Monthly Archives: January 2010

Mr. Obama’s Junk Economics: Democrats Relinquish the Populist Option to the Republicans

By Michael Hudson

In a dress rehearsal for this November’s mid-term election, Democrats and Republicans vied last week for who could denounce the banks and blame the other party the most for the giveaways to Wall Street that have swollen the public debt since September 2008, pushing the federal budget into deficit and the economy into a slump.
The Republicans are winning the populist war. On the weekend before his State of the Union address on Wednesday, Mr. Obama strong-armed Democratic senators to re-appoint Ben Bernanke as Federal Reserve Chairman. His Wednesday speech did not mention this act (happily applauded by Wall Street). The President sought to defuse voter opposition by acknowledging that nobody likes the banks. But he claimed that unemployment would be much higher if they hadn’t been bailed out. So the giveaway of public funds was all for the workers. The $13 trillion that has created a new power elite was just an incidental byproduct. Unpleasant, perhaps, as American democracy slips into oligarchy. But all for the people. The least bad option. It had to be done. People might not like it, but Main Street simply cannot prosper without creating hundreds of Wall Street billionaires – without enabling them to increase their bonuses and capital gains as bank stock prices quadruple. It’s all to get credit flowing again (at 30% for credit card users, to be sure).

So the rest of us must wait for wealth to trickle down. The cover story is that this is how the world works, like it or not. At least this is the argument of the lobbyists who are drafting and censoring laws and signing off on just who is acceptable to run the Federal Reserve, Treasury and other public-subsidy agencies. The working assumption is that the economy cannot recover without enriching Wall Street.

This is the Administration’s tragic flaw. What the economy needs is to recover from the Bush-Obama supposed cure, i.e., from the mushrooming debt overhead. It needs to recover from the enrichment of Wall Street. It doesn’t need more credit, but a write-down for the unpayably high debts that the banks have imposed on American families, businesses, states and localities, real estate, and the federal government itself.

Instead of helping debtors, Mr. Obama has moved to heal the creditors, making them whole at public expense. If debtors cannot pay, the Treasury and Fed will take their IOUs and bad casino gambles onto the public sector’s balance sheet. The financial winners must come first – and it seems second and third, too. The rationale is that unless the government gives the large financial institutions what they want and saves them from taking a loss, their “incentive” to protect the economy from devastation will be gone.

Knuckling under to this protection racket is not the change that most people voted for in November 2008. So on Thursday afternoon, most Republican senators opposed a second four-year term for Bernanke. By leading the effort to re-confirm him, the Corporate Democrats (but not most of their colleagues who had to face voters this autumn) removed this albatross from the Republican neck and put it around their own.

For starters, Chairman Bernanke has convinced the President that the Fed should be the single regulator of Wall Street – ideologically kindred, and drawn from its ranks, or with its assent. Mr. Obama’s address made no reference to the Consumer Financial Products Agency he promised a year ago to be the centerpiece of financial reform. Its main sponsor, Elizabeth Warren, has been warning that hopes for reform are being overwhelmed by financial lobbyists arguing that truth-in-lending laws and anti-usury regulations threaten to reduce bank profits, forcing lenders to raise costs to consumers. In Mr. Bernanke’s world, regulations to protect consumers simply will oblige the banks to pass on the cost increase caused by this “government interference.” The more regulation there is, the more consumers will have to pay.

This is the inside-out picture drawn by bank lobbyists and purveyed by Mr. Obama’s economic team. Could George Bush have gotten away with it? Democrats have a friendlier and more compassionate face, but the substance remains the same.

Most economists believe that Mr. Obama is whistling in the dark when he says the economy will recover this year under Chairman Bernanke’s guidance. The financial screws are being tightened, yet the Fed refuses to abide by its charter and regulate credit card rates going through the roof. Instead of countercyclical federal spending to rescue the economy from debt deflation, Mr. Obama says that since we have given so much to Wall Street in the past year and a half, little is left to spend on the “real” economy. Sounding like a Republican in Democratic clothing not unlike his Senate mentor Joe Lieberman, his State of the Union speech urged creation of a bipartisan (that is, Republican-friendly) working group to agree on how to lower the deficit. The President proposes that starting next year Congress should freeze spending not already committed under entitlement programs.

Testifying Wednesday morning as a run-up to Pres. Obama’s evening speech, Messrs. Geithner and Paulson at least avoided the Washington ploy of emulating Alzheimer’s patients and saying that they couldn’t recall anything about their giveaways. Sophisticated enough to outplay their questioners in verbal tennis, the past and present Treasury Secretaries brazened it out. Using the Plausible Deniability defense, they claimed that they weren’t even in the loop when it came to paying AIG enough to turn around and pay Goldman Sachs and other arbitrageurs 100 cents on the dollar for securities worth about a fifth as much. It was all done by their subordinates. Their underlings did it. “This was a Federal Reserve loan,” Mr. Paulson explained. “They had the authority. They had the technical expertise … and I was working on many other things which were in my bailiwick.” And in any case an AIG bankruptcy “would have buckled our financial system and wrought economic havoc.” Unemployment, he warned, “could have risen to 25%.” The Fed had to protect people.

When there was no way to dodge, they frankly admitted what had happened, providing helpful pieties to the effect that it is the job of Congress to change the law to make sure nothing like this happens again. Yes, there was a big giveaway, but we saved the economy. Wall Street’s loss would have been the peoples’ loss. Certainly we need new rules to protect the taxpayer, blah, blah, blah. We’re all in the same boat. If the banks took a loss, they would have to raise the price of financial services and we would all have had to pay more. Thank heavens that everything is getting back to normal now.

“A lot of people think the president of the New York Fed works for the government,” Democrat Marcy Kaptur of Ohio concluded, “but in fact he works for the banks on the board that elected you.” Not so, testified New York Federal Reserve general counsel Thomas Baxter. “A.I.G. wanted to keep the information confidential, for fear that it would lose business if customers were named.” And if it lost business, “This would have had the effect of harming the taxpayers’ investment in A.I.G.” So it was all to save the taxpayers money that the Fed spent $185 billion of their money.

But was it really necessary not to let A.I.G. go bankrupt in September of 2008? The Wall Street Journal’s editorial page blew the whistle on how the government’s wheeler-dealer insiders have been changing their story again and again – not usually a sign of truthfulness. “Secretary of the Treasury Timothy Geithner and predecessor Hank Paulson said they didn’t bail out AIG to save its derivatives counterparties” from bad credit default swap contracts because if it would have asked these counterparties to “take a haircut,” credit-ratings agencies would have downgraded AIG. A lower rating would have obliged it to post even more collateral on its other swap contracts, presumably because of the higher risk.

There are a number of problems with this story, the editorial explained. First of all, Goldman Sachs and other counterparties unilaterally said the prices had declined for securities that had no market price at all, only subjective valuations. A.I.G. would have been reasonable in disputing this. In any event, as the firm’s new 80% stockholder, the U.S. Government said it would stand behind AIG. This should have removed fears of non-payment. But most important of all was the claim by Messrs. Paulson and Geithner that failure to “honor” AIG’s swaps would have threatened its far-flung insurance businesses on which so many American consumers depended. New York Insurance Superintendent Eric Dinallo, who was AIG’s principal insurance regulator at the time, testified before the Senate last year that these operations were not threatened at all! “‘The main reason why the federal government decided to rescue AIG was not because of its insurance companies.’ He was so confident in the health of the AIG subsidiaries that, before the federal bailout, he was working on a plan to transfer $20 billion of their excess reserves to the parent company.”

This directly contradicts Mr. Geithner’s claim “that the ‘people responsible’ for overseeing the insurance subsidiaries ‘had no idea’ about the risks facing AIG policyholders. He’s talking about Mr. Dinallo here. Instead of being safely segregated, Mr. Geithner said the insurance businesses were ‘tightly connected’ to the parent company. Mr. Paulson added that the healthy parts of AIG had been ‘infected’ by the ‘toxic assets.’ He added, ‘One part of the company would have contaminated the other.’” Does this mean that New York’s “heavy state insurance regulation was a sham,” the newspaper asked? It would seem that “When push came to shove, policyholders were not protected from a default by the parent company.” It urges that Mr. Dinallo be brought back to straighten the matter out.

Mr. Geithner closed his own comments by saying, “if you are outraged by what happened with A.I.G., then you should be deeply committed to financial reform.” This is rhetorical judo. The financial system in question is not the economy at large. It was A.I.G.’s carefully segregated bookies’ account for wealthy hedge fund gambles and Wall Street speculations that should have had little to do with the “real” economy at all.

Wall Street – and most business schools – promote the myth that the “real” economy of production and consumption cannot function without making Wall Street’s insiders immensely rich. Emulating Louis XIV, Wall Street’s spokesmen explain, “L’economie, c’est nous.” There seems nothing to be done about banks impoverishing people by extortionate credit card rates, junk securities and a debt burden so heavy that it will require one bailout after another over the next few years. Present policy is based on the assumption that the U.S. economy will crash if we don’t keep the debt overhead growing at past exponential rates. It is credit – that is, debt – that is supposed to pull real estate out of its present negative equity. Credit – that is, debt leveraging – that is supposed to raise stock market prices to enable pension funds to meet their scheduled payments. And it is credit – that is, debt –is supposed to be the key to employment growth.

Credit means giving Wall Street what it wants. Regulating it is supposed to interfere with prosperity. Truth-in-lending, for example, will increase the “cost of production” by “making” banks charge consumers even more for creating credit on their computer keyboards.

This Stockholm syndrome when it comes to Wall Street’s power-grab is junk economics. Wall Street is not “the economy.” It is a superstructure of credit and money management privileges positioned to extract as much as it can, while threatening to close down the economy if it does not get its way. High finance holds the economy hostage not only economically but also intellectually at least to the extent of having captured Mr. Obama’s brain – and also the federal budget, as money paid to Wall Street has crowded out spending on economic recovery. It has re-defined “reform” to mean putting Wall Street even more in power by making the Fed the sole regulator of Wall Street. Under these conditions, saving “the system” means saving a mess. It means saving a debt dynamic that must grow exponentially at the economy’s expense, absorbing more and more federal bailout funds and hence crowding out the spending needed to revive the economy.

Mr. Paulson’s testimony echoed the idea that the rescue of A.I.G. was necessary to keep the economy from collapsing. “We would have seen a complete collapse of our financial system,” Mr. Paulson said, “and unemployment easily could have risen to the 25 percent level reached in the Great Depression.” So it was all for the working class, for employees and consumers. It was done to save the government – a.k.a. “taxpayers” – from losing money on its investment. It was to save the economy from breaking down – or perhaps to pay off protection-racket money to Wall Street not to wreck the economy. And as we all know, taxpayers today are mainly the lower-income individuals unable to take their revenue in the form of low-taxed “capital gains” like Wall Street traders, in today’s fiscal war between finance and labor.

It seems to be merely an incidental by-product of saving taxpayers and labor that Wall Street ended up with the hundreds of billions of dollars of gains (and losses avoided) – at a $13 trillion expense of government and of about four million jobs in the overall economy whose employment is shrinking, and about four million home foreclosures in 2009-10. The cover story is that matters would have been worse otherwise. This was the price for “saving the system.” But “the system” turns out to be the Bubble Economy, in which the Obama administration has put as much faith as Bush did. This is why the same managers have been kept in place. This policy has enabled Republicans to strike a posture of denouncing the banks in preparation for this November’s mid-term election.

“Saving the economy” has become a euphemism for the policy of keeping bad debts on the books and saving high finance from writing them down to reflect the realistic ability to pay. Wall Street has used its bailout money to lobby Washington, back its political nominees to hold Congress hostage, and blame the downturn on any regulator or president who does not yield to its demands.

The resulting program is not saving the economy; it is sacrificing it. What has been saved is the debt overhead – the wrong side of the balance sheet.

The reactionary political outlook

A bipartisan compact between Corporate Democrats and Republicans is not the change voters expected in November 2008. Confronted with the “Obama surprise” – an absence of change – the only option that many voters believe they have is to change the existing party. Republicans are setting their eyes on Pres. Obama’s former Senate seat in Illinois, Vice Pres. Biden’s seat in Baltimore, and Majority Leader Reid’s seat in Nevada. Losing these and other seats would create a political standoff giving Mr. Obama further excuse for not changing course.

This kind of standoff normally would enable a popular president to ask voters to elect a majority large enough to legislate the program he outlines. But instead of a program, Mr. Obama has simply appointed the leading Bush-era administrators and brought back the Clinton “Rubinomics” team from Wall Street. His spending freeze in a shrinking economy is a Republican program, his modest “stimulus package” is over, and he has dropped the Consumer Financial Products Agency under Wall Street pressure. So if we are to look at what the administration actually is doing, its program is simply a blank check to the Fed and Treasury (under Bush-era management) to revive Wall Street fortunes – in a nutshell, more Rubinomics.

Convergence between the two parties reflects the privatization of politics by political lobbying and campaign contributions. Getting paid back with fiscal favors, sell-offs and bailouts promises to increase in the wake of the recent Supreme Court “Frankenstein” decision that corporations are virtual people when it comes to freedom of speech and the purchase of media time.

The only countervailing power is that within the Republican Party a fringe of tea partiers threatens to run against more established candidates safely sold to special interests. The Democratic Party always has been a looser coalition, which may not hold together if the Rubinomics team continues to lock out non-Corporate Democrats. So a political realignment may be in the making. Financial and fiscal restructuring issues span left and right, progressive Democrats and populist Republicans. So far, their sentiments are reactive rather than being spelled out in a policy program. But there is a widening realization that the economy has painted itself into a financial corner.

What is needed is to explain to voters how financial and tax policies are symbiotic. The tax shift off finance, insurance and real estate (FIRE) onto labor and industry since 1980 has polarized the economy between a creditor class at the top of and an indebted “real” economy below. Unless this tax favoritism is reversed, more and more revenue will be diverted away from spending on consumption and investment to pay debt service and “financialize” the economy even more.

It is natural that the world’s most debt-ridden economies – Latvia and its Baltic and post-Soviet neighbors, and Iceland – are the first to perceive the problem. They may be viewed as an object lesson for a dystopian future of debt peonage. New Europe’s debt strains are threatening to break up the core euro-currency area (aggravated from within by the Greek, Spanish and Irish public debt problems). The British economy is likewise financialized, weakening sterling. And Europe lacks the U.S. financial safeguard that enables mortgage debtors here to walk away from properties that have fallen into negative equity. Insolvent homeowners in Europe face a lifetime of literal debt peonage to make the banks (even foreign banks, which dominate Central Europe’s post-Soviet economies) whole on their bad debts as the continent’s real estate prices are plunging even more steeply than those in the United States – some 70 percent in Iceland and Latvia.

The only silver lining I can see is that perception will spread that the financial sector is an intrusive dynamic subjecting the economy to debt deflation. But at present, lawmakers are acting as if the economy is an albatross around Wall Street’s neck. (“How are we wealthy people to bear the cost of healing the sick and employing the masses?” the financial sector complains. “The cost is eating into our ability to create wealth.”) Libertarians have warned that our economy is going down the Road to Serfdom. What they do not realize is that by fighting against government power to check financial hubris, they are paving the road for centralized financial planning by Wall Street. They have been tricked into leading the parade on behalf of the financial, insurance and real estate sector – down the road to debt peonage in a monopolized and polarized economy.

Testimony By Geithner, Bernanke and Paulson Demonstrates Need for Thorough Investigation of AIG Deals

By William K. Black

The truly extraordinary disclosures were that Paulson, Bernanke, and Geithner all purported to have had no involvement in one of the most expensive decisions in history — the decision to pay 100 cents on the dollar to the least deserving of recipients (and who, if Geithner’s testimony were to be believed, did not need to receive that largess) — and the unprincipled and indefensible decision to try to get AIG to cover up that fact and the beneficiaries of that largess. Indeed, Bernanke testified that he entered into an oral recusal (such recusals have to be put in writing under Office of Government Ethics rules) that meant that at the most critical time in financial regulation in 80 years an “acting” official was left in charge of all regulatory decisions at the NY Fed. This is bizarre because he was one of the rare senior public officials that did not have a clear conflict of interest due to their Wall Street ties. Those senior officials, e.g., Paulson, that had clear conflicts of interest did not recuse themeselves and Goldman Sachs was the biggest single recipient of what two Fed Members aptly labeled a “gift” from the taxpayers. Worse, the acting Fed President reported to the NY Fed Board and its Chair, Stephen Friedman (of Goldman), who purchased a large block of Goldman stock in December 2008. (Rep. Issa has charged that this indicates he was trading on inside information that produced a large investment profit.) This was such an outrageous conflict of interest that other regional Fed banks were outraged. Worse, the Fed staff approved Friedman’s conflict of interest. Still worse, he did not inform the Fed of his large purchase of Goldman shares in December 2008 (just after it received $12.9 B from the taxpayers (via AIG)).

Note that (1) Friedman was a Class C “Public Interest” director for the NY Fed (“Hi, I’m from Government Sachs and I’m here to represent the public’s interest”), (2) that Baxter was his leading defender (yep, the same NY Fed General Counsel that pushed the AIG cover up), and (3) and that the WSJ story logically should have noted that Geithner had recused himself during November and December 2008 because that fact would have been relevant to their study and they obviously wrote the story on the basis of interviews with senior NY Fed staff — but it does not. That makes it even more dubious that Geithner recused himself and/or it means that the NY Fed officials were trying to avoid public knowledge of the recusal. Baxter, as NY Fed GC, should have been involved in the recusal and screening procedures (again, mandated by OGE rules, particularly for nominees requiring Senate confirmation.

Analytically, the key development was the failure of the Committee to point out that all of Geithner’s arguments about the financial catastrophe that was (purportedly) certain if AIG were to spin off its trading unit and place it in bankruptcy proved the opposite of his conclusion about leverage. Recall that Lehman had gone done and every big AIG counterparty was desperately seeking federal aid and regulatory forbearance. They knew that if they tried to collect on their CDS they would cause AIG to fail and that they would be risking (1) getting zero cents on the dollar on their CDS (or, at most, whatever grossly inadequate collateral AIG had pledged), (2) royally pissing off every developed nation in the world — at a time when they needed government bailouts, liquidity lines, and regulatory forbearance. In sum, the very facts Geithner stressed in his testimony provided the government with the ultimate in negotiating leverage, particularly if, as Geithner testified, none of the counterparties needed to collect on the AIG CDS to remain healthy — (personally, I find Geithner’s claim dubious). Stiglitz’ new book, Freefall, points out that other distressed sellers of CDS “protection” during this period negotiated settlements in which they paid 13 cents on the dollar.

It was downright humorous to see Geithner purport to be affronted that anyone might be concerned that Goldman, and Goldman alums drawing federal paychecks, might serve Goldman’s interests. As Liar’s Poker emphasized, there’s always a “fool” in the game. Thanks to Geithner, Bernanke, Friedman, and Paulson the U.S. taxpayer was that “fool” — and AIG was their tool. Actually, my favorite is their decision to use AIG to secretly bail out UBS. Switzerland is a rich nation, why should we pay to bail out transactions that were never federally insured. But it gets better. We bailed out UBS while we were prosecuting them for massive tax fraud involving exceptionally wealthy Americans that were seeking to evade some of the lowest marginal income tax rates in the developed world. So, in economic substance, U.S. taxpayers paid the “fine” that UBS purported to pay to end the prosecution and gave UBS roughly $4.25 billion extra as a lagniappe. (Oh, and the Swiss courts just decided to shaft us by refusing to comply with the disclosures of the indentities of the U.S. tax cheats required under the settlement with UBS.) So, we are now the global “fool.”

It is inconceivable that Bernanke should be reappointed before his role, and the role of his agency, in the twin AIG scandals (the give away and the cover up) are investigated.

Can we spend our way out of the recession? Is the fiscal deficit unsustainable? And is it time to cut government spending?

By Eric Tymoigne

If the reader is familiar with history, she or he will note a close similarity between the current policy debates and those of the 1930s; the latest similarity is the proposed spending freeze by the Obama Administration. In the early 1930s, President Roosevelt first criticized President Hoover for engaging in deficit spending and driving the country down the road to ruin, and then proceeded to implement policies that further increased the fiscal deficit of the federal government to about 5% of GDP (a historical record at that time). These policies greatly helped the economy to get out of the Great Depression, but were the subject of ferocious attacks on the ground that the “massive” deficits would lead to the insolvency of the country, uncontrollable inflation, wasteful spending, the taking over of the economy by the government, and, ultimately, the rise of Communism. A cartoon in the Chicago Tribune says it all. Those criticisms were so ferocious and effective at frightening the population that Roosevelt decided to return to a balance budget during the election year of 1936, just like President Obama wants to do.

Did any of those problems actually materialize? As the saying goes “the proof is in the pudding.” There was no government takeover, no rise of Communism, and no insolvency. In fact, Roosevelt proceeded to increase government deficit over 20% of GDP during WWII without any of those problems arising. The non-sense about insolvency and government takeover of the economy have been explained elsewhere on this blog (here and here) and on Bill Mitchell’s blog and no additional time needs to be devoted to that subject. Instead, let us see what the actual consequences of rising federal government deficit (current government outlays minus current government receipts) and rising public debt (the sum of all past and current federal government deficits and surpluses) were.

Staying in the pre-WWII period, unemployment went down steeply to about 10% of the economy, once one removes people employed by government programs from the unemployment data. Even if one just follows the official BLS data (the gray line in Figure 1), unemployment rate was down to 15%. Far from great but much better than 25%. Unemployment would have declined much further if Roosevelt had let the government spending grow. However, political pressures pushed him to limit government spending and government deficit and to actually reduce them massively. This generated a recession in 1937, followed by rising unemployment.

Figure 1. Annual Unemployment Rate in the U.S.: 1890-2009.

The main argument used for counting people employed by the CCC, WPA and other government programs as unemployed, is that those jobs were makeshift jobs not driven by the needs of the private sector. They were wasteful employment not justified by the profit motive. However, while they probably were not profitable, they were extremely beneficial for the welfare of the US population and provided the foundation for the long period of stability after WWII. Here are some of the achievements through June 1940, 3 years before most employment programs ended (NRPB is the National Resources Planning Board’s Security Work and Relief Policy):

Work Projects Adminitration (WPA)
“Through December 31, 1940, some of the tangible accomplishments of WPA projects were as follows: over 560,000 miles of highways, roads and streets constructed or improved; almost 5,000 schools built and 30,000 improved; 143 new hospitals provided and almost 1,700 improved; over 2,000 stadiums, grandstands, and bleachers built; 1,490 parks, 2,700 playgrounds, and more than 700 swimming pools constructed; 19,700 miles of new storm and sanitary sewers laid; over 2,000,000 sanitary privies built. Conservation work included the planting of more than 100,000,000 trees, and the construction or improvement of over 6,000 miles of fire and forest trails. The work in airport and airway facilities included some 500 landing fields and over 1,800 runways. During January 1941, 1,000,000 adults and 37,000 children were enrolled in classes and nursery schools; over 280,000 persons received music instruction and over 67,000 art instruction; and attendance at concerts reached almost 3,000,000 people. Participant hours in various recreational activities totaled almost 14,000,000. Since the beginning of the WPA, welfare activities have included a total of 312,045,000 garments completed by sewing projects and of 85,270,000 other articles, while more than 57,000,000 quarts of food have been canned and almost 600,000,000 school lunches were served.” (NRPB 1942: 342, n.4)
National Youth Administration (NYA)
“Through June 30, 1940, the accomplishments of youth workers on the out-of-school program had included the following: New construction or additions to more than 6,000 public buildings, such as schools, libraries, gymnasiums, and hospitals, and addition to or repair or improvement of about 18,300 others; construction of almost 4,000 recreational structures, such as stadiums, bandstands, and park shelters, and repair or improvement of nearly 6,000 others; construction of 350 swimming or wading pools and 3,500 tennis courts. About 1,500 miles of roads had been constructed and 7,000 repaired or improved; nearly 2,000 bridges had been built. Seven landing fields had been constructed at airports. 188 miles of sewer and water lines had been laid, and 6,200 sanitary privies built. Over 6.5 million articles of clothing had been produced or renovated, nearly 2 million articles of furniture constructed or repaired, and 350,000 tools or other mechanical equipment constructed or repaired. 77.5 million school lunches had been served by NYA youth; nearly 4 million pounds of foodstuffs had been produced and nearly 7 million pounds canned or preserved. Conservation activities had included the construction or repair of 127 miles of levees and retaining walls and 15,700 check and storage dams.” (NRPB 1942: 342, n.5)

Civilian Conservation Corps (CCC)
“Through June 30, 1940, the accomplishments on these [CCC] projects included: The construction of 37,203 vehicle bridges, 21,684,898 rods of fence, and 79,538 mileage of telephone lines; the development of almost 21,000 springs waterhole, and small reservoirs; the building of more than 5 million permanent and temporary check dams in connection with treating gullies for erosion control; as well as the planting, seeding, or sodding of 114 million square yards of terraces for protection against erosion; the planting or seeding of almost 2,000,000 acres of forest land with an average of 1,000 trees to the acre; 5,741,000 man-days spent in fighting forest fires and 5,392,000 man-days in fire presuppression and prevention work; forest-stand improvement on 3,694,930 acres; development of about 55,000 acres of public camp and picnic grounds; stocking lakes, ponds, and streams with 9.3 million fish.” (NRPB 1942: 343, n.8)

The overall cost of running those programs was extremely small, less than 1% of GDP. Despite their limited scope, they helped millions of people to make a living, helped to avoid waste of resources (if they had been left idle), and promoted the growth of U.S. infrastructures. In addition, the large deficit spending flooded the private sector with cash; thereby, restoring profitability and willingness to employ. War deficit spending reinforced this trend by flushing banks and private businesses with money and by creating a long period of financial stability. All this without any sign of insolvency of the federal government.

A final complaint is usually that government deficit always creates huge inflation and even hyperinflation. There is here a ton of data going against this argument. One just needs to look at Japan over the past 20 years: massive debt, very low interest rate, deflation or stable prices. But we do not have to go that far. Here is the United States, the “massive” deficits of the 1930s and 1940s did not generate high inflation.

Figure 2. Annual CPI Growth in the US.

In the 1930s, inflation stayed moderate at about 3%, after WWII inflation did spike to 15% for one year but that was it. And this spike is explained by the disturbances in the production system induced by WWII. After the production capacities were reoriented toward meeting the demands of a peaceful economy, inflation declined tremendously even though public debt was still very high relative to GDP. Today for the first time since 1955, the US economy experienced deflation despite rapidly rising deficits. Thus, there is no automatic relationship between government spending and inflation. It all depends on the state of the economy. If the economy is at full employment, any type of spending (private domestic consumption, private domestic investment, exports, and government spending) leads to inflation. If production capacities are underemployed, as they are today, companies can meet all the additional private or public demand without increasing their prices.

So can we spend our way out of a recession? Yes we can; provided that spending is high enough. Will a sovereign government go bankrupt by doing so? No, it will not. Does government spending lead to inflation? No, it does not. Does bigger government spending mean that the government will take over the economy? No, it does not. Does it mean that all types of spending are equally beneficial? Definitely not. Government spending can be wasteful if there is no improvement in the welfare of society through infrastructure spending, better social programs, and other government spending, preferably employment-enhancing, that improve the standard of living of the population. That is the major critique that one can make about the Obama administration under the guidance of Geithner and Summers. Far too much money was spent on wasteful financial rescues and far too few dollars were used for the benefits of the overall population. The clear example of this is that, while unemployment as leveled off it has not declined significantly. Even more telling is what has happened to the employment-population ratio. The latter has been dropping so much that all the gains of the past 25 years have been eliminated.

Figure 3. Employment-Population Ratio

We need a second “stimulus.” Even better, we need a permanent employment policy that provides a buffer against unemployment through employment-government programs. Those who promote small government do so on the basis of a value system, not on the basis of sound economic arguments or historical data. Unfortunately, this value system is highly dangerous for the well-being of the U.S. population. The alternative is not government takeover but rather using the government in a productive fashion to improve economic well being. Make your voice heard, not just by hanging passively signs in the streets and going to vote, but through massive organized protests and, if necessary, strikes. This is how a healthy democracy works. This is what happens all the time in other democratic countries and this is what this country did in the 1930s with the Bonus Marchers, industrial strikes, and the peasant movements. Want a few ideas to fight for? What about increasing healthcare benefits, eliminating the payroll tax, engaging in massive green infrastructure programs, providing free education in the fields in need (definitely not finance)? Those were the sort of commitments made during the 1930s and they have been hugely popular among the U.S. population, have contributed to the rise of US economic power, and have not affected at all the solvency of the United States. Again the proof is in the pudding: just look at the popularity of Medicare, Social Security, the air transportation system, the highway system and many other achievements of the New Deal and post-WWII policies.

A Plea to the President: Tear Up That Speech

By Stephanie Kelton

My colleague and fellow blogger, Randy Wray, has just argued that President Obama should scrap the speech he’s planning to deliver tonight and surprise the American people with something entirely different. I couldn’t agree more. And while I agree that job creation must be JOB ONE in the months (and years) ahead, I would encourage the President to make massive tax relief the cornerstone of tonight’s speech.
Specifically, the President should call on Congress to support a full and immediate payroll tax holiday. Right now, the government takes away about 15% of our incomes in the form of payroll taxes. With a full payroll tax holiday, a married couple earning $60,000 a year would see their take-home pay increase by about $750 each month. In the aggregate, this will help millions of Americans pay their mortgages, student loans, credit card bills, and so on, while at the same time reducing business expenses (remember that employers contribute to the payroll tax too). All told, a full payroll tax holiday would allow Americans to keep about $1 trillion this year.
So stand before us, Mr. President, and tell us that you want to stop taking this income away from us until we, as a nation, have clawed back every job that has been lost since the start of the recession. Tell us that you intend to take bold steps to protect jobs, keep families intact and provide relief for millions of American businesses. Tell us that you have done all you intend to do to help the banks and the automakers and that you will not accept a jobless recovery — that an increase in economic activity is meaningless without rising employment in good jobs.
And, most importantly, tell us that you refuse to adopt a timeline for cutting the deficit. Tell us that you will not take one dime of payroll taxes away from us until your Administration can declare “Mission Accomplished” on the job front.
Finally, tell the American people that anyone who opposes a payroll tax holiday wants to keep taking hundreds, perhaps thousands, of dollars from them every month. Then watch what happens in 2012.

What President Obama Ought To Say In His State Of The Union Address

By L. Randall Wray

President Obama: Over the past year it has become amply clear that targeting most of the Federal Government’s assistance toward Wall Street rather than Main Street has done nothing to help pull our economy out of the deepest downturn since the Great Depression. I have become convinced that the single most important thing Washington can do to help America is to create jobs–and to create them on an unprecedented scale. I am talking about millions of jobs, maybe tens of millions.

So here is what I propose to do. I am directing my administration to come up with a plan that will guarantee a decent job at decent pay for any American who wants to work–regardless of race, regardless of gender, regardless of education or training, and regardless of previous work experience. I want these to be productive jobs–jobs that will enhance the well-being of everyone in our country. Among the areas that ought to be targeted I would include education, care for our aging population, cleaning up our environment and retrofitting buildings to make them energy efficient, and repairing and improving our nation’s infrastructure.

It is time that we take seriously the United Nation’s Universal Declaration of Human Rights, which guarantees the right to a job–which was actually one of the key components of the Second Bill of Rights proposed by my predecessor, Franklin Roosevelt more than 65 years ago. I am ashamed that our nation has not lived up to its commitment to human rights, and I aim to change that.

This program will be permanent, and it will ensure that from this day forward, the United States economy will operate with true, full employment. We will look to the New Deal job creation programs for inspiration, but we will go further because we will end forever the horror of involuntary unemployment. Eliminating the scourge of unemployment is good politics, it is good social policy, and it is good economics.

Now, I am not an expert in esoteric economic theories that are common in the ivory towers of some universities. But I can tell what is nonsense. And any economist who tells you that it makes sense to keep tens of millions of people unemployed is spouting nonsense.

Our nation faces many challenges, today and in the years to come. But we can solve these by working together–and it will take all of us, working, together, to meet those challenges. The truth is that we can no longer afford to keep people out of work. The job is too big. So I ask my administration, and I ask you, the American people, to put our minds together to create those jobs and I will commit the Federal Government budget to provision of decent wages for all of those who want to fill them.

Thank you.

“Giving up on the Fed”

By Warren Mosler

We’re getting closer to the point discussed a few weeks ago about markets giving up on the Fed.

At the time the 10 year was maybe 3.75-3.80, gold had gone about 1,200, the dollar was near the lows, crude was back over 80, stocks were up, all based on the belief the Fed had the power to ‘reflate’ and was ‘printing money’ through trillions of ‘quantitative easing’ which was, sooner or later, hyper inflationary, along with 0 interest rates and ‘record deficits’ which would drive up interest rates, risk default and a sudden breakdown of the $US, all contributing to the same inflationary collapse.

Now that the bets have been placed, and none of that is happening, it’s all starting to erode. Crude is back below 75 (the Saudis’ actual target/range?), gold is selling off, the dollar is edging higher, the 10 year just traded at 3.57, stocks are selling off, etc.

The next step is for first markets and then policy makers to realize the Fed has no tools to inflate. That 0 rates and qe don’t cut it. Nor are deficits large enough to reflate. Bernanke was asked by Time magazine late last year if he had any tools left. He said yes. When asked what they were, he had no specific answer. Well, if he does have more tools, with 10% unemployment and weak prices and a dual mandate for full employment and price stability, what’s he waiting for?

Should market psychology turn to the notion that the Fed has no tools to inflate, and we have a Congress dead set against larger deficits, it can all get very ugly very quickly in the race to the exit from the inflation plays (including steepeners) currently on the books.

State of the Union Rhetoric, 2010: Part II Euphemisms, oxymorons and internal contradictions

Euphemisms, oxymorons and internal contradictions
By Michael Hudson

The State of the Union address is in danger of purveying the usual euphemisms. I expect Mr. Obama to brag that he has overseen a recovery. But can there be any such thing as a jobless recovery? What has recovered are stock market averages and Wall Street bonuses, not disposable personal income or discretionary spending after paying debt service.

There is a dream that what can be “recovered” is something so idyllic as to be mythical: a Bubble Economy enabling people to make money without actually working, by borrowing and riding the tide of asset-price inflation to make capital gains. Corporate Democrat Harold Ford Jr. writes nostalgically that Bill Clinton’s eight years in office created 22 million jobs, “balanced the budget and left his successor with a surplus. This can be done again,” if only Mr. Obama moves further to the right (which Mr. Ford calls the center, meaning the Bayhs and Republicans).

Well, no it can’t be done again. Pres. Clinton’s administration balanced the budget by “welfare reform” to cut back public spending. This would be lethal today. Meanwhile, his explosion of bank credit and the boom (rising stock prices and bonuses without any earnings) fueled the early stages of the Greenspan bubble. It was a debt-leveraged illusion. Instead of the government running budget deficits to expand domestic demand, Mr. Clinton left it to banks to extend interest-bearing credit – debt pollution that we are still struggling to clean up.

The danger is that when Mr. Obama speaks of “stabilizing the economy,” he means trying to sustain the rise in compound interest and debt. This mathematical financial dynamic is autonomous from the “real” industrial economy, overwhelming it economically. That is what makes the present economic road to debt peonage so self-defeating.

Debts that can’t be paid, won’t be. So defaults are rising. The question that Mr. Obama should be addressing is how to deal with the excess of debt above the ability to pay – and of negative equity for the one-quarter of U.S. real estate that has a higher mortgage debt than the market price is worth. If the hope is still to “borrow our way out of debt” by getting the banks to start lending again, then listeners on Wednesday will know that Mr. Obama’s second year in office will be worse for the economy than his first.

How realistic is it to expect the speech to make clear that “we can’t go home again”? Mr. Obama promised change. “We simply cannot return to business as usual,” he said on Jan. 21, introducing the “Volcker plan.” But how can there be meaningful structural change if the plan is to return to an idealized dynamic that enriched Wall Street but not the rest of the economy?

The word “recession” implies that economic trends will return to normal almost naturally

Any dream of “recovery” in today’s debt-leveraged economy is a false hope. Yet high financial circles expect Mr. Obama to insist that the economy cannot recover without first reimbursing and enriching Wall Street. To re-inflate asset prices, Mr. Obama’s team looks to Japan’s post-1990 model. A compliant Federal Reserve is to flood the credit markets to lower interest rates to revive bank lending –interest-bearing debt borrowed to buy real estate already in place (and stocks and bonds already issued), enabling banks to work out of their negative equity position by inflating asset prices relative to wages.

The promise is that re-inflating prices will help the “real” economy. But what will “recover” is the rising trend of consumer and homeowner debt responsible for stifling the economy with debt deflation in the first place. This end-result of the Clinton-Bush bubble economy is still being applauded as a model for recovery.

We are not really emerging from a “recession.” The word means literally a falling below a trend line. The economy cannot “recover” its past exponential growth, because it was not really normal. GDP is rising mainly for the FIRE sector – finance, insurance and real estate – not the “real economy.” Financial and corporate managers are paying themselves more for their success in paying their employees less.
This is the antithesis of recovery for Main Street. That is what makes the FIRE sector so self-destructive, and what has ended America’s great post-1945 upswing.

There are two economies – and the extractive FIRE sector dominates the “real” economy

When listening to the State of the Union speech, one should ask just which economy Mr. Obama means when he talks about recovery. Most wage earners and taxpayers will think of the “real” economy of production and consumption. But Mr. Obama believes that this “Economy #1” is dependent on that of Wall Street. His major campaign contributors and “wealth creators” in the FIRE sector – Economy #2, wrapped around the “real” Economy #1.

Economy #2 is the “balance sheet” economy of property and debt. The wealthiest 10% lend out their savings to become debts owed by the bottom 90%. A rising share of gains are made in extractive ways, by charging rent and interest, by financial speculation (“capital gains”), and by shifting taxes off itself onto the “real” Economy #1.

John Edwards talked about “the two economies,” but never explained what he meant operationally. Back in the 1960s when Michael Harrington wrote The Other America, the term meant affluent vs. poor America. For 19th-century novelists such as Charles Dickens and Benjamin Disraeli, it referred to property owners vs. renters. Today, it is finance vs. debtors. Any discussion of economic polarization betweens rich and poor must focus on the deepening indebtedness of most families, companies, real estate, cities and states to an emerging financial oligarchy.

Financial oligarchy is antithetical to democracy. That is what the political fight in Washington is all about today. The Corporate Democrats are trying to get democratically elected to bring about oligarchy. I hope that this is a political oxymoron, but I worry about how many people but into the idea that “wealth creation” requires debt creation. While wealth gushes upward through the Wall Street financial siphon, trickle-down economic ideology to fuel a Bubble Economy via debt-leveraged asset-price inflation.

The role of public spending – and hence budget deficits – no longer means taxing citizens to spend on improving their well-being within Economy #1. Since the 2008 financial meltdown the enormous rise in national debt has resulted from reimbursing Wall Street for its bad gambles on derivatives, collateralized debt obligations and credit default swaps that had little to do with the “real” economy. They could have been wiped out without bringing down the economy. That was an idle threat. A.I.G.’s swap insurance department could have collapsed (it was largely in London anyway) while keeping its normal insurance activities unscathed. But the government paid off the financial sector’s bad speculative debts by taking them onto the public balance sheet.

The economy is best viewed as the FIRE sector wrapped around the production and consumption core, extracting financial and rent charges that are not technologically or economically necessary costs.
Say’s Law of markets, taught to every economics student, states that workers and their employers use their wages and profits to buy what they produce (consumer goods and capital goods). Profits are earned by employing labor to produce goods and services to sell at a markup. (M – C – M’ to the initiated.)

The financial and property sector is wrapped around this core, siphoning off revenue from this circular flow. This FIRE sector is extractive. Its revenue takes the form of what classical economists called “economic rent,” a broad category that includes interest, monopoly super-profits (price gouging) and land rent, as well as “capital” gains. (These are mainly land-price gains and stock-market gains, not gains from industrial capital as such.) Economic rent and capital gains are income without a corresponding necessary cost of production (M – M’ to the initiated). “Banks have lent increasingly to buy up these rentier rights to extract interest, and less and less to promote industrial capital formation. Wealth creation” FIRE-style consists most easily of privatizing the public domain and erecting tollbooths to charge access fees for basic necessities such as health insurance, land sites, home ownership, the communication spectrum (cable and phone rights), patent medicine, water and electricity, and other public utilities, including the use of convenient money (credit cards), or the credit needed to get by. This kind of wealth is not what Adam Smith described in The Wealth of Nations. It is a form of overhead, not a means of production. The revenue it extracts is a zero-sum economic activity, meaning that one party’s gain (that of Wall Street usually) is another’s loss.

Debt deflation resulting from a distorted “financialized” economy

The problem that Mr. Obama faces is one that he cannot voice politically without offending his political constituency. The Bubble Economy has left families, companies, real estate and government so heavily indebted that they must use current income to pay banks and bondholders. The U.S. economy is in a debt deflation. The debt service they pay is not available for spending on goods and services. This is why sales are falling, shops are closing down and employment continues to be cut back.

Banks evidently do not believe that the debt problem can be solved. That is why they have taken the $13 trillion in bailout money and run – by it out in bonuses, or buying other banks and foreign affiliates. They see the domestic economy as being all loaned up. The game is over. Why would they make yet more loans against real estate already in negative equity, with mortgage debt in excess of the market price that can be recovered? Banks are not writing more “equity lines of credit” against homes or making second mortgages in today’s market, so consumers cannot use rising mortgage debt to fuel their spending.

Banks also are cutting back their credit card limits. They are “earning their way out of debt,” making up for the bad gambles they have taken with depositor funds, by raising interest rates, penalties and fees, by borrowing low-interest credit from the Federal Reserve and investing it abroad – preferably in currencies rising against the dollar. This is what Japan did in the “carry trade.” It kept the yen’s exchange rate down, and it is lowering the dollar’s exchange rate today. This threatens to raise prices for imports, on which domestic consumer prices are based. So easy credit for Wall Street means a cost squeeze for consumers.
The President needs a better set of advisors. But Wall Street has obtained veto power over just who they should be. Control over the President’s ear time has been part of the financial sector’s takeover of government. Wall Street has threatened that the stock market will plunge if oligarch-friendly Fed Chairman Bernanke is not reappointed. Mr. Obama insists on keeping him on board, in the belief that what’s good for Wall Street is good for the economy at large.

But what’s good for the banks is a larger market for their credit – more debt for the families and companies that are their customers, higher fees and penalties, no truth-in-lending laws, harsher bankruptcy terms, and further deregulation and bailouts.

This is the program that Mr. Bernanke has advised Washington to follow. Wall Street hopes that he will be kept on board. Mr. Bernanke’s advice has helped bolster that of Tim Geithner at Treasury and Larry Summers as chief advisor to convince Pres. Obama that “recovery” requires more credit.

Going down this road will make the debt overhead heavier, raising the cost of living and doing business. So we must beware of the President using the term “recovery” in his State of the Union speech to mean a recovery of debt and giving more money to Wall Street Jobs cannot revive without consumers having more to spend. And consumer demand (I don’t like this jargon word, because only Wall Street and the Pentagon’s military-industrial complex really make demands) cannot be revived without reducing the debt burden. Bankers are refusing to write down mortgages and other debts to reflect the ability to pay. That act of economic realism would mean taking a loss on their bad debts. So they have asked the government to lend new buyers enough credit to re-inflate housing prices. This is the aim of the housing subsidy to new homebuyers. It leaves more revenue to be capitalized into higher mortgage loans to support prices for real estate fallen into negative equity.

The pretense is that this is subsidizing the middle class, but homebuyers are only the intermediaries for government credit (debt to be paid off by taxpayers) to mortgage bankers. Nearly 90 percent of new home mortgages are being funded or guaranteed by the FHA, Fannie Mae and Freddie Mac – all providing a concealed subsidy to Wall Street.

Mr. Obama’s most dangerous belief is the myth that the economy needs the financial sector to lead its recovery by providing credit. Every economy needs a means of payment, which is why Wall Street has been able to threaten to wreck the economy if the government does not give in to its demands. But the monetary function should not be confused with predatory lending and casino gambling, not to mention Wall Street’s use of bailout funds on lobbying efforts to spread its gospel.

Deficit reduction

It seems absurd for politicians to worry that running a deficit from health care or Social Security can cause serious economic problems, after having given away $13 trillion to Wall Street and a blank check to the Pentagon. The “stimulus package” was only about 5 percent of this amount. But Mr. Obama has announced that he intends on Tuesday to close the barn door by proposing a bipartisan Senate Budget Commission to recommend how to limit future deficits – now that Congress is unwilling to give away any more money to Wall Street.

Republican approval would set the stage for Wednesday’s State of the Union message promising to press for “fiscal responsibility,” as if a lower deficit will help recovery. I suspect that Republicans will have little interest in joining. They see the aim as being to co-opt their criticism of Democratic spending plans. But in view of the rising and well-subsidized efforts of Harold Ford and his fellow Corporate Democrats, the actual “bipartisan” aim seems to be to provide political cover for cutting spending on labor and on social services. Mr. Obama already has sent up trial balloons about needing to address the Social Security and Medicare deficits, as if they should not be financed out of the general budget by taxpayers including the higher brackets (presently exempted from FICA paycheck withholding).

Traditionally, running deficits is supposed to help pull economies out of recession. But today, spending money on public services is deemed “bad,” because it may be “inflationary” – that is, threatening to raise wages. Talk of cutting deficits thus is class-war talk – on behalf of the FIRE sector.

The economy needs deficit spending to avoid unemployment and poverty, to increase social spending to deal with the present economic shrinkage, and to maintain their capital infrastructure. The federal government also needs to increase revenue sharing with states forced to slash their budgets in response to falling tax revenue and rising unemployment insurance.

But the deficits that the Bush-Obama administration have run are nothing like the familiar old Keynesian-style deficits to help the economy recover. Running up public debt to pay Wall Street in the hope that much of this credit will be lent out to inflate asset prices is deemed good. This belief will form the context for Wednesday’s State of the Union speech. So we are brought back to the idea of economic recovery and just what is to be recovered.

Financial lobbyists are hoping to get the government to fill the gap in domestic demand below full-employment levels by providing bank credit. When governments spend money to help increase economic activity, this does not help the banks sell more interest bearing debt. Wall Street’s golden age occurred under Bill Clinton, whose budget surplus was more than offset by an explosion of commercial bank lending.

The pro-financial mass media reiterate that deficits are inflationary and bankrupt economies. The reality is that Keynesian-style deficits raise wage levels relative to the price of property (the cost of obtaining housing, and of buying stocks and bonds to yield a retirement income). The aim of running a “Wall Street deficit” is just the reverse: It is to re-inflate property prices relative to wages.

A generation of financial “ideological engineering” has told people to welcome asset-price inflation (the Bubble Economy). People became accustomed to imagine that they were getting richer when the price of their homes rose. The problem is that real estate is worth what banks will lend – and mortgage loans are a form of debt, which needs to be repaid.

I worry that Wednesday’s address will celebrate this failed era.

Will Bernanke Be Reappointed? Does It Matter?

By L. Randall Wray

There is a lot of speculation over the reappointment of Ben Bernanke to continue to head the Fed, with the Obama Administration pushing hard. Of course, Wall Street is also calling in its favors. It looks like a done deal. The Administration has probably got the 60 votes required in the Senate to remove the hold, and the 51 votes needed for confirmation.

Does it matter? Well, on one level, this is a reward for incompetence—something that is never a good idea. Chairman Bernanke never saw “it” (the great financial crisis) coming, and indeed, actively promoted practices that made the crisis inevitable. However, on that score he is not nearly as guilty as his predecessor—Greenspan–who ruled monetary policy from 1987 to 2005. Poor Bernanke was left to clean up the mess, while Greenspan got to retire to great acclaim (that did not last long!). As the crisis unfolded, Bernanke had to learn on the job. While he was supposedly a student of the Great Depression and thus should have known what to do, in truth, he had always misunderstood the crisis of the 1930s. Hence, he has taken many half-steps and made many mis-steps over the past three years that made matters worse. Yet, if we look at where the Fed stands now, it has finally got to the position it should have immediately taken. It has satisfied the liquidity desires of the private financial system by expanding its own balance sheet to $2 trillion, and it is paying interest on reserves (reducing the “tax” on banks and simplifying interest rate targeting procedure). It took some time, but Bernanke finally figured out how to deal with the crisis. The liquidity crisis is over (at least for now). Banks are still insolvent—but that is a matter mostly for the FDIC, not for the Fed.

Here are my fears should Bernanke be reappointed.

1. He does not understand that “unwinding” the Fed’s balance sheet is nothing to be concerned about. As I have written previously, this will occur naturally as banks pay-off their loans that the Fed extended in the crisis, and as banks repurchase the assets they sold to the Fed to obtain reserves. However, Bernanke still seems to believe in the discredited “deposit multiplier” and believes the Fed will have to take action to drain reserves (“reverse the quantitative easing”) to prevent excess reserves from fueling inflation. This is nonsense. Banks do not lend reserves and existence of excess reserves does not make them more willing to lend. The Fed does not need to do anything more than to accommodate banks—no concerted action is required. Still, even in the worst case, the Fed will not be able to create a huge mess. Since it operates with an overnight interest rate target, if it tries to remove reserves that the banks want to hold, it will drive rates above the target—so will have to add back the reserves. This could create some uncertainty but it is not likely to generate any crisis.

2. Bernanke might appear to be a “born again” regulator, but that is highly doubtful. The Fed will never take regulation seriously because it is captured by Wall Street. So the important thing is to ensure that the Fed does not become the “super duper systemic regulator” that many are now proposing. This job needs to go to the FDIC, which has in the past actually done some regulating.

3. A win for Bernanke might energize the forces that want to keep Timmy Geithner and Larry Summers in their jobs. In truth, it is far more important to remove Timmy and Larry (and to remove Robert Rubin from his position as advisor to the administration). I have not seen any evidence that Bernanke has been corrupted by Wall Street. Unfortunately, the same cannot be said of Geithner and Summers—where apparent conflicts of interest abound, and questionable decisions have been taken that favor Wall Street institutions. And the Treasury is far more important than the Fed. If we are going to reregulate financial institutions (as Obama now seems inclined to do), we have got to have real regulators at the Treasury. Neither Timmy nor Larry has ever indicated any interest in “interfering” with Wall Street. Indeed, Geithner seems to have been leaking to the press his dissatisfaction with Obama’s recent proposals. Perhaps he is already angling for his Wall Street rewards—seeking a well-compensated position in a financial institution should he be fired.

To be clear, I would prefer to replace Bernanke with someone who actually understands monetary policy and who advocates regulation and supervision of financial institutions. Unfortunately, that looks unlikely. We need to turn our attention to Rubin, Geithner and Summers. Obama does not need any action by Congress to rid himself of these anchors that are dragging down his administration, as well as the Democratic party.

State of the Union Junk Economics, 2010: How Much More “Debt Recovery” can the Economy Take?

By Michael Hudson

It’s make or break time for Democrats since last Tuesday’s defeat in Massachusetts. At stake is Mr. Obama’s credibility as an agent for change. Exit polls show that voters see his main change to be favoritism to Wall Street, to a degree that the “old Democrats” would not have let a Republican administration get away with. Rivalry over just what party is more Wall Street friendly prompted Jay Leno to joke that Mr. Obama has done the impossible: resurrected the seemingly dying Republican Party and given it the coveted label of the “Party of Change” running against Wall Street.

Some politicians are hoping that the effect of Massachusetts has been an oxymoron, a “fortuitous calamity” in the form of a wake-up call to Washington. The question is, will the party be able to drag Mr. Obama away from the Corporate Democrats? This is the setting for what must certainly be a hastily rewritten State of the Union message. Instead of celebrating a Republican- and Lieberman-approved health care bill, Mr. Obama finds himself obliged to respond to voters who celebrated his first anniversary in office by choosing a Republican as their designated voice for change. That was supposed to be his line.

My reading of last week’s election is that voters who felt duped by Mr. Obama’s promise as a reform candidate did not really turn Republican, but at least they could throw out the Democrats for failing to make a credible start fixing the debt-strapped economy. The President has begged the banks to start lending again. But this means loading the economy down with yet more debt. The $13 trillion bailout was supposed to help them do this, but they have simply taken the money and run, paying it out in bonuses and salaries, stepping up their lobbying efforts to buy Congress, and buying out other banks to grow larger and increase their monopoly power.

The contrast between Wall Street’s recovery and the failure of the “real” economy to recover its employment and consumption levels has enabled Republicans to depict Mr. Obama and his party as stalling against financial reform. Instead of fulfilling his election promise to become an agent of change, the past year has seen a continuity with the widely rejected Bush policies. Even the personnel remain the same. Over the weekend, Mr. Obama reiterated his endorsement for reappointing Helicopter Ben Bernanke as Federal Reserve Chairman.

As ex officio lobbyist for high finance, Mr. Bernanke’s money drop seemed to land only on Wall Street. Now that it has emptied out the government’s credit in an unparalleled deficit, Mr. Obama is saying, “No more. I’m drawing the line. No further deficit.” There goes any hope for stimulating the “real” economy. Treasury apparatchik Tim Geithner, backed with his armada of administrators on loan from Goldman Sachs, is unlikely to support indebted labor, consumers or their companies in any way that does not benefit Wall Street first.

Even worse has been Mr. Obama’s rehabilitation of Clinton Rubinomics deregulator Larry Summers as chief advisor, sidelining Paul Volcker until he was hurriedly flown back from political Siberia, as if to soften the leak by the Wall Street Journal on January 15 that Mr. Obama and the Democrats were not unhappy to see Elizabeth Warren’s Consumer Financial Products Agency die stillborn, despite Mr. Obama promise that the agency was “non-negotiable.”

Democrats insist that politics had nothing to do with the timing of Mr. Obama’s 180-degree turn and sudden infusion of passion for the “Volcker rule” to re-separate commercial banking from its casino capitalist outgrowth. The photo-op with Mr. Volcker was intended to provide at least a semblance of regulation of the sort that was normal before Mr. Summers and other Clinton-Gore era “Democratic Leadership Committee” operatives had backed Republicans to repeal Glass-Steagall. They are now back in the White House, and the Democrats have failed every litmus test involving finance, insurance and real estate – the FIRE sector, which remains the major campaign contributor and lobbyist for both parties.

Democrats up for re-election this November are jumping ship. On Friday, within just 72 hours of the Massachusetts vote, Barbara Boxer and other Democrats on the Senate Finance Committee came out against reappointing Mr. Bernanke. Republican leaders already had taken a head start on opposing him. Still, many Democrats have found enough born-again populism to sacrifice Mr. Bernanke, and perhaps Messrs. Summers and Geithner as well.

It is bad enough that Mr. Obama has not joined in the criticism of Mr. Bernanke for having refused to regulate mortgage fraud or slow the bubble economy even when the law required him to do so. And it is bad enough that Mr. Bernanke has been so willfully blind as to deny that the Fed was fueling the Bubble with low interest rates and a refusal to regulate fraud. What he calls the “free market” is what many consider to be consumer fraud.

The widening public perception of Mr. Obama’s first year as being a Great Continuity with the Bush Administration has enabled Republicans to position themselves for this year’s mid-term elections – and 2012 – by reminding voters how they opposed the bank bailout back in September 2008, when Mr. Obama supported it. Now that support for Wall Street has become the third rail in American politics, they may appoint a standard bearer who voted against the bailout.

This is ironic. George W. Bush ran for president saying: “I’m a uniter, not a divider,” and proceeded to divide the country (needing only 50 Senate votes plus the Vice Presidential tie-breaker to do it). Mr. Obama promised change, but then decided that he wants to be bipartisan (and insisting that he needs 60 votes; many are asking whether, if he had them, he then would say that he needed 90 votes to get the Baucuses and Bayhs, Liebermans and Boehners on board for his promised change). On Tuesday he is scheduled to invite Republicans to participate in a joint committee on the budget deficit – to get Republicans on board for tax increases to finance future giveaways to their mutual Wall Street constituency. They probably will say “no.” This should enable him to make a clean break. But then he would not be who he is.

For opportunists in both parties, the trick is how to wrap pro-Wall Street policies in enough populist rhetoric to win re-election, given that the FIRE sector remains the key source of funding for most political campaigns. The contrast between rhetoric and policy reality is the basic set of forces pulling Wednesday’s State of the Union address this Wednesday – and for the next two years. The real question is thus whether Mr. Obama’s promise to make an about-face and back financial reform will remain merely rhetorical, or actually be substantive?

Putting Mr. Obama’s speech in perspective

Spending a year hoping to get Republicans to sign onto health care almost seems to have been a tactic to give Mr. Obama a plausible excuse for stalling rather than to address what most voters are mainly concerned about: the economy. Subsidizing the debt overhead and the debt deflation that is shrinking markets and causing unemployment, home foreclosures and a capital flight out of the dollar has cost $13 trillion in just over a year – more than ten times the anticipated shortfall of any public health insurance reform or an entire decade of the anticipated Social Security shortfall.

Not only are voters angry, so are the community organizers and Mr. Obama’s former Harvard Law School colleagues with whom I have spoken. Instead of providing help in slowing the foreclosure process or pressuring banks to renegotiate, his solution is for the Fed to flood the banking system with enough money at low enough interest rates to re-inflate housing prices. What Mr. Obama seems to mean by “recovery” is that consumers once again will be extended Bubble-era levels of debt to afford housing at prices that will rescue bank balance sheets.

It is an impossible dream. American workers now pay about 40% of their take-home pay on housing, and another 15% on debt service – even before buying goods and services. No wonder our economy has lost its export markets! Debts that can’t be paid, won’t be.

The moral is that the solution to any given problem – in this case, how to make Wall Street richer by debt leveraging – creates a new problem, in this case bankruptcy for high-priced American industry. The cost of living and doing business is inflated by high financial charges, HMO and insurance charges, and debt-inflated real estate prices. This has made Mr. Obama’s Wall Street constituency richer, but as the Chinese proverb expresses the problem: “He who tries to go two roads at once will get a broken hip joint.”

Banks have not paid much attention to Mr. Obama’s urging them to renegotiate bad mortgages. Their profits lie in driving homeowners out of their homes if they do not stay and fight. What is needed is to help debtors fight against junk mortgages issued irresponsibly beyond their reasonable means to pay.

When homeowners do fight, they win. In Cambridge, Massachusetts, I spoke to community leaders who organized neighborhood protests blocking evictions from being carried out. I spoke to lawyers advising that victims of predatory mortgages insist that the foreclosing parties produce the physical mortgages in court. (They rarely are able to do this.) These people feel they are getting little help from Washington.

And last Friday, Nomi Prins, Bob Johnson and other financial insiders voiced fears that the “Volcker Rule” separating commercial banking from casino derivatives gambling will end up being gutted by so many loopholes (such as letting banks to write their contracts out of their London branches) that it will end up merely rhetorical, not substantive. Financial lobbyists have the upper hand in detoothing and disabling attempts to reduce their power or even to enact simple truth-in-lending laws.

Two opposing lines of advice to Mr. Obama

Over the weekend Sen. John McCain suggested that Mr. Obama should reach out to Republicans in his State of the Union address. Bush advisor Karl Rove advised him to move to “the center” – what most people used to call the right wing of the spectrum. The Republicans blame Mr. Obama’s deepening unpopularity on his alleged move to the left.

It is more realistic to say that he has been perceived as being too little for change, too centrist while the economy is polarizing. It certainly seems unlikely that he will now turn on his FIRE-sector backers. His plan is that real estate prices can be re-inflated on enough credit – that is, enough more mortgage debt – to enable the banks to work out of the negative equity position into which their loan portfolios and investments have fallen.

The inherent impossibility of this plan succeeding is the main problem that we may expect from this Wednesday’s State of the Union address. Mr. Obama will promise to cut taxes further for working Americans, but his financial policy aims to raise the cost of their housing, their debt service and the cost of buying pensions. Some trade-off!

America’s debt overhead exceeds the means to pay. Rhetoric alone cannot solve this problem, even when delivered with Mr. Obama’s rhetorical élan. Its solution requires a policy alternative more radical than his current advisors are willing to accept, because the inevitable solution must be to write down debts to reflect the capacity to pay under today’s market conditions. This means that some banks and creditors must take a loss.

In the 2008 election campaign, Rep. Dennis Kucinich kept spelling out precisely what law he had introduced to Congress to effect each change he proposed. Mr. Obama never descended to this concrete level. But after spending a year treading water, he now must be asked to do so.

For starters, the litmus test for commitment to change should be to rapidly push through the Consumer Finance Protection Agency while the Democrats still have their political Viagra fillip from last Tuesday – and before Wall Street lobbyists wield their bankrolls.

There is talk in the press about the Democrats not even pressing forward with the Consumer Financial Protection Agency. The argument is that if they can’t get their health care plan by the Senate in the face of HMO and drug company lobbyists, what chance do they have when it comes on to taking on predatory Wall Street lenders?

It is a false worry – or even worse, an excuse to continue doing nothing. Republicans were able to mobilize populist opposition to the health-care bill by representing it as adding to the cost of relatively healthy young adults forced into the arms of the HMO monopolies. But it is much harder for the Republicans to buck financial reform and still strike their pose as opposing Wall Street. Proposing strong legislation against Wall Street will force politicians of both parties to show their true colors. If they don’t jump on board the best and most popular law the Democrats can draw up, they will lose their ability to pose. And what is populist politics these days without such a pose?

If the Democrats do not force the debt reform issue, we must conclude that they don’t really want financial restructuring. This is what Celinda Lake, pollster for the losing Democratic senate candidate last Tuesday, found that most voters believed to be the case: “When six times more people think that the banks benefited from the stimulus than working families, you’ve got a problem. And it’s not just a problem with what Martha Coakley did in her campaign” she wrote in her day-after report. “Voters are still voting for the change they voted for in 2008, but they want to see it. And right now they think they’ve got economic policies for Washington that are delivering more for banks than Main Street.”

Mr. Obama needs to signal a change of heart by replacing his failed deregulatory-era trio of Summers, Bernanke and Geithner with advisors who will focus more on the “real” economy than on Wall Street’s shadow economy.

I don’t see him doing this. I will discuss how to pierce what I expect to be Wednesday evening’s rhetorical fog in Part II of this article tomorrow.

“Obama Takes a Baby Step in the Right Direction”

By L. Randall Wray*

Today, President Obama finally took meaningful action toward financial reform, apparently prodded by his disaster in Massachusetts. Heck, if the Democrats cannot retain Teddy’s seat, there is no safe refuge. The Republicans and Tea Partiers will take the next election in a landslide unless Obama changes course, and fast.

Briefly, here is what he announced. Government spent a huge bundle trying to rescue Wall Street, and while that was distasteful, it was necessary, for otherwise the economy would have slipped into a second great depression. The financial system is now stronger than it was when he took office, but Wall Street continues to engage in its antisocial practices, Hoovering all the nation’s profits, paying huge bonuses, and trading rather than lending.

According to Obama, the root of the problem is that these institutions take advantage of their government guarantees (deposit insurance and bail-outs when things go bad) to gamble with house money. He says the root of the crisis was that these government-protected institutions engaged in proprietary trading and created their own hedge funds and private equity firms. The access to insured deposits gave them low cost funds with which they took huge risks at taxpayer expense. Further, they have sent an army of lobbyists to Washington to prevent financial reform. Hence, he proposes a new “Volcker Rule” that would prohibit these regulated financial institutions from operating hedge funds, private equity funds, or proprietary trading. And the government will prevent further consolidation of the financial sector.

The reforms sound good. It is always too easy to criticize reform for not going far enough. However, the nature of this proposal seems to indicate that Obama still does not understand the scope of the problem. Let me provide what I believe to be more than mere quibbles:

1. The financial bail-out was not needed and would do nothing to prevent another great depression. We had a liquidity crisis that could have been resolved in the normal way, through lending by the Fed without limit, to all financial institutions, and without collateral. That is how you end a liquidity crisis. But that has nothing to do with the Paulson/Rubin/Geithner plans that variously bought bad assets, injected capital, and provided guarantees — in an amount estimated above $20 trillion. None of that was necessary and none of it prevented collapse of the economic system. Banks are still massively insolvent. If we wanted to leave insolvent institutions open, all we had to do was to use forbearance. And, in truth, that is the only reason they are still open for business.

2. And of course, none of that had any benefit at all for Main Street. Indeed, we could have closed down the top 20 banks (responsible for almost all of the mess) with no impact on the economy. The only thing that has helped was the fiscal stimulus package. That will soon run out, and although it helped it was far too small. Obama has zero chance of getting more money for Main Street unless he can convince Congress and the public that he has changed his ways. The reforms he has announced fall short.

3. The financial system is not healthier today. Indeed, it is much more dangerous. The Bush and Obama administrations reacted to the crisis by encouraging and subsidizing consolidation of the sector in the hands of gargantuan and dangerously insolvent institutions. The sector is essentially run by a handful of rapacious institutions that have made out like bandits because of the crisis: Goldman, JP Morgan, Citi, Chase and Bank of America. All of these are systemically dangerous. All should be closed. Today.

4. Yes, the lobbyists are a problem. What do you expect when you operate a revolving door between Wall Street and the administration? Goldman essentially runs the Treasury. The lobbyists are in Washington to meet with their former colleagues, and to oil that revolving door. There is only one solution: ban all former employees of the financial sector from government employment (including roles as advisors), and prohibit all government employees from ever working for a Wall Street firm.

5. It is not enough to subject banks to the requirements of the Volcker Rule. Any institution that has access to the Fed and to the FDIC should be prohibited from making ANY KINDS OF TRADES. They should make loans, and purchase securities, and then hold them. (An exception can be made for government debt.) They should perform underwriting and due diligence to ensure that the assets they hold meet appropriate standards of risk. And then they should bear all the risk through maturity of the assets. They should not be allowed to offload assets, much less to short assets that they sell, while knowing they are trash (Goldman’s favorite strategy). They should not be able to hedge risks through derivatives. They should not be allowed to purchase credit default “insurance” to protect themselves. They should not be allowed to move risk off balance sheet. They should not be involved in equities markets. Any behemoth that does not like these conditions can hand back its bank charter and become an unprotected financial institution. Those that retain their charters will be treated as public-private partnerships, which is what banks are. They put up $5 of their own money, then gamble with $95 of government (guaranteed) money. The only public purpose they serve is underwriting-and that only works if they hold all the risks.

6. Obama ignores fraud. It is rampant in the financial sector. Indeed, it has no doubt increased since the crisis. Where do you think all of those record profits come from? It is a massive control fraud, based on Ponzi (or Bernie Madoff) schemes. This must be investigated. Fraudulent institutions must be shut down. Management must be prosecuted and jailed. Only if Obama is willing to take on fraud will we know that he really is about hope and change. He has got to start with the Rubin, Geithner and Summers team. Fire them, then investigate them. That is change I can believe in-and an end to “business as usual”, as Obama put it.

*This post was first published on New Deal 2.0