild, or shallow recession, will have a V-shaped curve, and won’t last long, probably under a year. Reach back to a simple graph, from your Algebra II days, with the horizontal “X” axis showing time intervals, usually economic quarters of the year, and the “Y” vertical axis showing some measure of economic output, usually Gross Domestic Product (GDP) or perhaps employment levels. So a “V” shape would show plunging output, sliding down to the bottom of the V, and rising with recovery as we moved left to right along the time axis. Same idea with the “U-shaped” recession graph, only now the bottom of the U spreads out longer on the time axis than the V – and of course you can have a pretty wide U indicating a longer recession. But the “L-shaped” one – that’s the great worry, because it plunges and continues horizontally as a very depressed level of growth along the time axis, with the worst case being the ten year Japanese disaster from 1990-2000….
I’m not sure it was appropriate to keep calling the Japanese fiasco a recession; anything that bad that lasts that long is closer to the Depression category, but perhaps a modern version, without the unemployment level and sheer physical misery characteristics of the Great Depression of the 1930’s. Because we are witnessing the fallout from the collapse of the greatest speculative bubble in world history, passed along by a very interlinked and poorly regulated world financial system, and now an emerging worldwide recession, I suspect that what we are about to go through may be christened with its own special designation some day, one we haven’t yet invented, because it’s probably not going to resemble previous events.
At the end of that terrible week in October, U.S. equity markets had lost $4.5 trillion dollars, down 29.4% from Sept. 2 to Oct. 23rd; world markets had lost $16.3 trillion, down 34.7% in the same time frame (Washington Post, Saturday, October 25, 2008, Page A7). As leaders from the G-20 gathered in Washington for their initial conference on Nov. 14-15, the Washington Post published a startling graphic of equity market losses for the participants over the year, from November 12, 2007 to November 12, 2008. Russia led the disaster roll, with losses of 65.7%; Turkey, Argentina and China were all in the range of 50% losses, Japan – 45.8%. The U.S. – “just” 36.2%. For once, Mexico was shown mercy by the market gods: it had the smallest losses at “just” 33.3%. Truly a world-wide economic crisis.
Latest update, Thanksgiving, 2008: Here is Dr. Roubini on the context and meaning of the latest round of massive Treasury/Fed operations, announced on November 25, at http://www.rgemonitor.com/roubini-monitor/254591/desperate_measures_by_d... [6] His conclusions reinforce our wariness to call a bottom in the stock markets and indexes.
I had to think overnight on whether to include the following two articles, from Nov. 25th and 26. I didn’t encounter them until after this essay was in its editing phase, but they speak directly to the crisis at Citigroup and the banking system more generally. And since one is from Martin Weiss, quoted elsewhere with respect, I thought my readers should brace themselves and get “the worst case” briefing. No illusions. It’s consistent with the repeat word from Dr. Roubini just above: “desperate measures by desperate policy makers in desperate times…” Weiss’ article from Nov. 25th is “Citigroup Collapsed! Global Banking System Shutdown Possible.” His major point is that the bad assets “have not been liquidated, merely shuffled to the large banks.” (At http://www.marketoracle.co.uk/Article7487.html [7] ) Pam Martens article cited elsewhere in this essay makes a similar point. Then, on the following day, Nov. 26th, F. William Engdahl wrote “The Real Truth behind the Citigroup Bank Nationalization,” also at Market Oracle. Here are two of the major points, important enough for you to get them directly; they support the analysis of Bill Greider and Nouriel Roubini of where we are going to end up with our banking system. Are Geithner and Summers ready to face this possibility?
The scale of the hidden losses of perhaps the twenty-largest US banks is so enormous that if not before, the first Presidential decree of President Barack Obama will likely have to be declaration of a US ‘Bank Holiday’ and the full nationalization of the major banks, taking on the toxic assets and losses until the economy can again function with credit flowing to industry once more…
For GM to go into bankruptcy risks a disaster of colossal proportions. Although Lehman Bros., the biggest bankruptcy in US history, appears to have had an orderly settlement of its credit default swaps, the disruption occurred before-hand, as protection writers had to post additional collateral prior to settlement. That was a major factor in the dramatic global market sell-off in October. GM is bigger by far, meaning bigger collateral damage, and this would take place when the financial system is even weaker than when Lehman failed. (At http://www.marketoracle.co.uk/Article7502.html [8] )
3. Cures for Plunging House Prices and Foreclosures: No Consensus
As national frustration grows over the shifting strategies for the bailout, and information is hard to get, even for Congressional leaders, the cries for action to stem the fall in housing prices and to lower the foreclosure rate grow louder, and anger builds as citizens say it is unfair to concentrate solely on the financial/credit sector.
Let’s try to set some numerical markers on what is going on. Even that is not easy, but here’s my best shot at it. So what is the situation in November of 2008? The last data we had from the Case-Shiller Home Price Index, issued at the end of October and covering home prices through the end of Aug. 2008, show a year over year fall in prices of 17.7% for its 10 city composite, and 16.6% for its broader 20 city index. You’ll hear lots of different numbers from various sources, but Case-Shiller is the gold standard until something better comes along. This report marked 20 consecutive months of year over year price declines. Prices had peaked in July of 2006. The Washington, DC area showed a decline of 15.4%.
According to a CNN Money.com article from November 13 by Catherine Clifford, there were 279,561 filings for foreclosure in Oct. of 2008, and 84,868 actual foreclosures.
That’s up 5% from September for filings, and a 25% increase since Sept. of 2007. Since August of 2007, nearly one million homes have been foreclosed: 936,439 to be exact.
FDIC Chair Sheila Blair said in testimony to the House Financial Services Committee on November 18 that we may see 5 million homes foreclosed on in the next two years if we don’t intervene more forcefully. (Neil Irwin, “Lawmakers Blast Handling of Bailout,” The Washington Post, November 19, 2008, Page A1.)
If you listen to the numbers tossed around in newspaper articles or discussions of how bad it could get, the figure of 20% is often used for how far housing prices have fallen (close to the “official” Case-Shiller number), and 10-20% more is given for the further declines before prices bottom out. Keep in mind that in most of the other 10 recessions that the US has experienced since the end of World War II, it has been job losses that have preceded foreclosures and housing price declines. In our current woes, it has been faulty mortgages resetting that have led to the initial avalanche of foreclosures and price declines; now there will be a second wave on top of this “structural mortgage situation,” a more conventional wave due to job losses that will continue to drive this cycle, probably into 2010.
Since economist Dean Baker of the Center for Economic and Policy Research has been one of the “deans” in calling the housing bubble ahead of his colleagues, and he pays very close attention to housing prices and mortgage data, issuing a Housing Market Monitor weekly bulletin, we should take notice of one he sent out on October 22, 2008 with the heading “Short Sale: The Wave of the Future.” What Dean was focusing on was the fact that there were many “pay option ARMs” mortgages issued during the height of the bubble, in the ALT-A market with 5 year resets now coming due in 2010-2011. Translation: these were mortgages with adjustable rates (interest rates) and with a range of payment options (interest only, interest and principle…and so on….) – in the market generally seen as a better credit risk for the issuers, the ALT-A, a step up from the subprime level. The conventional thinking was look out, here comes another wave of defaults and foreclosures. Dean thinks that since the average time of ownership in our highly mobile society is just over 5 years, these are homes that are coming to the market already, and a high percentage were bought in bubble areas, especially California, many for investments only. In the worst hit locales in California, almost 40% of the sales are short sales – the mortgage is worth more than the house due to the large price declines there. The owner-seller isn’t going to have the funds to make up the difference (the poor national savings rate again), so the losses are going to be born by the institutional holders, whomever and wherever they are. (And that’s a story in itself). Baker’s assumptions add up to this: “If just one-fifth of home sales nationwide are short sales, with an average loss of $60,000 (@ 25 percent of the average house price) per home, this would imply losses to the banks of $60 billion a year. These losses will be in addition to the losses that banks will incur from future defaults or write-downs. There is a long way to go before the financial system is back to normal.”
A search for the number of homes nationwide that are “upside-down/underwater” – the mortgage owed is more than the house is worth – shows that the estimates range between 18% and 40%. Roubini sees 40% as the final figure at the end of the crisis; it is used by Martin Weiss as here now in Nov. 2008; but the figures I’ve seen from First American CoreLogic of 7.5 million under now, and 2.1 million close, comes to 18% of total mortgages, so that’s the most solid data I’ve seen. We know it’s far higher – close to 40%, in the worst bubble markets like California and Nevada.
Despite a powerful consensus that no one stands to gain from a continued wave of foreclosures (Freddie Mac says it costs them $60,000 average; other banks say it costs them 20-25% off the existing mortgage loan), efforts to stem the tide are falling far short as the numbers above show. More than a million new foreclosures looming up in 2009 should be unacceptable to all parties, and to this nation. The FDIC’s newly proposed program, released Nov. 14, is to reduce interest rates, extend the payback period (from 30-40 years, if necessary), and finally, if the first two features don’t work, to move some principal payments to the back-end, later years of the long payment trail. A guideline of keeping total monthly payment costs in the range of 28-31% of borrower gross income is more lenient that the one used by Fannie and Freddie, at 38%. The FDIC will try to induce private mortgage companies/servicers to engage in mortgage re-writes by paying them $1,000 for each loan relaxed, and will split any losses with the holders if a re-written loan goes into foreclosure, provided several additional thresholds are passed. This FDIC plan advocated by Chair Sheila Bair, is the most structured, and standardized, so far, intended to improve upon what the FDIC says been a slow and inadequate private sector rework process which gets to just 4% of the total loan delinquencies per month. Bair’s proposal is meeting opposition at Treasury and in the private sector, at which it is aimed. (See FDIC Details Plan to Alter Mortgages,” by Binyamin Applebaum, November 14, 2008, A1, The Washington Post, at http://www.washingtonpost.com/wp-dyn/content/article/2008/11/13/AR200811... [9]
Now comes the hard part. Fannie and Freddie only have “jurisdiction” over 10% of the mortgages likely to go bad. The bulk of the rest, some $1.5 trillion dollars worth of subprime and alt-A loans, are held by “Securitization Trusts,” presided over by “servicers” who have to consult with their many far-flung investors before they can get into “modifications.” Some work under explicit contracts that forbid any, or limit the degree of potential modifications. Investors are obviously nervous about potential changes like this, and the issue of violation of contracts, a legal Rubicon, hangs over the plans. And then the discussion evolves to: what type of modifications? The ones we have just discussed above, from the FDIC and Fannie and Freddie, can alter the payback rate, length and terms, but don’t get at a reduction of the actual “principal” of the mortgage loan, a salient fact when so many of the homes purchased in the last 4-5 years have seen the market price of the house dip well below the mortgage principal owed – the “underwater” problem. The Congressional bill passed in July and which first took effect on October first, allows the Federal Housing Authority to insure mortgages which have been rewritten from the nightmare formats into safer 30 year fixed rate mode, but only if lenders are willing to write down 10% of the outstanding mortgage principal.
This is going to be an important, contentious issue over the next year. Progressives are by no means uniform in their thinking about the problem. Public Citizen’s Consumer Law and Policy Blog criticized the Fannie and Freddie plan, and by extension, the FDIC’s, on the grounds that it “calls only for monthly payment reductions, not for principal reductions...” and the agencies “are still proposing to defer mortgage debt that far exceeds home prices, rather than writing it off, i.e., kick the can down the road.” Public Citizen’s Alan White observes that “we still need to deal with the servicers and investors who control most of the problem mortgages, and we still need to attack the $10 trillion problem of the overleveraged homeowner.” (At http://pubcit.typepad.com/clpblog/2008/11/todays-fanniefr.html [10])
That’s a policy path that the Center for Economic Policy Research’s Dean Baker is very reluctant to travel down. Working with researchers at the National Low Income Housing Coalition to produce an October 2008 17 page report (“The Changing Prospects for Building Home Equity: An Updated Analysis of Rents and the Price of Housing in 100 Metropolitan Areas” Baker and colleagues have this to say about the type of direct market interventions that are indicated by Public Citizen (and some other prominent economists, like Alan Blinder of Princeton – these are my observations – they are not named in the report):
Given the remaining mismatch between home prices and rent levels in most bubble markets, we argue it is still unwise for policy makers to attempt to directly intervene in housing markets to maintain what are historically unprecedented high home prices. Polices that encourage occupancy, discourage vacancy, and maintain employment to stabilize hard hit communities are likely to be the best approach to assuring prices do not fall any further than is necessary to reestablish a stable housing market.
Here’s the link for the full report: at http://www.cepr.net/documents/publications/100city_2008_05.pdf [11]
If I understand Dean Baker correctly, based on other postings, he might consider interventions in limited, bubble specific markets if housing prices plunged below his historical markers of 15 times rent. For those who want to see the complexities and considerations in Alan Blinder’s thinking, here’s his New York Times piece from March of 2008, “How To Cast a Mortgage Lifeline” at http://www.nytimes.com/2008/03/30/business/30hous.html?scp=1&sq=alan+bli... [12]
My guess is that the arc of events, as they have done consistently since we began this economic slide in August of 2007, will carry us to places we don’t want to go, so we should prepare for a housing market that continues to plunge, especially in the bubble markets areas, plunge below the markers Dean Baker has set out.
Readers may recall that in our August posting, “The Guns (and Economy) of August, we introduced Martin Weiss’s fictional script for “The Last Government Rescue.” (At http://www.marketoracle.co.uk/Article5766.html [13]). It is really worth a revisit. As the story builds towards its climax, Former Fed. Chairman Paul Volcker speaks the following words in the “fictional” account: “‘Gentlemen, do you not see where this discussion is headed? It’s headed toward nationalization of the GSE’s, nationalization of Detroit’s Big Three, nationalization of major banks.’” I think that’s a pretty remarkable forecast from Weiss at Aug. 5, 2008. The cast of characters, and the occasion of their grand meeting around a conference table have turned out to be closer to current fact than fiction, having correctly brought former Fed. Reserve Chairman Paul Volker, and the G.M. Chairman to center stage, close to where they are now in mid-November 2008, with Volker a key advisor to President elect Obama (named Nov. 26th as Chairman of the Economic Advisory Council) , and the auto-industry poised on the verge of bankruptcy. So Martin Weiss has earned our consideration. Let’s take a look at his current article on the mortgage/housing crisis: “The Great American Housing Market Nightmare: Next Phase,” posted November 4, 2008, again at the Market Oracle website at http://www.marketoracle.co.uk/Article7126.html [14]
Weiss doesn’t waste much time setting up the crunch lines of his article. In the second sentence he states that “…in reality, home prices don’t stop going down at some particular level that appears to be ‘cheap.’ Nor do they stop falling because they match some historical price that was previously a low. The end of the decline in home prices will come only when there are no new economic forces driving them down. When will that be? I’d love to say it’s just around the corner. But everything I see tells me that, despite the sharp declines already recorded, a steeper plunge in home values is dead ahead.”
I’m not going to plug in Weiss’s “predicted” numbers for you, they’re really shocking and no one knows the bottom for sure. But I will say that Dr. Weiss has a feel for the crisis we are in that transcends the numbers that are tossed about. By writing about the bursting of the Great Tulip Mania of 17th Century Holland, the South Sea Bubble collapse of the second decade of the 18th century in England, Weiss tells me that he’s ploughing the same ground covered by classics such as Charles P. Kindleberger’s Manias, Panics and Crashes (1978, latest edition 2005)) and Edward Chancellor’s more recent Devil Take the Hindmost: A History of Financial Speculation (1999).
The fate of housing prices seems to most likely rest with the success of the policy measures, especially ones for infrastructure spending and job creation, designed to prevent a severe recession from becoming a depression. Something tells me that the FDIC program which seeks to re-structure mortgages without buying them outright or writing down the principal is going to be overwhelmed by broader economic currents. I hope I’m wrong. As I was looking back over Nouriel Roubini’s relevant writings on this topic, I found one from September 24, 2008 that is worth taking a look at. It calls for a New Deal type Home Owner’s Loan Corporation, “which was created to buy mortgages from banks at a discount price, reduce further the face value of such mortgages and refinance distressed homeowners into new mortgages with lower face value and lower fixed rate mortgage rates.” Roubini puts it bluntly: “The lack of debt relief to the distressed households is the reason why this financial crisis is becoming more severe and the economic recession – with a sharp fall now in real consumption spending – now worsening.” So there is the dilemma again: can we remedy the situation without writing down the costs of the underwater mortgages, and who takes the losses when we do?
Read the full article at http://www.rgemonitor.com/roubini-monitor/253739/home_home_owners_mortga... [15]
Here are two New York Times articles that you may find of interest on the mortgage crisis:
November 11, Joe Nocera: “Can Anyone solve the Securitization Problem?” at http://executivesuite.blogs.nytimes.com/2008/11/11/can-anyone-solve-the-... [16] ;
November 15, Joe Nocera: “Facing Crisis, Congress Makes Sense.” At http://www.nytimes.com/2008/11/15/business/15nocera.html [17] ;
4. Paulson and the Bailout
Much of the current controversy and confusion about the financial crisis inevitably centers upon America’s Secretary of the Treasury, Henry M. Paulson, Jr. and the bailout signed into law on October 3rd. As criticism intensifies from both sides of the political spectrum, and as the economic clouds lower in late November, yours truly has taken a closer look. Here’s my take on some of the mystery and confusion he and his policies have generated.
First, a little biographical sketch. The familiar: a Phi Beta Kappa English major at Dartmouth, 6’5” tall, an offensive lineman, All East, maybe just a bit intimidating (a little understatement here), MBA at Harvard Business School, and, not always mentioned, he did a stint under John Ehrlichman in 1972-73 in the Nixon White House during the crisis days. Started at Goldman Sachs in 1974 and became CEO in 1999, ousting Jon Corzine, current Governor of NJ. To balance the lineman pushing people around notion, recognize his extended work for the Nature Conservancy and other good environmental work. He has tremendous experience with China, although it seems like he couldn’t sell them on the merits of American derivatives. Score one there for the Chinese. Please take note of the very long stint with one firm, at Goldman Sachs, and mark the fall of those years: his work covered the entire age of what I have called “Market Utopianism,” a six year head start on the Reagan presidency and witness to all the particular Wall Street sub-eras: mergers and acquisitions, high tech and dot.com, securitization and high leverage….
As I tried to make sense of the Paulson reign at Treasury, from the summer of 2006 until the present now in late November, I kept asking myself, especially now through the bailout and the continued market crisis of the fall of 2008: what do the policies, and methods mean for the average citizen in a supposedly democratic republic? It isn’t just how Paulson and the Treasury have operated; it’s also how Congress has reacted, especially since the post Lehman collapse of mid-September and the bailout controversy. Does it really differ from the uncritical and starry eyed (and most regrettable) treatment afforded to the maestro, Alan Greenspan, who finally took some Congressional heat during the hearings held by Chairman Henry A. Waxman of the House Oversight and Government Reform Committee on October 23rd, and then offered a very modest retreat from his faith in unregulated markets. My concern extends to the Fed as well, because the outlines of future reform directions there have them getting proprietary, closed door looks at troubled institutions, like hedge funds and private equity firms, to assess the threat their conditions pose for systemic risk, but it’s not clear yet at all that they will be subject to greater public transparency and explicit limits on their leverage and capital range. Time and time again, we’re going to find that for crucial questions and policy calls concerning decisions which affect every citizen’s money and livelihood, the substance (and procedures) of economic power still seems to be wielded like the proceedings of an exclusive gentleman’s club.
The key to understanding Henry Paulson’s actions and worldview is to remember that he and his firm, Goldman Sachs, have been at the epicenter of the vast, leveraged, speculative bubble that has now burst. And they have been a “band of brothers” in a worldview that has been urging deregulatory action upon the various federal agencies over the past thirty years. You could say that Paulson was at the private epicenter until 2006. Robert Rubin has been closer to the public epicenter, although since 1999, he has been shuttling back and forth between a large private role with Citigroup, a public role with the Hamilton Project, and behind the scenes power broker with the Democratic Party. Enormous miscalculations of a most fundamental nature have been made about the role of government towards markets, an entire set of operating assumptions have been proven wrong, and a complete Wall Street business model with it. The costs have been measured in trillions of dollars of losses around the world, millions of lost jobs, millions of lost homes. Secretary Paulson’s original mission when he took the Treasury job in the summer of 2006 was to put the finishing touches on the conservative deregulatory model, simplified and made more rational across the four main agencies – but – still touting financial “innovation” as the dominant value. (And he was to have another go at some variation of privatizing Social Security and Medicare until catastrophe intervened). As the events of March, 2008 made clear, there was going to be a head on clash between financial innovation and systemic security, and the Treasury’s proposed rules from that month reflected the contradictions. For leaders who were having a hard time comprehending the intertwined and catastrophic implications that the “innovations” of the past 15 years or so had wrought, it took quite a leap of faith to worry, at that point in 2008, about keeping the door open for future dramatic inventions. The financial world would do well in the next 5 years or so simply to straighten out the mess we’re in and take Robert Kuttner’s “plain vanilla” model advice to keep things simple and direct for investing. Here’ what Kuttner means, with a little more detail, at The American Prospect magazine online at http://www.prospect.org/cs/articles?article=the_case_for_plain_vanilla [18]
If you understand how deeply immersed Henry Paulson was in the old model, you can begin to understand why he and his team have consistently been behind the curve of events since August of 2007. They are making it up as they go along because the old model doesn’t work and they have to adopt a crisis-at-a-time approach because you can’t expect an intellectual framework of 30 years standing to be reversed in the heads of those where it was most deeply implanted – not in the space of 18 months, at any rate. Readers will remember our early October plea for Congress to hold at least a week’s worth of hearings on the original bailout plan – setting a deadline of Columbus Day – because there was so much soundly grounded dissent about Treasury’s plan to purchase the toxic mortgage “assets” from banks as their centerpiece action. Most of the dissent was arguing for a more direct approach to the bank’s troubles along the lines adopted by Great Britain, close to the nationalization called for by Bill Greider and Nouriel Roubini. Roubini was calling for an extensive and rapid triage plan for the entire troubled Wall Street row, in the manner the FDIC deploys: decide who is sick but salvageable, and who is only having a temporary liquidity problem as opposed to a solvency problem, and who is beyond hope. Yet such a massive and drastic plan implies a complete loss of confidence in the old model, and an admission that massive changes are here now – a leap of intellectual faith that I believe insiders like Secretary Paulson, Chairman Bernanke and NY Fed. Reserve Chairman Geithner could not make over these past 18 months. They have been an emergency room team of economic doctors greeting financial patients as they’re wheeled into the room one by one….another team will have to be called upon to get the ER docs a new comprehensive model of treatment to address the situation. And new treatment protocols, to be successful, will likely have to depend upon a new model of what is at the root of the problem, since a generalized deflation is now looming. This line of analysis is becoming explicit from some surprising quarters. A New York Times article from November 22 put it this way:
“Experts said the government may have to act on multiple fronts, perhaps including an outright nationalization of major banks and much more aggressive efforts to stimulate the economy. ‘This may well involve nationalizing some of the largest banks, starting with Citigroup,’ said Kenneth S. Rogoff, a professor of economics at Harvard. ‘It will mean spending trillions of dollars.’ With the economy in a free fall, Mr. Rogoff said the current bailout was ‘underpowered.’ Housing prices continue to drop. The next wave of defaults, he said, could hit hedge funds and private-equity investors.” See “Hints of Relief From the Siege,” by Edmund L. Andrews and Mark Landler at http://www.nytimes.com/2008/11/22/business/22bailout.html [19]
We will soon see whether Timothy Geithner, President-elect Obama’s choice to head Treasury, can successfully make such a sweeping transition. For the real task ahead is going to be doubly difficult: crisis management done simultaneously with the construction of a new working model for our financial system, and the economy itself. For intimations about how this might unfold, let’s take a closer look at the events of the past two months as they’ve unfolded and been covered in the press, and keep in mind the question of how we might work structurally to bring in perspectives from citizens and experts alike, from outside the old Wall Street Club system. This writer is not naïve enough to think it is wise, or possible to jettison all the old experienced hands, and indeed, the Robert Rubin School is going to be very well represented at many places on the Obama economic team. Yet even The New York Times editorial page is asking the tough questions about how much of a change in thinking has occurred from the Clinton era among the President-elect’s economic leaders (See “Mr. Obama’s Economic Advisers,” November 25, 2008 at http://www.nytimes.com/2008/11/25/opinion/25tue1.html [20] ).
Doubts about Henry Paulson’s course of action were in fact surfacing this summer. That’s when this writer noticed claims for Paulson’s “early awareness” of the troubles – combined with worries already about his course of action. Thus a David Ignatius Op-Ed column in The Washington Post on July 18, 2008, “The View from the Eye of the Storm,” claimed that Paulson “…saw the storm clouds gathering two years ago when he became Treasury Secretary.” The article credits Paulson with all the right recognitions: troubling derivatives, excessive leverage, illusions at Fannie and Freddie… The same claims were made by Paulson himself in a more balanced, and critical article that the New York Times ran on July 27, 2008, “Can Hank Paulson Defuse This Crisis?” following a Paulson’s visit to the paper for a meeting with reporters and editors. Since the crisis we are now passing through is one for the history books, there are going to be a lot of folks pouring over these claims, and also trying to reconcile them with his repeated minimizations in public about the extent of the crisis, at so many different stages since August of 2007. Doubtless part of the defense will be that the ritual role of central financial institution actors calls for calming markets; yet there is substantial evidence to show strategy after strategy falling behind events – and falling below the needed scale. If the early claims for comprehension of the problems are valid back to the summer of 2006, then he will have even more explaining to do.
And the press is getting tougher – well some of the press at least. Necessarily, they are looking back at key stops along the deregulatory highway, and that is not making life easier for key players in the bailout and Federal Reserve strategy. The New York Times’ Stephen Labaton reminded everyone that Secretary Paulson should be prepared for the downward pressures of deleveraging, because Paulson was the head of Goldman Sachs in 2004, when it and the four other major investment banks were lobbying hard to get the Securities and Exchange Commission (SEC) to weaken its “Net Capital Rule.” This removed the obstacle to leverage limits at these five banks, allowing them to keep much less capital set aside as reserves. The key meeting took place at the SEC on April 28, 2004 and it does not make for pleasant reading today. It might even make you angry. Christopher Cox, current Chairman of the SEC, is shown in a particularly harsh light; maybe John McCain had something after all in his call for Cox to be fired. The article appeared on October 3, 2008 and you can find it at http://www.nytimes.com/2008/10/03/business/03sec.html [21] (“The Reckoning: Agency’s ’04 Rule Let Banks Pile Up New Debt.”)
The two part series about Secretary Paulson written by David Cho, which appeared in The Washington Post on November 18th and 19th, and presents him as a pragmatic, chastened leader who now accepts the need for regulations, but one who still manages to give the regulatory reality a couple of back-handed swipes: “‘I’ve realized how flawed it is and how imperfect, but how necessary it is…’” (My emphasis.). Although the article gives a St. Paul like spin with the title of the opening – “A Conversion in ‘This Storm’” – we don’t find life before the conversion presented in all its fallen splendor: there is no mention of the weakening of the “Net Capital Rule” or that key SEC meeting in 2004.
The New York Times again displayed its more aggressive attitude with a .powerful piece by Joe Nocera on October 23rd – “So When Will Banks Give Loans?” Nocera had obtained access a tape recording of an executive at JP Morgan Chase during an employee conference call…fielding a question about how the firm intended to use its new $25 billion capital injection from the bailout- “TARP” program. Here’s the executive’s answer on how the money was to be used:
“Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase,” he began. “What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”
Although Nocera doesn’t call attention to it, what strikes me as even more remarkable than the indifference to loaning the money, is the tone of casualness about “recession” turning into “depression”: P Morgan will just ride it out, no problem for them, they’re sitting pretty.
Nocera then goes on to build a case against the whole Treasury program: calling attention to a new tax break, which some have said is worth $140 billion and has dubious legality in being issued by Treasury, set in motion to encourage mergers, then the PNC purchase of National City…he goes on to link the program’s uncertainty to that terrible week in the markets, which we have mentioned earlier – October 20-24th. Some of the market turbulence he attributes to the fact that “investors no longer trust Treasury. First it says it has to have $700 billion to buy back toxic mortgage-backed securities. Then, as Mr. Paulson divulged to The Times this week, it turns out that even before the bill passed the House, he told his staff to start drawing up a plan for capital injections. Fearing Congress’s reaction, he didn’t tell the Hill about his change of heart. Now, he’s shifted gears again, and is directing Treasury to use the money for force bank acquisitions.” The article ends with an angry quote from a very unlikely populist, Senator Chris Dodd of Connecticut, Chairman of the Senate Banking Committee: “‘If it turns out that they are hoarding, you’ll have a revolution on your hands. People will be so livid and furious that their tax money is going to line their pockets instead of doing the right thing. There will be hell to pay.’” Nocera adds: “Let’s hope so.” You can read the full article at http://www.nytimes.com/2008/10/25/business/25nocera.html?_r=1&scp=1&sq=s... [22]
The standing of the Bailout received another blow in November when author Naomi Klein of No Logo and The Shock Doctrine brought her corporate network parsing skills to bear with an excellent article subtlety entitled “The New Trough,” posted November 13, 2008 at Rolling Stone online (at http://www.rollingstone.com/politics/story/24012700/the_new_trough/print [23] .) While the subtitle, “The Wall Street bailout looks a lot like Iraq – a ‘free-fraud zone’ where private contractors cash in on the mess they helped create” may be a premature call on what is unfolding, it does zero in on the risk to all the “outsiders” trying to figure out how it is being run. After all, we are dealing with an economic emergency, a catastrophe of finance, and in the wonderful circular reasoning about these matters in all the right power circles, political and economic, you can’t understand the problems without direct participatory experience so…for legal advice, Klein tells us, the taxpayers’ representatives at Treasury (bear with me on that one folks….) hired the firm of Simpson Thatcher & Bartlett, “a Wall Street heavy hitter…” which just so happens to have “represented seven of the nine” firms in previous legal matters, the very ones receiving taxpayer money in the bailout. But I want readers to relax; the firm has its potential conflicts under control, Klein tells us. I know I breathed a sigh of relief when I read that….
According to its contract, Simpson Thatcher has agreed not to represent any of the banks ‘against the U.S.’ when they negotiate with Treasury for the equity money. However, the firm has retained the right to represent banks when they apply for other parts of the $700 billion bailout not covered by its contract. (It has promised to erect a ‘firewall’ to stem the flow of ‘confidential information’ to those clients.)
Now firewall assurance is a sensitive topic with this writer as we leave “The End of an Era” that took down many of the “firewalls” bequeathed to us by the first New Deal. For a law firm which has close ties to so many of the institutions which lobbied so hard to deregulate over the past thirty years, how confident should we the public be with the legal guidance they’re giving? Klein says not too confident, putting some of the responsibility on them (as well as Paulson) for failing to obtain legal lock language that would require the bailout banks to keep those loans flowing to the public, a sore point of contention as we’ve seen above from Connecticut “prairie populist” Chris Dodd. Treasury spokeswoman Jennifer Zuccarelli is quoted by Klein as saying “‘There is no obligation for banks to lend the money one way or the other…But the banks have the understanding’ that the money is intended for loans. ‘We’re not looking to control their operations.’” Feeling better now? Put it on hold for a while.
While it is true the United States followed Great Britain’s Maggie Thatcher down the great neo-liberal deregulatory path over the past era, there is yet a residue of more decisive public action remaining in the British tradition, as can be seen by Klein’s line by line comparison of Prime Minister Gordon Brown’s banking intervention compared to Henry Paulson’s (and with all due respect to our figurehead President):
…Five days before Paulson struck his deal with the banks, British Prime Minister Gordon Brown negotiated a similar bailout – only he extracted meaningful guarantees for taxpayers: voting rights at the banks, seats on their boards, 12 percent in annual dividend payments to the government, a suspension of dividend payments to shareholders, restrictions on executive bonuses, and a legal requirement that the banks lend money to homeowners and small businesses…In sharp contrast, this is what U.S. taxpayers received: no controlling interest, no voting rights, no seats on the bank boards and just five percent in dividend payouts to the government, while shareholders continue to collect billions in dividends every quarter. What’s more, golden parachutes and bonuses already promised by the banks will still be paid out to executives – all before taxpayers are paid back.
I don’t know how many of you have been listening, as I’m “required” to do, to Secretary Paulson’s public speeches, but as I labor, legal pad and pen in hand as he expounds upon his pragmatic way of responding to the crisis, I realize by reading just this brief analysis by Klein that you can’t judge what he’s doing by remaining mired in his Wall Street worldview. Listening to his speeches is like driving down the proverbial country road: it’s dry and dusty, full of potholes, covered with a very coarse gravel – yet he makes you want to believe it’s also a road paved with good intentions. It takes a world traveler, corporate Rosetta Stone decipherer like Klein to give us an insightful translation. Klein cuts to the essence of the matter with a powerful and compact probe: “This raises an interesting point: Has the Treasury partially nationalized the private banks, as we have been told? Or is it the other way around? Is it Treasury that has been partially privatized by Wall Street, its massive rescue plan now entirely in the hands of a private bank it is directly subsidizing?”
She had arrived at this grand challenge after reviewing the role of the Bailout’s newly awarded “Master Custodian” contract to Bank of New York Mellon, whose terms posted online had its price tag “blacked out.” My take is that the privatization of Treasury is the correct call under Paulson’s stewardship, but not just because of Bank of New York Mellon’s and law firm Simpson Thatcher & Bartlett’s roles: it’s the entire worldview of the current crisis managers, shaped by the previous era, and leaving us all with the great question of whether minds that designed the architecture and furniture of the collapsed financial house can map a way out of the rubble, much less design a far safer structure. It’s a question we’ll revisit in a later section as we take a look at the major economic appointments of President-elect Obama.
5. Who Could Have Known? The Unsung Resistance
When I started out on this journey almost two years ago to sound the alarm over derivatives and to report on the financial crisis, I made a pledge to myself to introduce readers to those individuals who had tried to give advance warning of the impending calamity. My early focus was on the books written about the dangers, the ones The Washington Post and The New York Review of Books decided that the public needn’t be bothered with. The NYRB has finally relented, deciding by their December 4, 2008 issue that well, maybe this is a serious crisis after all, so they let George Soros write about it in “The Financial Mess and What to do About It.” Of course Mr. Soros takes the opportunity presented to turn in what in effect is a review of his own book, the one we presented in the two parts of “The End of an Era,” The New Paradigm for Financial Markets. And it’s a pretty good book, anticipating a far more severe crisis than mainstream economic opinion, and pointing out the flaws in the assumptions of “market fundamentalism.” The conclusion of the article does strike me as a strange one though, because Soros sounds a note on behalf of the economic establishment he’s had so many struggles with: we have to worry now about over-regulation. Well, I can draw up a very long list of things that we certainly need to be worried about at the end of November 2008, where the question has become not whether we’re going to have a severe recession – we are. The real question has become: can we head off a generalized deflation, the 2009-2010 equivalent of a second Great Depression? Of all the things that are really economically pressing for policy makers just now, about the last one ought to be worry about “over-regulation.” But you’re going to hear that alarm cry time and time again over the next year. And The Post? Well, I’m unaware that they ever have gotten around to any of the missing book reviews…but I have to confess I gave up searching back in September.
The New York Times, however, is helping the public recover its lost collective economic history through a series of articles called “The Reckoning,” which, starting on September 28, 2008, has reached a total of 11 pieces with the appearance of “Citigroup Pays for a Rush to Risk,” on Sunday, November 23rd. We’ll take a look at this latest one in a moment, because of its focus on Robert Rubin, whom we’re very interested in. But another earlier “Reckoning” article, one that appeared on October 9, “Taking Hard New Look at a Greenspan Legacy,” brought to light someone from the Unsung Resistance whom I hadn’t noticed of in any of the six books reviewed in “The End of an Era”: Brooksley E. Born, who headed the Commodity Futures Trading Commission from 1996-1999, under President Bill Clinton. {Actually, Born was mentioned in Robert Kuttner’s The Squandering of America, but just briefly, though he got the significance of her attempt bring derivatives under a regulatory system (in the other five books no mention at all.)}. Born’s unsung saga of regulatory courage in an anti-regulatory era also has the strong flavor of a tale of women interrupting a men’s club, and a very privileged one at that, the one closest to the nation’s financial dynamo, the Wall Street profit centers. We’re not going to retell the story in its entirety, because now you can read the NYTimes one here at http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html [24] , and one published almost exactly a week later, on October 15, in The Washington Post, under the heading “What Went Wrong.” It goes into Ms. Born’s tribulations at the hands of the economic hierarchy of Alan Greenspan, Robert Rubin, Arthur Levitt, Jr., and for a final excoriation, Larry Summers. The Post’s article actually goes into greater detail on the remarkable public hearings and successful legislative effort by these men and their agencies to rein in Born’s attempt to rein in derivatives. At
http://www.washingtonpost.com/wp-dyn/content/discussion/2008/10/13/DI200... [25]
Now there are several additional points to make here. First, Ms. Born has not stepped forward to tell her own story. She declined to be interviewed for either story, and as far as I know, never has issued a public statement or written about her experience, even though it has been almost a decade and the tribulations of our time call for it. The second is that it is worth reading both these accounts because at least two of the major participants are major players in the immediate economic world, Robert Rubin and Larry Summers, and they are likely to have a very large say in the economic policies and reforms to come. And Arthur Levitt, Jr. and Alan Greenspan are still public commentators; Levitt I see fairly often on videos at Bloomberg.com or being interviewed on CNBC, and Greenspan has given a restrained public “recantation” of some of his anti-regulatory dogma about derivatives on October 23, 2008, under prodding by House Oversight and Government Reform Committee Chairman Henry Waxman. William Greider called it “weasel-worded admission,” but for right now, that’s as much satisfaction as the “maestro” is going to give Ms. Born unless she gives him the full court press with her own published version of what happened back in 1998.
Representative Edward J. Markey (D, MA) also comes across credibly in the same NY Times article for his 1992 effort to have the General Accounting Office prepare a study of derivative risks, which it did and delivered in hearings in 1994. Markey drew up a bill the same year but it never went anywhere, in part because of Greenspan’s haunting (in retrospect) testimony about derivatives amplifying crisis risk – an “extremely remote” possibility.
Interestingly, the long Washington Post article from Oct. 15th fails to mention Rep. Markey at all; instead, it notes that in 1993 Rep. Jim Leach (R, IO) “issued a 902 page report that urged regulations to protect against systemic risk as well as supervision by the SEC or Treasury.” It also states that Senator Donald Riegle (D, MI) and Rep. Henry Gonzalez (D, TX) had their own bills in 1994 that went nowhere, and that “Mary Schapiro, Born’s predecessor, made her own run at the issue through enforcement action.”
Please add in the current financial analyst at Oppenheimer & Co., Meredith Whitney, whom we have quoted in a number of previous postings, and who has consistently challenged the far too rosy write-down numbers from the major banks and investment firms. Thomas Friedman’s Op-ed piece in The New York Times from November 26, 2008, justly cites her for getting things right (“All Fall Down.”)
The rationalizations of two of the key blockaders to reform are fascinating. In various articles, not just these two, Robert Rubin has said that there was no political chance to get derivative reform done, and that the Born years were consumed with other international economic crises. Rubin is cited as having recognized the dangers of derivatives in his 2003 book, and the cure, but the thrust of his pleadings were that it was just too tough to get done, he just didn’t have the clout. That’s from a member in full standing of “The Committee to Save the World” and the cover of Time magazine from Feb. 15, 1999 (at http://www.time.com/time/covers/0,16641,19990215,00.html [26]) . It rings just a little hollow, as we shall see, given the fact that Mr. Rubin still looks to be at the crossroad of economic personnel choices for the Obama administration, and holds a key position with Citicorp’s Board.
Prior to his congressional hearing recantation on October 23rd, Greenspan had maintained in an early October speech at Georgetown University his traditional firm line against further regulation, despite the ongoing calamity. He refused an interview for the Oct. 9th Times piece, deferring questions to his Age of Turbulence memoir. But reporter Peter Goodman caught a remarkable slant from the Georgetown speech, which casts quite a light on the Greenspan worldview which had so much influence over the development of the world’s greatest speculative bubble. Here’s Goodman’s take: “In his Georgetown speech, he entertained no talk of regulation, describing the financial turmoil as the failure of Wall Street to behave honorably. ‘In a market system based on trust, reputation has a significant economic value,’ Mr. Greenspan told the audience. ‘I am therefore distressed at how far we have let concerns for reputation slip in recent years.’”
Now that sounds to me very much like what one would hear in Victorian England from the leading financial figures; this is the “code of the club” from the heyday of classical economics, pre-New Deal, pre-Keynes. Perhaps the Bush administration should have had the regional heads of the various Federal Reserve banks challenging the likes of Angelo Mazilo et al to public duels to restore “honor” to the system.
It reminds me very much of Dean Baker’s posting of October 24, 2008 at The American Prospect magazine online, in a column he writes called “Beat the Press.” Note the date – it’s the day after Greenspan’s “retreat.” Testimony. Baker starts out by noting that The Washington Post article of the day, “Greenspan Says He Was Wrong on Regulation,” by my “favorite” Neil Irwin (and also Amity R. Paley) goes for commentary to another economist, Frederic S. Mishkin of Columbia University, someone who managed to get the call on Iceland’s stability completely upside-down. Here’s Baker’s take on how the economic profession has managed to miss so much of what was coming:
It would be difficult to imagine someone being more wrong about Iceland's economy than Mr. Mishkin, yet this does not damage his standing in the profession at all. Unlike custodians, cab drivers, or dishwashers, economists are not held accountable for their job performance. They can be wrong on everything they do every day of the week, and still be viewed as respected authorities by the Washington Post, and other media outlets, as well as members of Congress and others in policy positions.
This fact also supplies the answer to Alan Greenspan's claim that explosive situations like the housing bubble could not be seen:
"The Federal Reserve had as good an economic organization as exists ...If all those extraordinarily capable people were unable to foresee the development of this critical problem . . . we have to ask ourselves: Why is that? And the answer is that we're not smart enough as people. We just cannot see events that far in advance."
In fact, the problem is not that "we" cannot see events that far in advance. The problem is that the Federal Reserve Board and the economics profession as a whole functions more like a fraternity than a real forum for debate and truth seeking. Those whose views are taken seriously mimic the views of those with status and power within the profession, they do not think independently.
The failure of the economics profession to recognize the bubble and the harm that it would cause was due to the sociology of the profession. For any competent economist, the bubble was easy to see and the damage that its collapse would cause was entirely predictable.
For the complete article, here’s the link:
http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=10&year=... [27]
So now you know one of our main worries heading into the new administration and the greatest economic crisis since 1933: can the Obama team, very much drawn from the Rubin stable - the “old hands” of the Clinton era, saturated in the mores of the Greenspan financial era, break free from the constraints of “the club” and that calamitous worldview? As this is being written just before Thanksgiving, it appears that there is broad consensus among economists of all persuasions that a very large Keynesian public spending stimulus is needed. Nouriel Roubini is predicting a loss of GDP on the order of 5%, maybe more, when the numbers come out for November. For a 14 trillion dollar plus economy, a 5% contraction amounts to about $700 billion dollars. That’s how the numbers being tossed out in the press are arrived at, give or take a hundred billion or so. What’s far from certain is whether there is a similar consensus on the reconstruction of the banking system. The more one reads about the bailout of Citigroup, the more one wonders whether we are getting anywhere along Paulson’s path. Initially, William Greider’s call for full nationalization of our banks sounded like far too much, too soon when he issued it earlier this fall. But after reading more from Roubini, and from Naomi Klein, and looking at the British model, Bill is right. The system is completely broken, and the word nationalization in this context really means a rigorous FDIC-type handling – the financial “triage” Roubini wants. That would likely mean Citigroup wouldn’t make it, and would be unrecognizable if and when it emerged. But there has to be a whole new “business” model there at the Wall Street banks, the “plain vanilla model” put forward by Robert Kuttner, of lending to Main Street and taking what risks are taken on actual firms’ business plans, hopefully many of them for green/conservation/alternative energy type ideas, not the derivative speculative pyramid we’ve seen over the past decade. Can the new Treasury Secretary, Timothy Geithner, and Obama’s chief economist, Larry Summers, distance themselves from their ties to Rubin and Wall Street? That’s the huge question. The need for the massive stimulus is by comparison, an easier call... (But it may not be among congressional Republicans, and maybe Blue Dog Democrats as well.)
6. A Full Accounting for the American People
Does the substance of participatory democracy ever get shorter shrift than in times of foreign policy or economic emergency – categories which seem to eat up a larger and larger percentage of the recent historical record. And by participatory democracy I mean the range of ideas and opinions (and the type of forums held) that representative democracy listens to in formulating its course of action. Has anything domestic tested the words “accountability and transparency” more than the Paulson bailout plan? But we shouldn’t just pick on Paulson. Observers of the Federal Reserve, used to being steeped in “fed speak,” are taking – the best they can come up with – “educated stabs” at how those huge numbers are appearing on the Feds balance sheet and whether there has been an unannounced change in policy. See the article by Rebecca Wilder at RGEmonitor from Nov. 24 at http://www.rgemonitor.com/financemarkets-monitor/254545/has_the_fed_chan... [28]
Given the scope of intervention by the Federal Reserve into seemingly every nook and cranny of the world of financial markets – the Fed is running 11 programs of loans, swaps or direct assistance – eight created in the last 15 months and they’ve put $2 trillion into play – this is no longer the old game of “deciphering” the Fed’s traditionally cryptic style in normal times – the potential debts here that have to be repaid to foreign holders will have profound implications for America’s economic future and taxpayers’ obligations. That’s why readers should take a look at the Bloomberg.com article “Fed Defies Transparency Aim in Refusal to Disclose” by Mark Pittman, Bob Ivry and Alison Fitzgerald from Nov. 10th, at
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aOngFPgq7r3M [29] . The article doesn’t beat around the bush – the very first sentence states the case: “The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.”
Congressman Barney Frank is quoted as defending the Fed’s refusal to disclose more information on the grounds that such a release could further destabilize the markets, with the Fed information perhaps revealing the weaker firms, leaving them open to the “predation” we’ve talked about in earlier postings.
But another writer familiar with the ways of Wall Street is a bit tougher, and I actually learned more about the lawsuit from her article than from Bloomberg’s itself. That would be Pam Martens, writing in Counter Punch on Nov. 13, 2008: “The Two Trillion Dollar Black Hole” at http://www.counterpunch.org/martens11132008.html [30] Her subtitle indicates her unwillingness to put Barney Frank’s more lenient interpretation on matters: “Credit Crisis or a Collapsing Ponzi Scheme?” In Marten’s article, we learn that Bloomberg’s Pittman filed a Freedom of Information Act (FOIA) request with the Federal Reserve way back on May 20, 2008 asking whom the money was going to and what was being posted as collateral in return. But “Bloomberg also wanted details on ‘contracts with outside entities that show the employees or entities being used to price the Relevant Securities and to conduct the process of lending.’” Martens says the Fed was a day over their legal response date of June 18th; on the 19th they pushed the response time out until July 3rd, which they apparently were legally allowed to do. Matters were strung along until Aug. 15th, when Fed employees said the FOIA request was going to be denied at the end of September. Nothing more was heard and Bloomberg filed a formal lawsuit on November 7, 2008.
Martens goes on to quote directly from the Bloomberg suit: “To obtain access to this public money and to safeguard the taxpayers’ interests, borrowers are required to post collateral. Despite the manifest public interest in such matters, however, none of the programs themselves make reference to any public disclosure of the posted collateral or of the Fed’s method’s in valuing it. Thus, while the taxpayers are the ultimate counterparty for the collateral, they have not been given any information regarding the kind of collateral received, how it was valued, or by whom.”
Marten believes that it’s the old Credit Default Swaps that are at the root of the Fed’s reluctance to reveal more. So we’re right back to those two contradictory articles from Bloomberg that we cited in our first section, “Market Volatility and ‘The Bottom,’” on whether the Depository Trust and Clearing Corporation (DTCC) was laying all the cards on the table. Martens agrees with the critics alleging that there was nothing close to full disclosure of how large the CDSs problem is. Here’s how Martens sums it up: “These are not the credit default swaps recently disclosed by the …DTCC…These are the contracts that still live in darkness and are at the root of why the Wall Street banks won’t lend to each other and why their share prices are melting faster than a snow cone in July….Until Congress holds serious investigations and hearings, the U.S. taxpayer may be funding little more than Ponzi schemes while companies that provide real products and services, legitimate jobs and contributions to the economy are left to fail.”
Government hearings and accountability for the disaster are also on Bill Greider’s mind, as well as the worry that we may never get them because so many of those who presided over the collapsing system in the 1990’s are going to be again in the seats and corridors of power in the new Obama administration. He is, like I am, following the increasingly tough and investigative style of reporting at The New York Times, a good part of it under the heading we’ve told you about, “The Reckoning.” Although Greider’s article was written just before the election, on October 29th, the question he poses for President-elect Obama seems still to hold pretty well one month later, and the inability of the current bailout to stem the collapse may push the nature of future directions closer to Bill’s challenge than one would have thought in mid-November: “If the old financial order is at the heart of the economic problem, would the president be better off protecting it or trying to disturb its power and cut its institutions down to size? For the first time in many decades, it may be smarter politics to confront ‘malefactors of great wealth’ (as FDR called hem in the 1930’s) and force major reforms of their behavior. Does Obama have the guts for such a dramatic confrontation? We don’t yet know. But we do know it took a lot of nerve for a young African-American man with a different vision of the country to run for president when the reigning elders told him it was not his turn.” The article is entitled “Establishment Disorder,” and it ran in the Nation online on October 29 at http://www.thenation.com/doc/20081117/greider [31]
Something tells me that the latest taxpayer terms for the “rescue” of Citigroup, and Ruben’s ties to the firm, may turn many against continuing down the Paulson path we’ve been on. “Citi” has agreed to suspend dividends entirely for three years and reign in executive compensation (details “to be worked out later”), and to take the first $29 billion in losses, but the US government is on the hook for 90% of potential losses after that on a total basket of some $306 billion of various assets, many very troubled. This sounds to me like another long, slow bleed without decisive resolution, based on my understanding that Citigroup is on no one’s list of manageable or well run institutions, at least none of the folks I’ve been reading or listening to. The scope of their bad investments and the decisions that got them their have just been covered in depth by “The Reckoning” series article “Citigroup Saw No Red Flags Even as It Made Bolder Bets,” run on November 23, 2008, written by Eric Dash and Julie Creswell at
http://www.nytimes.com/2008/11/23/business/23citi.html?partner=rss&emc=r... [32]
Whatever advice Obama is getting now may well be shredded after being run through the Citigroup grinder, and lead to a process closer to what Roubini and Greider are calling for.
7. Preparing Progressives: Kuttner’s Obama’s Challenge, Galbraith’s The Predator State, Fraser’s Everyman A Speculator
Robert Kuttner’s Obama’s Challenge is a remarkable book. Written as guide and goad to a bold Obama Presidency, it was hustled off the printing presses in time to arrive at the Democratic Convention in Denver this summer. It assumed an Obama win, which seemed very uncertain when I wrote “The End of an Era, Part II,” just after Labor Day. But it all turned out well, and the major premise of the book, that Obama will be “A Great President, or a Failed One,” another audacious assertion by Kuttner, now hardly seems so, precisely because the entire nation, sans Bush’s hardcores, accepts the fact that we are staring at the closest we’ve ever been to a Great Depression II. (And I strongly suspect that the most cynical of Republican operatives believe that they have our new President exactly where they want him: in the deepest economic trough since Hoover). This work, though brief at 200 pages, has depth, written with near eloquence about Lincoln, FDR and LBJ and the crises that they faced, and how they rose and grew to meet the circumstances, thus framing the challenges for Obama in new perilous times. I’m not much of a Lincoln scholar, but I can vouch a bit better for the FDR and LBJ sections: even if they weren’t written for the task at hand, to help and push Obama, they would be models of succinct, inspirational history.
But Kuttner’s real bread and butter as a writer is his command of economic history and practice, the policy area which this writer believes Progressives have their greatest weaknesses. For a good portion of the Reagan era’s nearly three decades, conservative economics has dominated the public arena, forcing the Democrats to play inside their opponents tight frame of “free markets, smaller government, lower taxes” to borrow six of the ten words that George Lakoff uses to compactly summarize the Republican message (don’t think of an elephant, 2004). No one does a better job than Kuttner of explaining to the average reader just what a high price we have all paid for the terrible realities now unfolding, hidden for so long inside those six words. Lower taxes, or tax relief, hides the reality that tax burdens have been dramatically shifted since 1980 from the wealthy and from corporations and onto working class and middle class families. They’re the ones who have born the brunt of the regressivity of Reagan’s Social Security tax hike of the 1980’s, lower income tax rates at the high end of the earnings’ scale and on capital gains, all the profuse and complex flowering of tax dodges and shelters, here and abroad (follow the news on the UBS Switzerland-IRS story) and the rise of sin taxes and regressive sales taxes, which we know so well in Maryland. Voter anger is therefore directed, says Kuttner, at the proponent of any tax increase, but not at the real ideological architects who shifted the burdens off the wealthy. (May I make a suggestion to help redirect this anger? Check out Kensington, Maryland’s own Sam Pizzigati’s article here at http://www.alternet.org/workplace/105085/cheating_uncle_sam/ [33] , which suggests, based on IRS studies, that the wealthiest Americans may be depriving the rest of us, through various means of underreporting their incomes, of as much as $345 billion per year. It’s close to the figure that Robert Kuttner suggests we can raise by shifting the focus just a wee bit over at IRS, to put the matter as gently as possible.)
Although the Obama folks probably won’t like to hear it, since they had a winning tax strategy during the campaign, my take is that they still largely played within the Republican frame, as did Governor O’Malley in 2006 – both Democrats claiming they were cutting taxes for the vast majority of voters while raising them slightly on those at the very top. Such strategies were fine for the “average” times of the era we are now leaving, but we’re not going to have average times for a good number of years, maybe a decade. As of the end of November 2008, there is a strong consensus for deficit spending, out of sheer Keynesian necessity, and give Robert Kuttner credit for the foresight to have pegged it just about right, $600 billion, even though he was writing in the early summer of 2008. Kuttner has forecast the economic hurricane at a Category 4, and did it early, in his previous book from very late 2007, The Squandering of America. Here, in Obama’s Challenge, the longest chapter, almost 60 pages, contains the heart of the economic diagnosis and cure, under the title of “Repairing a Damaged Economy.”
The core of Kuttner’s own “audacious” message is that Democrats need to rip the Republican economic frame apart, those six powerful, distorting words that front for failed ideas, and construct their own. The “easy part,” the deficit spending to head off a second Great Depression, is already outlined, details to follow from the new Obama team. Kuttner is already looking beyond that two or three year program however, to the spending needs and structural transformations, including a new financial system, that will be necessary for full recovery and a more equitable and democratic society. He is courageous enough to put numbers on the scale of it, tell us where the savings and the new revenue needs to be found and raised, and to reassure us that in terms of scale of numbers - that we have been there before and so have others around the world, and it’s turned out quite well. And it will still be capitalism, although the rabid Right has been calling even the New Deal socialist for so long that citizens don’t know anymore how many different variations there are to capitalism out there in the big, wide world. The Right isn’t going to tell them, but Kuttner is. As strange as it now sounds, the hardest part may not be stopping the immediate deflationary spiral that we’re hearing so much about; the toughest part will come when things have stabilized a bit and the Clinton-Rubin formula, still so congenial to many Democrats as well as Republicans, reasserts itself. And if you are a Democrat that still believes that the Clinton years, especially the late 1990’s, really delivered the ultimate Democratic economic formula, you really need to read this book. Citizens of all persuasions owe it to themselves to spend $10.17 (at Amazon.com, at least) to get a “field guide” to the coming economic debates. It will enable you to get up at a briefing from your Congressional Rep. or local state delegation and demand something better than we’ve been hearing for the past 30 years. They’ll generously give you “three minutes” to do it, so you need a little preparation work.
A word about stimulus programs, a new New Deal, and conservative fears about such initiatives: there is so much neglected, under-funded, energy related infrastructure work to be done that there should never be an occasion to resurrect the old charge of “make work.” Think about energy audits and then physical retrofits of older commercial and residential properties. Programs should train new people, put those with construction skills but now unemployed back to work on everything from installing new insulation, new doors and windows and new alternative “rooftop” technologies, and repay whomever it is that advances the initial capital funding – and the owners – via the very direct route of energy cost savings. This whole direction should have been embarked upon before economic calamity struck: now there is no excuse (but we’re sure that opponents will point to low oil and gas prices). Are Montgomery County and the state of Maryland ready to step forward and help push this direction?
After you’ve read Kuttner, and you see that economics is comprehensible once someone shatters the protective and obscuring terminology, you’ll be ready for James K. Galbraith’s The Predator State (2008). The subtitle delivers another “liberating” message from that suffocating Republican frame: “How Conservatives Abandoned the Free Market and Why Liberals Should Too.” Here’s my take on Galbraith’s tale in a very condensed form. The main conservative economic ideas that fueled the Reagan era have been defeated in the mathematically oriented matrix that is also known as economic academe. Galbraith has a gift, like his famous father, John Kenneth, for translating that off-putting realm into understandable terms for you and me. And he’s says that the more Progressive ideas have won the day, and if you look at the serious Republican economists who have recently signed on for major Keynesian spending to fend off the deflationary abyss, you’ll see he’s not overselling what has happened. Just take a look at the title and headings of part one, and you’ll get the idea: The God that Failed: Whatever Happened to the Conservatives; The Freedom to Shop; Tax Cuts and the Marvelous Market of the Mind; Uncle Milton’s War; The Impossible Dream of Budget Balance; There is no such Thing As Free Trade…..
I like this book, which, despite being written for the general public, is a step up in degree of difficulty from Kuttner, but still well within your reach. Read it and you’ll be able to stride into the Cato Institute, American Enterprise Institute, the Heritage Foundation where the ghosts of Reagan abound, the lobbying lobbies on K Street, and push back, with style and intelligence. And won’t they be happy to see you? And fence with the editorials from George Will, Sebastian Mallaby and The Economist. I will post notice here that the book does not focus on the financial crisis, although its explanation of the Predator State, at a broad level of generalization, does explain in part how the financial sector deluded itself. And that’s ok, because a good part of the contentiousness that is bound to engulf the Obama program will be focused on issues of how well the market has worked, taxation and spending, trade and the two big deficits. But that’s down the road a bit. So it really covers “pillar” issues of macro economics that have been dominated by the Right since the mid-1970’s.
There’s just one reservation I’ll briefly note. Galbraith may be underestimating the willingness of the rest of the world to underwrite the continued dominance of the dollar as the world’s medium of exchange, as well as our trade deficit. We’ve noted Nouriel Roubini’s worries above, and in previous writings those of Kevin Phillips, George Soros, and Robert Kuttner. This is going to loom very large after the world economic crisis stabilizes a bit, and the U.S. has to worry about raising the revenue to pay off the trillions in new debt issued by the Federal Reserve and Treasury to keep the financial system functioning. But that’s a matter for future writings. I’m already collecting the articles on the topic from Phillips, Charles Morris and others.
Readers deserve at least a small serving of Galbraith’s style and content, so here it is, from the chapter entitled “The Rise of the Predator State,” pages 144 &146. It’s tough stuff; so is the place in history that we’ve arrived at, in part do to the following:
Under George W. Bush, a narrow coalition of the high plutocracy would rule, mainly from the resource industries (oil, mining, and agribusiness) and the surviving old-line industrial firms (notably automobiles, steel and defense), combined with big media, insurance, and pharmaceuticals…They bring on a tendency to run the state as though it were in fact, just a corporation, with the rules that govern companies displacing the rules that govern republics. And so today we live in a corporate republic, where the methods, norms, culture, and corruption of government have become those of the corporation. This is evident in decision making, public relations, accountability, ownership, and the character and attributes of the desirable chief executive officer…
Republican (with a small ‘r’) government, with its checks and balances, exists to limit the abuse of power. It is a matter of negotiation, compromise, the making of public arguments, and of listening to private dissent. Modern corporate decision-making structures exist, on the contrary, to permit senior executives to do what they want. This is the culture that Richard Cheney brought back into government from Halliburton that George Bush imbibed at his minor perches at Harken Energy and the Texas Rangers. The operational result is a government by cliques operating in secret, indeed with their very membership unknown outside…The government has thus been remade in the image of the business firm…It has come to absorb every great innovation in corporate mismanagement, deception, market manipulation, and fraud of the past forty years.
Although, as we have said, Galbraith’s focus is not on the financial sector and its wonderful world of derivatives, you can hear the echoes, worries, charges and outrage of his broader conceptual model in the anger of citizens directed at the “Bailout,” and as we all try to figure out just how the financial world brought us to the brink. Bill Greider insists we need to know how it happened, not for retribution, but so that we can design the proper remedies.
Just as this long essay was about to go to press, on November 26, I watched President- elect Obama’ press conference announcing an advisory economic panel, headed by Paul Volcker and Austen Goolsbee… with the rest of the members to be announced later, and hopefully they will be chosen from good minds outside the reigning orthodoxies. One of the questions our new President fielded from the press went to the heart of his previously announced choices of Timothy Geithner for Treasury Secretary and Larry Summers for his chief White House economic advisor…how much “change” does this represent if they are mostly from the previous circles that have gotten us in so much trouble? Obama’s response was that he needed people with direct hands on experience because we’re in the middle of a crisis, and that he would be making the top level decisions after listening to these experts, and that’s where the real change would come from. That was a good note to sound. And a new President gets the benefit of the doubts – for a while. My readers know Robert Kuttner has been worrying well in advance about the influence of Robert Rubin in matters financial throughout all the past 15 years or so. The mainstream press has been tracing the pathways of many key players in the administration through the Rubin circles of influence – without the more troubling history Kuttner supplies. This is a real, not an imagined worry for President-elect Obama. Thomas Friedman, whose columns on this crisis in The NY Times have been getting better and better, was struck exactly the same way I was by the “Reckoning” piece on Citigroup that we talked about above. Friedman’s “All Fall Down” is worth your quick read here at http://www.nytimes.com/2008/11/26/opinion/26friedman.html?hp [34] It appeared on the same day as this press conference, and, just to reinforce what’s “in the air,” the same day as a Tom Toles cartoon in The Washington Post here at http://www.washingtonpost.com/wp-srv/opinions/cartoonsandvideos/toles_ma... [35] For those who can’t make the link, it pictures President-elect Obama, leaning over a flattened accident victim called “the economy,” with an ambulance in the background, saying “And we’re putting the Wall St. guys who did this to you in charge of your recovery.” The little Greek Chorus figure at the bottom pipes in “They Have ‘hands-on’ experience.
So there is the worry: can the folks with the “hands-on” experience, change course, act on behalf of the good of the nation and not just the old Wall St. model, or will President Obama, as Bill Greider suggests, have to rapidly come to a major decision moment. Stay tuned for this thread, it’s close to the heart of the matter. And we wish Timothy Geithner well in his new job at Treasury, and remind him how tough it can be: FDR went through three Treasury Secretaries in 1933 before settling on Henry Morgenthau, Jr. who saw the job through… (They were in order: William H. Woodin –left for health reasons; Dean Acheson – protested gold policy; Lewis Douglas – general protest …thanks to Roy Jenkins’ Franklin Delano Roosevelt {2003}, one of the volumes in the American Presidents Series by Times Books.)
We’ll close with one more reading recommendation. It’s a read-in-bed book, with a lot of literary style and flair that one doesn’t often find in economic works. It’s by Steve Fraser, and it’s called Everyman a Speculator: A History of Wall Street in American Life, published in 2005. I recommend it over his shorter 2008 version, Wall Street, America’s Dream Palace.
Everyman’s great virtue is to look at the history of Wall Street through the very broad lens of American values, from Puritan religious attitudes towards gambling and speculation to what some of our great literary giants have had to say about Wall Street, and Street types, from Melville to Fitzgerald. Movies too. It brings, therefore, great insights to the large question we have posed above, and throughout this essay: can the economists closest to The Street of the Great Calamity stem the crisis and build the framework of reform? Fraser shows us that we have had, as a culture, great ambivalence towards The Street, as its roller coaster rides over time, its mania’s, panics and collapses have helped keep the public in an usually healthy, skeptical disposition, but not without it’s share of awe and admiration too. However, with the Reagan Revolution of 1980, there was a major and prolonged shift in the culture’s perception of the Street, to put it back on a high pedestal that it had not mounted since the 1920’s. Attitudes shifted so favorably that The Street was able to enter the late phase, and grandest of all, of history’s greatest speculative bubble with prestige still intact. Despite all the warning signs we have talked about in “The End of an Era,” and, especially, says Fraser, the corporate accounting scandals of the dot.com bust and beyond, and the Enron period that led to Sarbanes-Oxley, The Street rolled on. The aura from the 1980’s and mid-1990’s cast a glow that blinded the public, regulators, and economists too, right up the present collapse of 2007-2008. This book is hard to put down. And it tells you another side of economics, one that Dean Baker has suggested in the long quote we provided above. As in the great changes ushered in by the New Deal in 1933-1937, it wasn’t just about economics, it is about “standing” and prestige in the culture, and who speaks with authority on business and economics.
We have probably never had a President in American history who has come into office with a greater store of energy and optimism than FDR in 1932, despite the state of the country. The accounts of the circumstances of the Inauguration, amidst the collapse of the banking system, make for inspiring reading indeed. In that history, I do see the parallels in our new President. FDR was clear about who was responsible for the Depression, but went out of his way to work with business in experimental, pragmatic programs in the early New Deal. Yet despite his exceptional temperament, and non-ideological approach (as demonstrated in the passage of the NIRA and the evolution of the NRA, of the famous Blue Eagle), as Fraser tells us, by 1936, “Wall Street’s enmity for the president was raw and unconcealed. FDR taunted his enemies with memories of how these same speculators had pleaded with him back in 1933 for help and pledged their cooperation and swore they had learned their lesson, but with the first uptick in the market were back to their old-style selfishness run amuck.” I suspect that in the coming months and first years of the Obama administration, especially with his heavy appointment of Robert Rubin acolytes, we’re going to be hearing more about FDR’s SEC chief, the nation’s first, Joseph Kennedy. Kennedy’s appointment raises exactly the issues on so many minds today. Here’s what Steve Fraser has to say about him in his fine chapter on the early New Deal’s relation to the Street, “Evicted from the Temple.”
FDR’s appointment of the notorious bear and pool operator Joseph Kennedy as the new Securities and Exchange Commission’s first chairman seemed at first a shocking capitulation, and a fair number of newspapers reacted that way. (Indeed, Kennedy’s bear pool during the brief bull market of 1933 had been one of the inspirations for the second securities act, which he was now charged with enforcing.) Roosevelt was repaying a political debt since Kennedy had been one of a very few men from the Street who’d actively supported his run for the presidency. But in any event Kennedy hated the Morgan crowd, who’d shunned him for years, and his brief tenure made it clear the government and not the Exchange would set the rules. ‘The days of stock manipulation are over,’ he informed his one-time colleagues. ‘Things that seemed all right a few years ago find no place in our present-day philosophy.’
We are at the early stages of such a major shift, which of course is about economic theory and thought, but involves much, much more. When the public gets the full story of how Wall Street created and nurtured the greatest speculative bubble in history, the Street will not have the same standing it did in 1999 when “The Committee To Save the World” held sway, and our new President will hopefully learn that our diverse and talented country actually has sources of creativity and insight who do not work, and have not worked for, Goldman Sachs. I know that is hard to believe but…
Let us hope that the turmoil we are going to pass through will be creative, and will help broaden and balance the sources of “authority” in our economic life; and that the school boards in de-industrialized Pennsylvania will never again have to turn to Wall Street salesmen promising “cash up front” if you sign up for one of their “interest rate swap” mystery products. This is going to be one hell of a ride. Stay tuned.
The very best to all my readers until the next posting,
Bill Neil
Rockville, MD
w.neil@att.net [36]
1825 K Street, NW, Suite 400, Washington, DC 20006
202-955-5665 (tel) | 202-955-5606 (fax) | www.ourfuture.org
Links:
[1] http://www.nytimes.com/2008/10/29/business/economy/29leonhardt.html?_r=1&ref=business&oref=slogin
[2] http://www.rgemonitor.com/
[3] http://www.nytimes.com/2008/08/17/magazine/17pessimist-t.html
[4] http://www.bloomberg.com/apps/news?pid=newsarchive&sid=anyWls2bwwQs
[5] http://media.rgemonitor.com/papers/0/12_steps_NR
[6] http://www.rgemonitor.com/roubini-monitor/254591/desperate_measures_by_desperate_policy_makers_in_desperate_times_the_fed_moves_to_radically_unorthodox_policies_as_economy_is_in_free_fall_and_stag-deflation_deepens
[7] http://www.marketoracle.co.uk/Article7487.html
[8] http://www.marketoracle.co.uk/Article7502.html
[9] http://www.washingtonpost.com/wp-dyn/content/article/2008/11/13/AR2008111304490_pf.html
[10] http://pubcit.typepad.com/clpblog/2008/11/todays-fanniefr.html
[11] http://www.cepr.net/documents/publications/100city_2008_05.pdf
[12] http://www.nytimes.com/2008/03/30/business/30hous.html?scp=1&sq=alan blinder&st=nyt
[13] http://www.marketoracle.co.uk/Article5766.html
[14] http://www.marketoracle.co.uk/Article7126.html
[15] http://www.rgemonitor.com/roubini-monitor/253739/home_home_owners_mortgage_enterprise_a_10_step_plan_to_resolve_the_financial_crisis
[16] http://executivesuite.blogs.nytimes.com/2008/11/11/can-anyone-solve-the-securitization-problem/
[17] http://www.nytimes.com/2008/11/15/business/15nocera.html
[18] http://www.prospect.org/cs/articles?article=the_case_for_plain_vanilla
[19] http://www.nytimes.com/2008/11/22/business/22bailout.html
[20] http://www.nytimes.com/2008/11/25/opinion/25tue1.html
[21] http://www.nytimes.com/2008/10/03/business/03sec.html
[22] http://www.nytimes.com/2008/10/25/business/25nocera.html?_r=1&scp=1&sq=so when will banks give loans&st=cse
[23] http://www.rollingstone.com/politics/story/24012700/the_new_trough/print
[24] http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html
[25] http://www.washingtonpost.com/wp-dyn/content/discussion/2008/10/13/DI2008101302158.html
[26] http://www.time.com/time/covers/0,16641,19990215,00.html
[27] http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=10&year=2008&base_name=citing_the_biggest_losers_post
[28] http://www.rgemonitor.com/financemarkets-monitor/254545/has_the_fed_changed_its_policy_unannounced_part_2
[29] http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aOngFPgq7r3M
[30] http://www.counterpunch.org/martens11132008.html
[31] http://www.thenation.com/doc/20081117/greider
[32] http://www.nytimes.com/2008/11/23/business/23citi.html?partner=rss&emc=rss
[33] http://www.alternet.org/workplace/105085/cheating_uncle_sam/
[34] http://www.nytimes.com/2008/11/26/opinion/26friedman.html?hp
[35] http://www.washingtonpost.com/wp-srv/opinions/cartoonsandvideos/toles_main.html
[36] mailto:w.neil@att.net