Monthly Archives: August 2010



In a surprising turn of events, Representative Boehner finally got something right: Obama’s entire economics team has got to go. Many have already jumped ship, but unfortunately the worst members remain—including Timmy Geithner and Larry Summers. The sooner they are fired, the better.

Rep Boehner usually spends his time attacking seniors, people with disabilities, dependent children and widows and others on Social Security. He wants to cut their benefits—taking away their livelihood. here

However, he has finally found another issue: Obama’s economics team doesn’t care about job creation. here So far, nearly three years into the worst depression since the Great Depression, they’ve yet to turn any serious attention to Main Street. The health of Wall Street still consumes almost all of their time—and almost all government funds. Trillions for Wall Street, not even peanuts for Americans losing their jobs and homes. No one, except a highly compensated Wall Street trader, could possibly disagree with Boehner. Fire Timmy and Larry and the rest of the Government Sachs team.

But he’s only half right. According to Boehner, the problem with Obama’s team is that none of them has ever met a payroll. They do not know how to run a business. Hence, he claims, they do not know how to create jobs. What we need is a good, pro-business economics team that will cut taxes and slash regulations. Maybe bust a few unions and get rid of jobs-killing minimum wage laws. Loosen worker safety protection. Eliminate welfare (and Social Security) to increase the work incentive. It is the same old-same old—the Republican “Party of No” platform of the past three decades.

No, that is not the problem with the Obama team. Rather, it was bought and paid for by Wall Street. It is not interested in creating jobs because that is not the mission Wall Street provided. The only hope is to bring in a new team that is not beholden to Government Sachs. No one with any connection to Wall Street firms ought to be allowed in Treasury.
Putting Wall Street people on the economics teams raises two conflicts: a conflict of mission and a conflict of interest. Wall Street has no “dog in the hunt” when it comes to the health of the economy—it just wants to skim 40% off the top, inserting ever more finance into every activity, whether that is health insurance, “peasant” insurance, or “death settlements”. (see here , here , and here) Thus, the mission of Goldman alumni in Treasury is to increase Wall Street’s share. And the conflicts of interest are obvious—top officials at Treasury plan to return to Wall Street, rewarded with high paying financial sector jobs. It is no wonder that Timmy’s team could care less about job creation.
Further, formulating good fiscal policy that promotes job creation requires no experience at meeting a payroll. Running Treasury is not like running a for-profit firm. Government is not a giant business. It must operate in the public interest—not in the interest of a firm, or even necessarily in the narrow interests of firms, more generally. What might appear to be a pro-business policy might actually hurt business at the national level. Sure, firms hate regulations, decent wages and working conditions, and taxes. Many probably would support Boehner’s race to the bottom efforts—trying to lower wages and benefits to compete with the meanest labor conditions on the planet. But at the aggregate level, that policy is self-defeating, as Henry Ford recognized, because it destroys the domestic market for our nation’s output. It would only ensure a prolonged and deeper depression. Putting a business-friendly team into Treasury is probably the worst thing we could do for American business. It is precisely what President Hoover did, and we know how that turned out. The Party of No wants to do it again. Now, just what is that definition of insanity? Oh, right—try the same old policies that failed in the past.

Indeed, the private sector is not going to lead us out of this depression, anyway. Real recovery is going to require government initiative, starting with job creation by government. And we will need direct job creation, with government paying the wages and benefits for perhaps 12 million new jobs. here This ain’t rocket science. We’ve got perhaps 25 million people who want jobs (or more hours) and we’ve got billions of hours of work that needs to be done. Government can play match maker. Match 12 million workers to tasks that need to get done. That will create demand for private sector output, which will create more jobs.

So the private sector does have a role to play, but the Party of No’s platform of cutting wages and benefits and regulations is not the answer. Rather, an immediate payroll tax holiday will benefit both workers and firms, lowering the costs of retaining existing workers and of hiring new ones—while boosting consumption out of higher take-home pay. As government employment increases, that will generate the demand required to get Main Street back on track.

So, the problem is not that Geithner’s team does not know how to meet a payroll. Instead, the real tragedy is that the economics team has been running policy that is against the public interest. Policy has been operated in Wall Street’s interest, helping it to meet the payrolls of Goldman and other bloodsucking vampire squids. That is the true scandal, and that is why the Obama economics team must go. This is not a partisan issue. It is a national priority.

Oh, and while we are at it, hire Elizabeth Warren. here That, too, should not be a partisan issue. It is a national imperative. If necessary, make it a recess appointment. The Party of No voted against consumer protection. It is steadfastly on the side of predatory lending. Why should it have any say over who will do the protecting of consumers against the predators?


L. Randall Wray

Another one in the category of “you just can’t make this up”. Recall that Fred Mishkin was on the Fed’s Board of Governors when the global financial system bombed. Now watch this:

For Mishkin’s report on Iceland, go here. For Tyler Durden’s commentary on the report and the video, go here.

If you are an academic, his performance makes you want to curl up under a table. If you are not in academics, it might make you want to take a baseball bat to the pointy-headed intellectuals at the nation’s “elite” universities. To be sure, what Columbia University’s Mishkin did to Iceland is no worse than what economics professors at Harvard—hey, Larry Summers, that includes you—have been doing to countries all over the world. The “research” they are paid to do is not research at all—it is marketing. In the case of Iceland, Freddie was paid by the Chamber of Commerce to do a fluff job—and he fluffed the heck out of Iceland. I wonder what the good people now suffering in Iceland would like to do with him.
One could give him a bit of slack—after all, why would anyone expect that Freddie knew anything at all about Iceland. His research method was to “talk to people” and to “trust the central bank”. That he didn’t see a financial collapse coming right around the corner isn’t, I guess, too surprising. Besides, if you are paid well to not see a crisis coming, you probably will not look too hard. Still, his squirming video takes the cake—even more fun than Geithner’s performances in front of Congress. Oh, right, his doctoring of his CV to change the title of his paper from “Stability” to “Instability” is a “typo”. And, right, he cannot remember how much he was paid as fluffer, but it is in the “public record”. Give us a break.

Actually, I had seen Mishkin squirm like that before. At the very beginning of the US financial crisis (April 2007)—when most still did not see it coming—Mishkin as member of the BOG gave a dinner speech. There was no indication in his speech that he “saw it coming”—he predicted moderate growth, emphasized some strong data in housing as well as low unemployment, and said the Fed would keep its interest rate target at 5.25. While it is hard to believe now, the Fed and most of the press was still worried about inflation at that time—even though anyone who was paying attention could see the economy was beginning to collapse into what would obviously be the worst crisis since the Great Depression. Still, commodities prices were being driven by a speculative boom coming mostly from pension funds—a story for another day. So Freddie was peppered with questions from the media present asking whether the Fed would be able to prevent an inflationary burst. Mishkin’s response was eerily similar to the response he gave in the video—you’ve got to trust the central bank. Do not worry, the Fed has ample ammunition to kill inflation.

When he returned to our table, we grilled him a bit more on that topic, and some of us also argued that the real danger facing the US was a financial crisis and deflation—not inflation. Let me interject that I liked Mishkin. He was a pleasant conversationalist, not at all arrogant, and even somewhat self-effacing. But when he gave his pat answer, “don’t worry, we are the Fed and we know what we are doing”, Jamie Galbraith pressed him for details: what are you going to do about inflation? And, if you raise interest rates now, when debt loads are so high, won’t that cause a wave of delinquencies on mortgages and consumer debt? That’s when we saw the same transformation you just witnessed in the video—from an easy, affable, confidence to sheer horror. Mishkin had been found out and was looking for the exits.

I must say that it was never clear exactly what that horror was. At the time I did not believe that Mishkin’s heart was in the inflation story. Surely he could not have believed, then, that the real danger was inflation. He’d been coached at the Fed about what he ought to say—and the Fed was riding the inflation story to divert attention away from the real danger. The Fed needed to keep the speculative bubbles going as long as possible—an election was around the corner and Republicans needed help. I was sure that he was actually afraid that we were right: the economy was going bust. And the Fed had nothing up its sleeve to prevent Armageddon.

Shortly thereafter, Mishkin left the Fed (August 2008—the second-shortest term ever served). That looked suspicious—and although I never tried to find out why, it fit with my interpretation that he knew what was coming, and so like Greenspan jumped the sinking ship before the Fed would be exposed as the impotent Wizard of Oz behind the curtain.

However, since then, Greenspan has publicly admitted that he had been clueless. His whole approach to economics was dangerously wrong. He never saw nothing coming. And after viewing this video, I am not so sure Mishkin had any clue, either.

Maybe his term at the Fed, like his research for Iceland, was nothing but marketing, too.
Columbia professor? Check.
NBER researcher? Check.
FDIC researcher? Check.
Highly paid consultant for international research? Check.
Vice President of NYFed? Check.
Former BOG member? Check.
Top selling money and banking textbook author? You betcha.

All he needed was a few months at the helm of the central bank, something he could add to the textbook blurb, to ramp up those sales.

GEITHNER DOTH PROTEST TOO MUCH: Does Timmy Work for Goldman Sachs?

L. Randall Wray

You cannot make this stuff up. Timmy and his staff have gone into overdrive, denying that he has ever been employed by Goldman Sachs. The damage control began when NYC Mayor Michael Bloomberg said Geithner used to work at Goldman. here.
Look, Bloomberg’s the Mayor of Wall Street, and a guy who knew his way around Wall Street before he became a politician. He ought to know which Treasury Secretaries work for Wall Street’s most powerful bank. To be more specific: Bob, Hank, and Timmy—they are the team from Government Sachs and they are at Treasury to run government in Wall Street’s interests.

Timmy and his staff are trying to carefully parse words: it all depends on what one means when one says that Timmy worked for Goldman. If you mean by work “on Goldman’s payroll”, then technically Timmy’s employment at Goldman is yet to come. It is future tense: Timmy “will work” for Goldman. He’ll take a top management position on Wall Street when and if President Obama ever wakes up to the scandal going on at Treasury.

Until then, Timmy is just carrying water for Goldman, funneling Uncle Sam’s money to the firm in the biggest wheelbarrows he can find. He’s not “working for” Goldman—just watching out for the firm’s interests—since he is not yet technically on the payroll.

Timmy has been fighting the perception that he worked for Goldman since his career in “public service” began, working in the Reagan administration. Most of his career has been in Treasury, where he worked for Treasury Secretary Rubin, and at the NYFed where he worked closely with Treasury Secretary Paulson—both of whom had been on Goldman’s payroll.

Even Rahm Emanuel’s wife remarked at a dinner party that Timmy must look forward to returning to Goldman.

Why does everyone think Timmy worked for Goldman? Because he did, and he does. Like a good CEO, he is taking his pay in deferred compensation. When he retires from “public service”, he will go to Wall Street and he will be richly rewarded for his many years of service.

Look, Timmy, the careful parsing of words just doesn’t work. Ask Bill Clinton, who famously tried this tack, after he had said in reference to Monica “there’s nothing going on between us”:

“It depends on what the meaning of the word ‘is’ is. If the–if he–if ‘is’ means is and never has been, that is not–that is one thing. If it means there is none, that was a completely true statement….Now, if someone had asked me on that day, are you having any kind of sexual relations with Ms. Lewinsky, that is, asked me a question in the present tense, I would have said no. And it would have been completely true.”

So, Timmy, is there anything going on between you and Goldman?

Does stimulus work? Marshall Auerback on Deficit Hysteria

Watch it here.

The Wingnuts go after Fannie and Freddie

By L. Randall Wray

In recent weeks the wingnut right wing ideologues have made a lot of headway in their goal of gutting Social Security. Well-funded by hedge fund manager Pete Peterson as well as right wing Washington think tanks, they have promoted the preposterous notion that our wealthy and productive economy cannot afford to take care of our elders. Now they have turned their sights on Fannie and Freddie. They argue that it is time to cut Uncle Sam out of the home mortgage market. Just as he has no role to play in providing decent pensions to our retired population, he should not help make homeownership affordable for most Americans. “Free markets” can do it all so much better than Uncle Sam can do.

Give me a break. These are the same bozos that are promoting home foreclosure and happily cheering the biggest transfer of wealth to Wall Street that the US has ever seen. Without Fannie and Freddie there would be no home financing or refinancing going on right now. Oh, right, free markets did such a good job with the subprime mortgage market, creating a global financial crisis that rivals the Great Crash of 1929. Hey, let’s reward them by getting government out of the mortgage markets so that Pete Peterson can run the whole shebang for the benefit of Wall Street. That, of course, is the real goal. Wall Street wants to get back to predatory lending as quickly as possible, and hates the competition from a newly missioned Fannie and Freddie—which have turned away from the practices that assisted rapacious private lenders from 2004 to 2008. Better close them down because Wall Street hates competition.

And, yes, let’s reduce Social Security benefits and raise payroll taxes, squeezing our seniors so that they have no choice but to let Pete Peterson charge them exorbitant fees to manage their miniscule life savings. Government is running out of keystrokes and won’t be able to afford to credit retiree bank accounts fifty years from now. Better slash Social Security now.

Ain’t it all just so convenient for the Pete Petersons of the world? Shift the blame, no matter how ridiculous the claims. Our current problems are caused by runaway Fannie and Freddie and Social Security—providing safety nets that our homeowners and seniors abused, taking advantage of poor little defenseless Goldmans and Morgans and Citibanks. That was the cause of the crisis! If we had just had more free market abuse of consumers, everything would have just been fine. Besides, government is broke. We’ve got to tighten the purse strings. Running out of cash, you know. No more keystrokes to credit bank accounts.

How about a reality check? Fannie and Freddie made no subprime loans. Indeed, they originated no loans at all. Yes, they offered insurance on privately originated mortgages, and yes, they lowered their standards. This has been carefully studied, and all analysts have reached the conclusion that Fannie and Freddie got into trouble because they catered to “free” market demands that they either insure the kinds of toxic mortgages markets wanted to provide or that they become irrelevant. The free markets wanted to do Liar loans and NINJA loans, making loans that borrowers could never service. The old fuddy duddies Fannie and Freddie would never have agreed to guarantee this trash, so they were partially privatized, with big gun, high paid CEOs hired. And just like magic, they started behaving like a Goldman or a Countrywide—maximizing CEO pay while damning the firms. Yes, that is the free market solution and my colleague Bill Black calls it control fraud. Fannie became a control fraud, just like all the big boy private financial institutions. Peterson’s solution? Promote control frauds by freeing markets.

The thing that the wingnuts cannot explain is why Fannie and Freddie—which had a history that goes back to the mid 1960s – did not encounter significant problems until they were directed by Congress to replicate a market-oriented strategy. And the wingnuts cannot explain why defaults on home mortgages were so rare until the “free markets” took over the mortgage sector. Heck, Fannie and Freddie even survived the savings and loan fiasco of the 1980s, when thrifts were “freed” to pursue free market maximization that resulted in suicide for the whole industry. It was only after 2004 when Fannie and Freddie were directed to cater to control frauds like Countrywide that they got into trouble.

Make no mistake. The wingnuts are likely to win these battles. President Obama will not put up a fight—he’s already bought the Peterson story, hook, line and sinker. Social Security is a done deal. It is going to be “reformed”. That is, it will be handed over to Pete Peterson, who will manage it right down the rat hole where all the private pensions are going. Wall Street will gamble away all the funds, whilst enriching itself with management fees. And Fannie and Freddie will be shut down so that Wall Street will have free reign in the housing market. Homeownership rates will plummet. Predatory mortgages will be the rule. Wealth will trickle up. Democratic Party coffers will be replenished. Obama will declare Social Security and Fannie and Freddie to be reformed—just like the healthcare system.

The only possible hope is that financial markets completely collapse in the next three to four months. That would discredit Pete Peterson and the wingnuts at his think tanks. It would make it possible to stop the right wing stampede and the collective amnesia about the last three years—that is, about the global financial crisis caused by free market wingnuts. Resumption of the crisis could discredit the crazy troglodyte thinking promoted at Chicago and Washington think tanks.

What is the free market path to homeownership? A subprime crisis.

What is the free market path to private pensions? Across the board collapse of commodities, real estate, and equities markets.

What is the free market alternative to Social Security? An impoverished elderly population.

What is the free market alternative to Medicare? High priced health insurance that most elderly people cannot afford.

Not to worry, all these reductions of government interference into the finely oiled free market machine will help to enrich Pete Peterson and the other funders of the wingnut think tanks.

Ok, how about a politically feasible alternative? We all know that Pete Peterson’s well-funded effort has convinced most policy makers that the federal government has run out of money, so cannot afford costly Social Security or government guarantees of mortgages. Any federal spending must be offset by tax hikes or spending cuts. Pete Peterson’s minions are fond of “infinite horizon” calculations that show that “government entitlements” will lead to shortfalls of tens of trillions of dollars. It is all nonsense, but it guides all policy making.

So here is a proposal consistent with such calculations. Let us raise Social Security benefits today to help seniors through the current depression. Let’s have a payroll tax holiday—stop collecting the taxes from employers and employees to put more pay into the hands of workers and to reduce the costs of employing them. Let us provide debt relief to homeowners so that they can keep their homes. Let us create a jobs program to put 12 million people back to work (the number of jobs created by New Deal programs).

To please the deficit hysteria crowd we will need to offset all of this spending. So let us propose that beginning in 2050 all seniors above age 65 will be ground to produce soylent green burgers, with a proviso that implementation can be postponed by majority vote of the population annually from 2050 on. For budgetary purposes, the future savings to Social Security and Medicare can be counted today, eliminating Peterson’s infinite horizon unfunded entitlements. Voters in 2050 and thereafter can decide whether they want those burgers—year-by-year so that infinite horizon forecasts will remain favorable. Each year voters will decide whether they want to eat seniors or feed them for one more year.

Personally, I don’t eat mammals, but I won’t be voting in 2050. Now, reptiles are an entirely different matter, and only discretion prevents me from naming a few that could be candidates for reptilian burgers. Bloodsucking vampire squid cakes, anyone?

Heck, no matter what we do today, it will be voters in 2050 that will decide the fate of seniors in 2050. That is what scares the Beetlejuice out of Pete Peterson—he’s afraid that American compassion and reason will triumph, hence the scaremongering to convince voters that retiring babyboomers expecting government to credit their bank accounts using keystrokes represents the biggest threat facing America today. And that is why the wingnuts think it is so important to start cutting benefits and raising payroll taxes today—to eliminate America’s most popular government program so that no one will have any alternative to Wall Street management of pensions. Yes it is unimaginatively silly—the agenda of simpletons who have no understanding of balance sheets or of sovereign currencies or of anything else that is important to the issues of Social Security or government guarantees of home mortgages. Unfortunately, these are the most dangerous kind of simpleton—with billions of dollars to throw around to get their way.

Remember Thatcher’s motto: TINA = there is no alternative to free markets. The wingnuts have learned these lessons well. Remove any alternative to Wall Street’s complete control over all aspects of life. Then TINA will be true.

I do not want to be accused of being unfair to wingnuts. There is certainly room for debate on the necessity of reforming Social Security and government guarantees of mortgages (and student loans, and small business loans, and farm loans, and veteran’s loans). One can coherently—even if repugnantly—argue that government should play no role in helping to provide seniors with a decent living standard. Declaring that any senior who is not sufficiently lucky, industrious, and foresighted to provide for her own retirement ought to live out a miserable old age is an opinion that deserves to be debated. But declaring that government simply cannot afford current law Social Security benefits it just plain ignorant—it is a position that deserves no attention. Siding with Wall Street against government protection of homeowners might be an unpopular position but it is, again, worthy of debate. Yet claiming that Fannie and Freddie as originally constituted would have contributed in an important way to the global financial crisis does not merit consideration. It is not even worthy of Fox News. It is beyond stupid. It is an outright misrepresentation of the facts.

Which Party Poses the Real Risk to Social Security’s Future? (Hint: it’s not Republicans)

By Marshall Auerback
** Originally posted at ND 2.0

New Economics Perspectives contributor Marshall Auerback takes aim at the party of FDR.

Happy Birthday Social Security! A Refresher Course in Macroeconomics For Laurence Kotlikoff

By Yeva Nersisyan
No day goes by without some deficit hawk trying to spread fear among ordinary Americans about the looming fiscal crisis. One gets the impression that the hawks are competing with one another to see who can come up with the scariest scenario. And it seems to be working. A recent USA Today/Gallup poll found that 64% of those surveyed in the poll disapprove of president Obama’s handling of the federal budget deficit. But Obama’s discretionary stimulus has been very small relative to the magnitude of the crisis we are in, and as discussed here most of the deficit was due to automatic stabilizers. Hence Obama’s policies have little to do with the rising deficit, and public disapproval of his policy demonstrates how misinformed the public is on the issues of federal deficit and debt.
A recent piece from one Boston University Economics professor, Laurence Kotlikoff, published in Bloomberg, was too outrageous to leave uncommented. Most of the deficit hawks seem to be united around the same agenda: getting rid of the very modest safety net that the U.S. government provides to its population. After making a bold claim that the U.S. is bankrupt here is what he has to say:

What it [the U.S.] can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy. 

The authority that he uses to support his claim that the U.S. is bankrupt is nothing other than the I.M.F (and you thought that the I.M.F is rethinking its position on economic policy!). But what exactly does he mean by “simplifying” the tax, health-care and retirement systems? The only thing that comes to mind is downsizing – cut, cut and cut. How else would you achieve the 14% permanent fiscal adjustment that he thinks is needed? According to Kotlikoff, not only will this help put the fiscal house in order but it will also “revitalize the economy”. Moreover, these programs could still be able to achieve their “legitimate purposes at much lower cost”. What could be better?
This is the most extreme deficit hawk position that one encounters. There is a legitimate concern about a double-dip recession in the U.S. Household balance sheets are no better than they were before the crisis. Household debt stands at 122% of personal disposable income. The unemployment rate is high and is expected to stay high for the foreseeable future. In this situation the U.S. consumer can by no means be expected to pull the economy out of the hole. U.S. corporations, facing uncertainty about the strength of consumer demand, aren’t hiring despite sitting on huge piles of cash. Just what exactly will fill the aggregate spending gap when the government withdraws its spending and how cutting entitlements will “revitalize the economy” is a mystery to me. And probably to Kotlikoff too, since he makes no attempt to offer explanation in this article.
According to the IMF closing the fiscal gap will require a “permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.” (“The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.”) This is the preferred definition of the fiscal gap promulgated by infinite horizon deficit warriors like Kotlikoff. In their world, an adjustment in the government’s fiscal balance from a 9% deficit to a 5% surplus (i.e. 14% adjustment) will take place without any negative effects on the rest of the economy. In the real world, however, we cannot have an adjustment in government’s financial balance without simultaneously having an adjustment in the non-government sector’s financial balance. A 14% of GDP fiscal adjustment means that the non-government sector’s financial balance will also adjust by the same amount, only in the other direction. For example, households could adjust their budgets to run huge deficits to allow the government to tighten its fiscal stance.
So what are our options according to Kotlikoff? To achieve this fiscal adjustment we will need nothing less than doubling of all of our taxes. “Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit”. (Of course doubling taxes is not something that he seems to be in favor of. This is just used to demonstrate how enormous the “hole” is). But one year will not do it. The U.S government will need to run a 5% surplus for many years to come to pay for scheduled expenses down the road.
Since the official deficit and debt numbers don’t look scary enough Kotlikoff offers us his own calculations. You see, the federal debt held by the public stands only at 53% of GDP and is expected to climb up to only about 68% in 2011. Compared to other developed nations this is a relatively low number. One could look at Japan and say: “Well, they have managed not to go bankrupt with a 200% Debt-to-GDP ratio so why would the U.S. be in trouble with a much lower level of debt?” Kotlikoff will then tell you that the fiscal gap is “more than 15 times the official debt”, a whopping $202 trillion. When baby boomers fully retire and collect all of their oversized benefits we will have an annual bill of $4 Trillion in today’s dollars. And if after all of this you still have any doubts then Kotlikoff will point you to the direction of Greece (I won’t go into that in this blog but you can read here on why the U.S. is not like Greece). Who wouldn’t be scared?
The alarming situation we are in, according to the deficit hysteria crowd, is the result of the government running a Ponzi scheme for 6 decades as it has been taking resources from the young and giving them to the old. If their point is that we are taking real resources from the young and giving them to the old, then yes, that’s what we are doing. And that’s what every society is doing, has always done, and will always be doing unless you want to let the elderly population die of hunger. Ditto for infants—the lazy do-nothings expect us, the working age population, to take care of them! Why can’t those lazy infants and elderly people pull their own weight?
But if it is all about real resources, the debate shifts to a completely different dimension. Will we have enough resources so that baby boomers can get a decent standard of living when they retire? Will the economy be able to produce enough to sustain its non-working members—young and old? This is the real issue and it cannot be solved by cutting government spending nor by raising taxes today. Nor can it even be resolved by ramping up financial saving today—that would only lead to more dollars chasing scarce resources tomorrow.
What matters is our capacity to produce goods and services in the future. If we want to be able to produce more in the future we need to invest more in education, technologies and infrastructure today. But if Kotlikoff thinks that we are redistributing “financial resources” from the young to the old (and I suspect that’s what he believes) then this is a false concern as explained below.
First of all, as discussed in many posts on this blog, the government is the monopoly issuer of the country’s currency and hence it cannot go bankrupt. It doesn’t need tax or bond revenues to spend; it simply spends by crediting bank accounts which ultimately amounts to creating new currency (cash or deposits in commercial banks). It then sells government securities to drain any excess reserves that the banking system might receive as a result of government spending. This is done to help the Fed hit its interest rate target. And even if the government wanted to, it couldn’t spend your tax money. Why? Because just as government spending creates new money, taxing destroys money. Government cannot spend that which doesn’t exist.
Both government bonds and currency are liabilities of the Federal government (Treasury and Fed), its IOUs. There is only one difference between the two – bonds pay higher interest than reserves. The government pays interest on bonds to offer an interest earning alternative to reserves. To get us to accept the currency, it imposes taxes on us. If currency is government’s IOU why would government need to borrow its own IOUs in order to spend? Furthermore, there is no balance sheet operation that allows one to borrow one’s own IOUs. When the government sells bonds, it simply exchanges one type of IOU for the other – this is not borrowing. When you deliver government’s IOUs to it to pay your taxes, it simply extinguishes your tax liability, just like you deliver bank deposits (bank IOUs) to a bank to discharge your obligations (bank loans) to it. If you could issue IOUs that were as acceptable as government IOUs, i.e. if everything was for sale in your IOUs, what kind of crazy idea would it be for you to borrow them back in order to spend?
The second problem with Kotlikoff’s argument is his presumption that government can somehow run fiscal surpluses for years on end. As explained in many posts on this blog government’s fiscal surplus means that the non-government sector is running a deficit. In other words, the government is injecting less income into the private sector (through its spending) then it is draining out of it (through taxation). Assuming a 4% of GDP trade deficit (although it could shrink if the government cuts spending), the negative adjustment in private sector (firms and households) balances desired by Kotlikoff will be in the amount of 9% of GDP (5% government surplus + 4% current account deficit/foreign sector surplus). The private sector will be dissaving at a rate of 9% of GDP per year. Can this go on forever or for many years as the IMF says it should?
In Kotlikoff’s world, where this somehow will have only positive effects, it can. But in the real world this is operationally impossible. For one thing, the private sector cannot indefinitely run a deficit without facing solvency problems – it is a user of the currency not the issuer. More importantly, a persistent federal budget surplus is impossible for a sovereign currency issuer like the US because the funds used to pay taxes ultimately come from government spending. If it continuously withdraws more funds from the economy then it’s injecting into the economy then at some point the private sector’s previously accumulated hoards of government IOUs will be depleted. People will simply be unable to pay their taxes.
Deficit hawks such as Dr. Kotlikoff simply shift the public debate from pressing issues such as high unemployment to false concerns about fiscal solvency and debt sustainability. They devise numbers which are meaningless for a nation operating with a sovereign currency, and use these to misinform and scare ordinary people. They are the reason why the very people who benefit from successful government programs (such as Social Security) undermine their own economic well-being by electing deficit hawks to Congress.
The academic experts calling for deficit reduction are irresponsible to say the least. They feel they can say anything without being held accountable for the impact of their ideas on the lives of people. We should devise some standard of accountability for professional economists, maybe similar to what we have for doctors. This would definitely throw some water on the deficit hysteria fire.

Investment Banking by Blood Sucking Vampire Squids

By L. Randall Wray

While investment banking today is often compared to a casino, that is not really fair. A casino is heavily regulated and while probabilities favor the house, gamblers can win abut 48% of the time. Casinos are regulated—by the state and presumably by the mob. Top executives who steal funds end up wearing very heavy shoes at the bottom of the ocean.

By contrast, the investment bank always wins, and its customers always lose. Investment banks are “self-regulated” (meaning, of course, they do whatever they want—sort of like leaving your 15 year old at home alone all summer with the admonition to “behave yourself” and keys to the liquor cabinet and the Porsche). Top management rakes off all the funds it wants with impunity. And then the CEOs go run the Treasury to bailout the investment banks should anything go wrong.

This summer I was lunching with a trader who works for one of these investment banks (hint: there are not many left, and he was not with Goldman). Speaking of Goldman he said “those guys are good”. Indeed they are so good, he said, “I don’t know why anyone would do business with them.”

He explained: When a firm approaches an investment bank to arrange for finance, the modern investment bank immediately puts together two teams. The first team arranges finance on the most favorable terms for the bank that they can manage to push onto their client—maximizing fees and penalties. The second team puts together bets that the client will not be able to service its debt. Since the debt cannot be serviced, it will not be serviced. Heads and tails, the investment bank wins.

Note that this is also true of hedge funds and the half dozen biggest banks that are bank holding companies providing a full range of financial “services”.

In the latest revelations, JPMorgan Chase suckered the Denver public school system into an exotic $750 million transaction that has gone horribly bad. In the spring of 2008, struggling with an underfunded pension system and the need to refinance some loans, it issued floating rate debt with a complicated derivative. Effectively, when rates rose, that derivative locked the school system into a high fixed rate. Morgan had put a huge “greenmail” clause into the deal—the school district is locked into a 30 year contract with a termination fee of $81 million. That, of course, is on top of the high fees Morgan had charged up-front because of the complexity of the deal.

To add insult to injury, the whole fiasco began because the pension fund was short $400 million, and subsequent losses due to bad performance of its portfolio since 2008 wiped out almost $800 million—so even with the financing arranged by Morgan the pension fund is back in the hole where it began but the school district is levered with costly debt that it cannot afford but probably cannot afford to refinance on better terms because of the termination penalties. This experience is repeated all across America—the Service Employees International Union estimates that over the past two years state and local governments have paid $28 billion in termination fees to get out of bad deals sold to them by Wall Street. (See Morgenson

Repeat that story thousands of times. Only the names of the cities and counties need to be changed. Analysts say that deals like that pushed onto Denver would never be accepted by for-profit firms. Investment banks preserve such shenanigans to screw the public. Michael Bennet, who was the head of the school district pushing for the deal had worked for the Anschutz Investment Company—so he knew what he was doing. He was rewarded for his efforts—he is now a US senator from Colorado.

Magnetar, a hedge fund, actually sought the very worst tranches of mortgage-backed securities, almost single-handedly propping up the market for toxic waste that it could put into CDOs sold on to “investors” (I use that term loosely because these were suckers to the “nth” degree). It then bought credit default insurance (from, of course, AIG) to bet on failure. By 1998, 96% of the CDO deals arranged by Magnetar were in default—as close to a sure bet as financial markets will ever find. In other words, the financial institution bets against households, firms, and governments—and loads the dice against them—with the bank winning when its customers fail.

In a case recently prosecuted by the SEC, Goldman created synthetic CDOs that placed bets on toxic waste MBSs. Goldman agreed to pay a fine of $550 million, without admitting guilt, although it did admit to a “mistake”. The deal was proposed by John Paulson, who approached Goldman to create toxic synthetic CDOs that he could bet against. Of course, that would require that Goldman could find clients willing to buy junk CDOs. According to the SEC, Goldman let Paulson suggest particularly risky securities to include in the CDOs. Goldman arranged 25 such deals, named Abacus, totaling about $11 billion. Out of 500 CDOs analyzed by UBS, only two did worse than Goldman’s Abacus. Just how toxic were these CDOs? Only 5 months after creating one of these Abacus CDOs, the ratings of 84% of the underlying mortgages had been downgraded. By betting against them, Goldman and Paulson won—Paulson pocketed $1 billion on the Abacus deals; he made a total of $5.7 billion shorting mortgage-based instruments in a span of two years. This is not genius work—an extraordinarily high percent of CDOs that are designed to fail will fail.

Previously, Goldman helped Greece to hide its government debt, then bet against the debt—another fairly certain bet since debt ratings would likely fall if the hidden debt was discovered. Goldman took on US states as clients (including California and New Jersey and 9 other states), earning fees for placing their debts, and then encouraged other clients to bet against state debt—using its knowledge of the precariousness of state finances to market the instruments that facilitated the shorts.

To be fair, Goldman is not alone — all of this appears to be common business procedure.

There is a theory that an invisible hand will guide unfettered markets to perform the public interest. In truth, unregulated Wall Street bets against the public and operates to ensure the public loses. Investment banks are now all corporations (and all have bank charters). Corporations and banks are chartered to further the public purpose. Why do we allow them the screw the public?


By L. Randall Wray

Outgoing Senator Dodd just weighed in on the possibility that Elizabeth Warren might get the top spot heading the new Bureau of Consumer Financial Protection at the Federal Reserve:

“What you don’t need to have is an eight-month battle for who the director or the head or chairperson of this new consumer financial protection bureau will be,” Dodd, a Connecticut Democrat and chairman of the Senate Banking Committee, said in an interview on Bloomberg Television’s “Conversations with Judy Woodruff,” to be broadcast today.
Let us get this straight. Dodd has been a shill for Wall Street for years. He has never seen a fight against Wall Street worth fighting. He is retiring. Why would anyone care what he thinks about Warren?

Let us get this straight. Warren created the proposal to create a consumer financial protection act and agency to enforce it. She has been the driving force behind it. No one is better qualified to lead it. Any other appointment would confirm that the Obama administration is not serious about reform.

Dodd is pushing Sheila Bair, head of the FDIC. She is a fine person. She says she does not want the job. I haven’t met her, but she is no Elizabeth Warren.

We know that Dodd does not take consumer protection seriously. He has been in the back pocket of rapacious lenders so long that his views have no credibility. He is the problem, not the solution. That is why he is leaving “public service”. He knows he has no chance to win an election in the aftermath of a crisis he helped to create.
Warren, by contrast, has been a tireless defender of consumers. She knows all the “tricks and traps” that credit card issuers put into the complex contracts that—literally—no law school grad could wade through. She forcefully argues that it makes no sense that we protect consumers from faulty toasters but let Wall Street steal their home and their life savings. She knows that Wall Street bought and paid for the 2005 Bankruptcy “Reform” Act written by the credit industry to screw the last dime out of overburdened homeowners—exactly on the cusp of the collapse. She knows that states (with the help of the Supreme Court) have raised the maximum permitted interest rate from a “measly” 36% in 1965 to a median of 398% in 2007. Yes, read that again—it is not a mistake, it is a disgrace.
Warren knows that financial products are only subject to contract law—based on the notion that both parties are fully informed. And are “equals” in the contract. Yep, right—you, dear reader, are equal to the team of vampire blood sucking squids at Goldman Sachs dead set on taking away your home. What, you do not have a good corporate lawyer looking over your mortgage contract? Sucker!
Other consumer products are subject to tort law—you can sue manufacturers for injury. Imagine if you bought a lawn tractor, with 37 pages of disclaimers, and buried deep inside in incomprehensible language the contract said that due to shoddy manufacturing practices, the blade is liable to occasionally fly off and take off your leg, but if it does that, we are not liable. That is exactly what your credit card contract says.
It ain’t right. Warren knows that. She wants to protect consumers of financial products—which, arguably are far more important today than are toasters that occasionally short and burn your toast.
If you are not convinced that she is the right person for the job, please read her excellent essay: “Redesigning regulation: a case study from the consumer market”, in Government and Markets, toward a new theory of regulation, edited by Edward Balleisen and David Moss, Cambridge University Press, 2010, based on a paper she gave back in 2008.

More Reasons to Doubt Rogoff and Reinhart

By Yeva Nersisyan
With unemployment expected to remain high in the U.S. and Europe and the possibility of a double-dip recession growing stronger, some sensible voices are calling for another round of fiscal stimulus. And then there are others who not only argue that we don’t need more stimulus, but make a case for starting to cut spending today, notwithstanding a very fragile “recovery.” Ken Rogoff (see here), who has become the de-facto authority on the issue of sovereign deficits and debt (together with his co-author, Carmen Reinhart), in a recent FT article is trying to make the case for the redundancy of further economic stimulus. Subpar economic performance and unemployment are the usual companions of post-financial crisis recovery, he argues, hence there is no need for a “panicked fiscal response” (even Secretary Geithner has cited their research to demonstrate that the current slow pace of recovery is normal). Rogoff goes on to argue that the long-term effects of government debt accumulation on growth shouldn’t be ignored. The theoretical and empirical bases for his arguments are found in his recent book with Reinhart, This Time is Different, as well as an NBER paper, “Growth in Time of Debt”. This paper, similar to the book, has been very popular, especially among those needing empirical justification for their anti-fiscal policy stance. While the RR book focuses on the short-run, immediate impacts of sovereign debt (i.e. financial and economic crises), the focus of the paper is the impact of sovereign debt on long-term growth. In this blog I want to give a quick, critical evaluation of the paper (a longer version can be found here).

When orthodox economists start their empirical research regarding the long-term impact of deficits and sovereign debt, they do not ask whether deficits contribute to or inhibit long-term economic growth. They do not ask, because they already “know” the answer, as the ECB put it: “Although fiscal consolidation may imply costs in terms of lower economic growth in the short run, the longer-run beneficial effects of fiscal consolidation are undisputed.” (ECB, Monthly Bulletin, June, 2010). What they want to find is some threshold for deficit-to-GDP and debt-to-GDP ratios beyond which debt becomes detrimental to growth. With this goal in mind, Rogoff and Reinhart embark on a “scientific” journey through time and space.
Their method is actually quite simple: they construct some arbitrary ranges for debt-to-GDP ratios (0-30, 30-60, 60-90, >90) and take the average of growth rates for each range. They then take the average of these averages for a large number of countries and conclude that when the government debt-to-GDP ratio crosses the threshold of 90% (again, an arbitrary number), median growth rates fall by one percentage point and the average falls even more. This limit is the same for developed and developing countries, however, when it comes to external debt (which is defined in their book as both public and private debt issued in a foreign jurisdiction, and usually, but not always, denominated in foreign currency), the threshold is much lower, just 60% of GDP. Once a country crosses this lower external debt threshold, annual growth declines by about 2 percentage points and at very high levels, the growth rate is cut almost in half.
Interestingly, however, average growth rates don’t monotonically decline, i.e. the average rate of growth is higher when debt-to-GDP ratio is in the 60-90% range than the lower range of 30-60%. In addition, growth rates don’t slow down for all the countries in their sample. For some countries the average growth rate is higher when debt is over 90% of GDP than for lower levels of debt. Reinhart and Rogoff don’t point out this “anomaly,” nor do they offer any explanations. More importantly, since they take the average of averages of a number of countries, it is possible that countries like the U.S. may drive the results for the whole group. They single out the case of the U.S. in their paper to demonstrate their results. However, a closer look shows that they only have 5 data points for the U.S. when the debt-to-GDP ratio was over 90%. This is only 2.3% of the total of 216 observations. Moreover, 3 out of these 5 observations are for the years 1945, 1946 and 1947, the period after WWII when government debt was high due to war spending. In this period, growth slowed down significantly as the government was withdrawing war spending from the economy. In 1946 alone, GDP contracted at a pace of -10.9%. Rogoff and Reinhart fail to even mention this in their paper. Similar situations might be true for many other countries, where high levels of debt-to-GDP follow extreme economic or political events.
But what is even more important is that what they find in the data is merely a correlation. The causation then is imposed by Reinhart and Rogoff with explanations based on Barro’s Ricardian equivalence theory. “The simplest connection between public debt and growth is suggested by Robert Barro (1979). Assuming taxes ultimately need to be raised to achieve debt sustainability, the distortionary impact imply is likely to lower potential output” [sic].
There is no doubt about the correlation between high debt-to-GDP ratios and low economic growth found in the data. However, there is a more sensible explanation for this correlation. As explained in many past posts on this blog, the government budget balance automatically goes into deficit in a recession leading to an accumulation of public debt. Besides, GDP, the denominator of the ratio shrinks making the ratio even larger. It is sufficient to look at what happened during this most recent crisis to see this. The average rate of growth has been -0.23% for the recession years 2007-2009. At the same time, government debt held by the public has increased from 36% of GDP in 2006 to about 52% in 2009. So if you look at the data, the rate of growth was 2.7% in 2006 corresponding to a debt-to-GDP ratio of 36%. In 2009 growth was -2.6% with a corresponding debt-to-GDP ratio of 52%. Hence there is a correlation between slow growth and high levels of debt which is not surprising. But unless you want to argue that the current recession was caused by high levels of government debt, then it is obvious that causation runs from slow growth to high debt and not the other way around as Reinhart and Rogoff claim.
They also find that growth deteriorates significantly at external debt levels of over 60% and that most default on external debt in emerging economies since 1970s has been at 60% or lower debt-to-GDP ratios (which is the Maastricht criteria). While this might be a surprising finding for them, it should be clear why countries are not tolerant to external debt which is almost always denominated in foreign currency. When a government borrows in foreign currency, even low levels of indebtedness can be unsustainable since the government is not able to issue that foreign currency to meet its debt obligations. As countries need to earn foreign exchange from exports, a sudden reversal in export conditions can render the country unable to meet its foreign debt obligations leading to a crisis and slower growth. Sovereign governments, on the other hand, do not face any financial constraints and cannot run out of their own currency as they are the monopoly issuers of that currency. They don’t need to increase taxes in the future (a la Barro) to pay off the debt as they make interest payments on their “debt” as well as payments of principal by crediting bank accounts, meaning that operationally they are not constrained on how much they can spend. See here for more on this.
While many experts believe that there is an acute possibility of a double-dip recession in the U.S. (see here) and other developed nations, Ken Rogoff is not one of them. And even if we do face the threat, he argues, monetary policy will suffice (if anything, this crisis has demonstrated the ineffectiveness of monetary policy (interest rate management to be more precise) not to be confused with the massive lender-of-last resort operations that the Fed undertook to stabilize the financial system).
Even if there was no threat of a double-dip recession, one could rightly argue that the current high levels of unemployment and underemployment require more government spending. Rogoff’s argument, however, is that sustained high unemployment is the normal consequence of a financial crisis and hence he seems to conclude that fiscal measures to solve the unemployment problem are unnecessary. This is very bad policy advice – we know we have a problem (unemployment), we know how to solve it (public works), but we shouldn’t do so for fear of growth slowing or markets disciplining the government at some indefinite time in the future, a fear based on the wobbly research of Reinhart and Rogoff.
To summarize, the Rogoff and Reinhart research is not a scientific quest but merely a journey with a set destination. It is not based on any sensible theory, and the statistical analysis is of questionable quality as well. Government deficits and debt largely mirror what goes on in the private sector. There are no magic numbers for deficit and debt ratios applicable to all countries and all times. Devising such ratios is a useless exercise.
Even in better times, the U.S. economy is operating with considerably high levels of unemployment and underemployment (see here), underscoring the necessity of government intervention in the economy. In a recession as the private sector cuts back its spending and tries to de-leverage, the role of government, as the only entity in the economy that can run persistent deficits without facing solvency issues, becomes especially important. Regardless of whether there is a threat of a double dip recession, the government should act to solve the unemployment problem through direct job creation TODAY. High levels of unemployment are not compatible with a democratic society.