Monthly Archives: April 2011

Will Iceland Vote “No” on April 9, or commit financial suicide?

By Michael Hudson

A year ago, in March 2010, Iceland’s economy was so small that it did not warrant much attention when 93% of its voters rejected the Social Democratic-Green government’s surrender to demands by Gordon Brown and the Dutch, the European Union (EU) bureaucracy and IMF that the island nation impose austerity. Britain and the Netherlands wanted to be reimbursed for having paid out more than $5 billion to some 340,000 of their own depositors – whom their own bank oversight agencies had failed to warn about the looting that was going on.

Iceland’s taxpayers were told to bear the cost, as virtual tribute. In effect, it was to be penance for believing the neoliberal fairy tales about how bank deregulation and “free markets” would make it the richest, happiest country in the world. Indeed it seemed to be, according to United Nations data. But the dream was dashed after the Icesave electronic Internet bank branches abroad were emptied out by their proprietors.

The dream was the neoliberal promise that running into debt was the way to get rich. Nobody at the time anticipated that taking private (and indeed, fraudulent) bank losses onto the public balance sheet would become the theme dividing Europe over the coming year, dividing European politics and even threatening to break up the Eurozone.

A landmark in this fight is to occur this Saturday, April 9. Icelanders will vote on whether to subject their economy to decades of poverty, bankruptcy and emigration of their work force. At least, that is the program supported by the existing Social Democratic-Green coalition government in urging a “Yes” vote on the Icesave bailout. Their financial surrender policy endorses the European Central Bank’s lobbying for the neoliberal deregulation that led to the real estate bubble and debt leveraging as if it were a success story rather than the road to national debt peonage. The reality was an enormous banking fraud and insider dealing as bank managers lent the money to themselves, leaving an empty shell – and then saying that this was all how “free markets” operate. Running into debt was promised to be the way to get rich. But the price to Iceland was for housing prices to plunge 70% (in a country where mortgage debtors are personally liable for their negative equity), a falling GDP, rising unemployment, defaults and foreclosures.

To put Saturday’s vote in perspective, it is helpful to see what has occurred in the past year along remarkably similar lines throughout Europe. For starters, the year has seen a new acronym: PIIGS, for Portugal, Ireland, Italy, Greece and Spain.

The eruption started in Greece. One legacy of the colonels’ regime was tax evasion by the rich. This led to budget deficits, and Wall Street banks helped the government conceal its public debt in “free enterprise” junk accounting. German and French creditors then made a fortune jacking up the interest rate that Greece had to pay for its increasing credit risk.

Greece was told to make up the tax shortfall by taxing labor and charging more for public services. This increases the cost of living and doing business, making the economy less competitive. That is the textbook neoliberal response: to turn the economy into a giant set of tollbooths. The idea is to slash government employment, lowering public-sector salaries to lead private-sector wages downward, while sharply cutting back social services and raising the cost of living with tollbooth charges on highways and other basic infrastructure.

The Baltic Tigers had led the way, and should have stood as a warning to the rest of Europe. Latvia set a record in 2008-09 by obeying EU Economics and Currency Commissioner Joaquin Almunia’s dictate and slashing its GDP by over 25% and public-sector wages by 30%. Latvia will not recover even its 2007 pre-crisis GDP peak until 2016 – an entire lost decade spent in financial penance for believing neoliberal promises that its real estate bubble was a success story.

In autumn 2009, Socialist premier George Papandreou promised an EU summit that Greece would not default on its €298bn debt, but warned: “We did not come to power to tear down the social state. Salaried workers will not pay for this situation: we will not proceed with wage freezes or cuts.” [1] But that seems to be what socialist and social democratic parties are for these days: to tighten the screws to a degree that conservative parties cannot get away with. Wage deflation is to go hand in hand with debt deflation and tax increases to shrink the economy.

The EU and IMF program inspired the modern version of Latin America’s “IMF riots” familiar from the 1970s and ‘80s. Mr. Almunia, the butcher of Latvia’s economy, demanded reforms in the form of cutbacks in health care, pensions and public employment, coupled with a proliferation of taxes, fees and tolls from roads to other basic infrastructure.

The word “reform” has been turned into a euphemism for downsizing the public sector and privatization sell-offs to creditors at giveaway prices. In Greece this policy inspired an “I won’t pay” civil disobedience revolt that grew quickly into “a nationwide anti-austerity movement. The movement’s supporters refuse to pay highway tolls. In Athens they ride buses and the metro without tickets to protest against an ’unfair’ 40 per cent increase in fares.” [2] The police evidently are sympathetic enough to refrain from fining most protesters.

All this is changing traditional political alignments not only in Greece but throughout Europe. The guiding mentality of Tony Blair-style “New Labour” policy is economic loyalty to Europe’s financial centers as government spending is slashed, public infrastructure privatized and banks bailed out with “taxpayer” burdens that fall mainly on labor. “Both the conservative and communist leaders have refused to support the EU-IMF programme. ‘This programme is strangling the Greek economy … it needs renegotiation and radical change,’ said Antonis Samaras, the conservative leader.” (Ibid.)

A Le Monde article accused the EU-IMF plan of riding “roughshod over the most elementary rules of democracy. If this plan is implemented, it will result in a collapse of the economy and of peoples’ incomes without precedent in Europe since the 1930s. Equally glaring is the collusion of markets, central banks and governments to make the people pay the bill for the arbitrary caprice of the system.” [3]

Ireland is the hardest hit Eurozone economy. Its long-term ruling Fianna Fail party agreed to take bank losses onto the public balance sheet, imposing what looks like decades of austerity – and the largest forced emigration since the Potato Famine of the mid-19th century. Voters responded by throwing the party out of office (it lost two-thirds of its seats in Parliament) when the opposition Fine Gael party promised to renegotiate last November’s $115-billion EU-IMF bailout loan and its accompanying austerity program.

A Financial Times editorial referred to the “rescue” package (a euphemism for financial destruction) as turning the nation into “Europe’s indentured slave.” [4] EU bureaucrats “want Irish taxpayers to throw more money into holes dug by private banks. As part of the rescue, Dublin must run down a pension fund built up when Berlin and Paris were violating the Maastricht rules. … so long as senior bondholders are seen as sacrosanct, fire sales of assets carry a risk of even greater losses to be billed to taxpayers.” EU offers to renegotiate the deal promise only token concessions that fail to rescue Ireland from making labor and industry pay for the nation’s reckless bank loans. Ireland’s choice is thus between rejection of or submission to EU demands that its government “make bankers whole” at the expense of labor and industry. It is reminiscent of when the economist William Nassau Senior (who took over Thomas Malthus’s position at the East India College) was told that a million people had died in Ireland’s potato famine. He remarked succinctly: “It is not enough.” So neoliberal junk economics has a long pedigree.

The result has radically reshaped the idea of national sovereignty and even the basic assumption underlying all political theory: the premise that governments act in the national interest. As Yves Smith’s Naked Capitalism website has pointed out:

The eurozone is up against Dani Rodrik’s trilemma: Democratic politics and the Nation State vs globalism based on the Bretton Woods system. You cannot have all three corners of the triangle at once. The creators of the European Union knew that the end game was the dissolution of nation states. …

But what they failed to anticipate is that the costs of these crises would be visited on the inhabitants of particular nation states, and that would lead them to rebel against the “inevitable” integration. As long as democratic mechanisms are intact in enough of the countries being pressed to wear the austerity hairshirt, revolt is indeed possible. Economists argue that the cost for any nation to exit the eurozone is prohibitive. But how does that stack up with a “rescue” program that virtually guarantees continued economic contraction and depopulation for Ireland? Faced with two unattractive alternatives, the desire for self-determination and for punishment of coercive European technocrats may make supposedly irrational moves seem compelling. [5]

The shape of Europe that is emerging is not the original view of mobilizing technology to raise living standards. The leaders who originally sponsored the EU viewed nation states as having plunged the continent into a millennium of warfare. But today, finance is the new mode of warfare. Its objective is the same as military conquest: to seize the land and basic infrastructure, and to levy tribute – euphemized as bailout repayments, as if the financial system were necessary to fuel industry and labor rather than siphoning off their surplus.

The Irish government’s €10 billion interest payments are projected to absorb 80% of the government’s 2010 income tax revenue. This is beyond the ability of any national government or economy to survive. It means that all growth must be paid as tribute to the EU for having bailed out reckless bankers in Germany and other countries that failed to realize the seemingly obvious fact that debts that can’t be paid won’t be. The problem is that during the interim it takes to realize this, economies will be destroyed, assets stripped, capital depleted and much labor obliged to emigrate. Latvia is the poster child for this, with a third of its population between 20 and 40 years old already having emigrated or reported to be planning to leave the country within the next few years.

The EU’s nightmare is that voters may wake up in the same way that Argentina finally did when it announced that the neoliberal advice it had taken from U.S. and IMF advisors had destroyed the economy so much that it could not pay. As matters turned out, it had little trouble in imposing a 70% write-down on foreign creditors. Its economy is now booming – because it became credit-worthy again, once it freed itself from its financial albatross!

Much the same occurred in Latin America and other Third World countries after Mexico announced that it could not pay its foreign debts in 1982. A wave of defaults spread – inspiring negotiated debt write-downs in the form of Brady Bonds. U.S. and other creditors calculated what debtors realistically could pay, and replaced the old irresponsible bank loans with new bonds. The United States and IMF members applauded the write-downs as a success story.

But Ireland, Greece and Iceland are now being told horror stories about what might happen if governments do not commit financial suicide. The fear is that debtors may revolt, leading the Eurozone to break up over demands that financialized economies turn over their entire surplus to creditors for as many years as the eye of forecasters can see, acquiescing to bank demands that they subject themselves to a generation of austerity, shrinkage and emigration.

That is the issue in Iceland’s election this Saturday. It is the issue now facing European voters as a whole: Are today’s economies to be run for the banks, bailing them out of unpayably high reckless loans at public expense? Or, will the financial system be reined in to serve the economy and raise wage levels instead of imposing austerity.

It seems ironic that the Socialist parties (Spain and Greece), the British Labour Party and various Social Democratic parties have moved to the pro-banker right wing of the political spectrum, committed to imposing anti-labor austerity not only in Europe, but also in New Zealand (the 1990s poster child for Thatcherite privatization) and even Australia. Their policy of downsizing public social services and embrace of privatization is the opposite of their position a century ago. How did they become so decoupled from their original labor constituencies? It seems as if their function is to impose whatever right-wing agenda the Conservative parties cannot get away with – not unlike Obama neutering possible Democratic Party alternatives to Republican lobbying for more Rubinomics.

Is it simply gullibility? That may have been the case in Russia, whose leaders seemed to have little idea of how to fend off destructive advice from the Harvard Boys and Jeffrey Sachs. But something more deliberate plagues Britain’s own Labour Party in out-Thatchering the Conservatives in privatizing the railroads and other key economic infrastructure with their Public-Private Partnership. It is the attitude that led Gordon Brown to threaten to blackball Icelandic membership in the EU if its voters oppose bailing out the failure of Britain’s own neoliberal bank insurance agency to prevent banksters from emptying out Icesave.

What seems remarkable is that Icelandic voters may take seriously their prime minister’s threat that a “No” vote on the Icesave bailout would lead the UK and Holland to blackball Icelandic entry. The new Conservative Prime Minister has little love for Mr. Brown, and realizes that his own voters are not eager to support membership of a country that is willing to sacrifice the domestic economy to pay bankers for what looks like shady loans. And what of the rest of Europe? Is buckling under to unfair bank demands really the way to make friends with the indebted PIIGS countries? Do these countries want to admit another neoliberal advocate favoring banks over their domestic economies? Or would Iceland make more friends by voting “No”?

Last weekend half a million British citizens marched in London to protest the threatened cutbacks in social services, education and transportation, and tax increases to pay for Gordon Brown’s bailout of Northern Rock and the Royal Bank of Scotland. The burden is to fall on labor and industry, not Britain’s financial class. The Daily Express, a traditionally campaigning national paper, is now running a full throttle campaign for Britain to leave the EU, on much the same ground that Britain has long rejected joining the euro.

What is the rationale of Iceland and other debtor countries paying, especially at this time? The proposed agreements would give Britain and Holland more than EU directives would. Iceland has a strong legal case. Social Democratic warnings about the EU seem so overblown that one wonders whether the Althing members are simply hoping to avoid an investigation as to what actually happened to Landsbanki’s Icesave deposits. Britain’s Serous Fraud Office recently became more serious in investigating what happened to the money, and has begun to arrest former directors. So this is a strange time indeed for Iceland’s government to agree to take bad bank debts onto its own balance sheet.

The EU has given Iceland bad advice: “Pay the Icesave debts, guarantee the bad bank loans, it really won’t cost too much. It will be fairly easy for your government to take it on.” One now can see that this is the same bad advice given to Ireland, Greece and other countries. “Fairly easy” is a euphemism for decades of economic shrinkage and emigration.

The problem is that the more Iceland’s economy shrinks, the more impossible it becomes to pay foreign debts. Iceland’s government is desperately begging to join Europe without asking just what the cost will be. It would plunge the krona’s exchange rate, shrink the economy, drive young workers to emigrate to find jobs and to avoid the bankruptcy foreclosures that would result from subjecting the nation to austerity.

Nobody really knows just how deep the hole is. Iceland’s government has not made a serious attempt to make a risk analysis. What is clear is that the EU and IMF have been irresponsibly optimistic. Each new statistical report is “surprising” and “unexpected.” On the basis of the IMF’s working assumption about the króna’s exchange rate at end-2009, for example, the IMF staff projected that gross external debt would be 160% of GDP. To be sure, they added that a further depreciation of the exchange rate of 30 percent would cause a precipitous rise in the debt ratio. This indeed has occurred. Back in November 2008, the IMF warned that the foreign debt it projected by yearend 2009 might reach 240% of GDP, a level it called “clearly unsustainable.” But today’s debt level has been estimated to stand at 260% of Icelandic GDP – even without including the government-sponsored Icesave debt and some other debt categories.

Creditors lose nothing by providing junk-economic advice. They have shown themselves quite willing to encourage economies to destroy themselves in the process of trying to pay – something like applauding nuclear power plant workers for walking into radiation to help put out a fire. For Ireland, the EU pressed the government to take responsibility for bank loans that turned out to be only about 30% (not a misprint!) of estimated market price. It said that this could “easily” be done. Ireland’s government agreed, at the cost of condemning the economy to two or more decades of poverty, emigration and bankruptcy.

What makes the problem worse is that foreign-currency debt is not paid out of GDP (whose transactions are in domestic currency), but out of net export earnings – plus whatever the government can be persuaded to sell off to private buyers. For Iceland, the question would become one of how many of its products and services – and natural resources and companies – Britain and the Netherlands would buy.

It is supposed to be the creditor’s responsibility to work with debtors and negotiate payment in exports. Instead of doing this, today’s creditors simply demand that governments sell off their land, mineral resources, basic infrastructure and natural monopolies to pay foreign creditors. These assets are forfeited in what is, in effect, a pre-bankruptcy proceeding. The new buyers then turn the economy into a set of tollbooths by raising access fees to transportation, phone service and other privatized sectors.

One would think that the normal response of a government in this kind of foreign debt negotiation would be to appoint a Group of Experts to lay out the economy’s position so as to evaluate the ability to pay foreign debts – and to structure the deal around the ability to pay. But there has been no risk assessment. The Althing has simply accepted the demands of the UK and Holland without any negotiation. It has not even protested the fact that Britain and Holland are still running up the interest clock on the charges they are demanding.

Why doesn’t Iceland’s population behave like that of Ireland or Greece, not to mention Argentina or the United States, and say to Europe’s financial negotiators: “Nice try! But we’re not falling for it. Your creditor game is over! No nation can be expected to keep committing financial suicide Ireland-style, imposing economic depression and forcing a large portion of the labor force to emigrate, simply to pay bank depositors for the crimes or negligence of bankers.”

The credit rating agencies have tried to reinforce the Althing’s attempt to panic the population into a “Yes” vote. On February 23, Moody’s threatened: “If the agreement is rejected, we would likely downgrade Iceland’s ratings to Ba1 or below.” If voters approve the agreement, however, “we would likely change the outlook on the government’s current Baa3 ratings to stable from negative,” in view of a likely “cut-off in the remaining US$1.1 billion committed by the other Nordic countries and probably also to delays in Iceland’s IMF program.”

Perhaps not many Icelanders realize that credit ratings agencies are, in effect, lobbyists for their clients, the financial sector. One would think that they had utterly lost their reputation for honesty – not to mention competence – by pasting AAA ratings on junk mortgages as prime enablers of the present global financial crash. The explanation is, they did it all for money. They are no more honest than was Arthur Andersen in approving Enron’s junk accounting.

My own view of ratings agencies is based in no small part on the story that Dennis Kucinich told me about the time when he was mayor of Cleveland, Ohio. The banks and some of their leading clients had set their eyes on privatizing the city’s publicly owned electric company. The privatizers wanted buy it on credit (with the tax-deductible interest charges depriving the government of collecting income tax on their takings), and sharply raise prices to pay for exorbitant executive salaries, outrageous underwriting fees to the banks, stock options for the big raiders, heavy interest charges to the banks and a nice free lunch to the ratings agencies. The banks asked Mayor Kucinich to sell them the bank, promising to help him be governor if he would sell out his constituency.

Mr. Kucinich said “No.” So the banks brought in their bullyboys, the ratings agencies. They threatened to downgrade Cleveland’s rating, so that it could not roll over the loan balances that it ran as a normal course with the banks. “Let us take your power company or we will wreck your city’s finances,” they said in effect.

Mr. Kucinich again said no. The banks carried out their threat – but the mayor had saved the city from having its incomes squeezed by predatory privatization charges. In due course its voters sent Mr. Kucinich to Congress, where he subsequently became an important presidential candidate.

So returning to the problem of the credit rating agencies, how can anyone believe that agreeing to pay an unpayably high debt would improve Iceland’s credit rating? Investors have learned to depend on their own common sense since losing hundreds of billions of dollars on the ratings agencies’ reckless ratings. The agencies managed to avoid criminal prosecution by noting that the small print of their contracts said that they were only providing an “opinion,” not a realistic analysis for which they could be expected to take any honest professional responsibility!

Argentina’s experience should provide the model for how writing off a significant portion of foreign debt makes the economy more creditworthy, not less. And as far as possible lawsuits are concerned, it is a central assumption of international law that no sovereign country should be forced to commit economic suicide by imposing financial austerity to the point of forcing emigration and demographic shrinkage. Nations are sovereign entities.

It thus would be legally as well as morally wrong for Iceland’s citizens to spend the rest of their lives paying off debts owed for money that should rather be an issue between Britain’s Serious Fraud Office and the British bank insurance agencies.

Overarching the vote is how high a price Iceland is willing to pay to join the EU. In fact, as the Eurozone faces a crisis from the PIIGS debtors, what kind of EU is going to emerge from today’s conflict between creditors and debtors? Fears have been growing that the euro-zone may break up in any case. So Iceland’s Social Democratic government may be trying to join an illusion – one that now seems to be breaking up, at least as far as its neoliberal extremism is concerned. Just yesterday (Thursday, April 7) a Financial Times editorial commented on what it deemed to be Portugal’s premature cave-in to EU demands:

Another eurozone country has been humbled by its banks. Earlier this week, Portugal’s banks were threatening a bond-buyers’ go-slow unless the caretaker government sought financial help from other European Union countries. … Lisbon should have stuck to its position. … it should still resist doing what the banks demanded: seeking an immediate bridging loan. … By jumping the gun, the government risks having scared markets away entirely. That may prejudice the outcome of negotiations about the longer-term facility.

The caretaker government has neither the moral nor the political authority to determine Portugal’s future in this way. It should not precipitately abandon the markets. That may mean paying high yields on debt issues in coming months – higher than they might have been had the government not folded its hand too soon. … The right time to opt for an external rescue would have been at the end of a national debate.” [6]

The same should be true for Iceland. Looking over the past year, it seems that the island nation has been used as a target for a psychological and political experiment – a cruel one – to see how much a population will be willing to pay that it does not really owe for what bank insiders have stolen or lent to themselves.

This is not only an Icelandic problem. It remains a problem in Ireland, and in the United States for that matter, as well as in Britain itself.

The moral is that creditor foreclosure – or voluntary forfeiture to pay international bankers – has become today’s preferred mode of economic warfare. It is cheaper than military conquest, but its aim is similar: to gain control of foreign property and levy tribute – in a way that the tribute-payers accept voluntarily. Land is appropriated and foreclosed on – or, what turns out to be the same thing, its rental income is pledged to foreign bank branches extending mortgage credit that absorbs the net rent. The result is economic austerity and chronic depression, ending the upsweep in living standards promised a generation ago.

Iceland’s government seems to have become decoupled from what is good for voters and for the very survival of Iceland’s economy. It thus challenges the assumption that underlies all social science and economics: that nations will act in their own self-interest. This is the assumption that underlies democracy: that voters will realize their self-interest and elect representatives to apply such policies. For the political scientist this is an anomaly. How does one explain why a national parliament is acting on behalf of Britain and the Dutch as creditors, rather than in the interest of their own country? Voters in other countries have removed their governments for agreeing to pay such questionable debts.

[1] Ambrose Evans-Pritchard, “Greece defies Europe as EMU crisis turns deadly serious,” The Telegraph (UK), December 18, 2009.

[2] Kerin Hope, “Greeks adopt ‘won’t pay’ attitude,” Financial Times, March 10, 2011.

[3] Olivier Besancenot and Pierre-François Grond, “The Greek People are the Victims of an Extortion Racket,”
Le Monde, May 14, 2010.

[4] Ireland’s winter of discontent,” Financial Times editorial, March 1, 2011.

[5] Yves Smith, “Will Ireland Threaten to Default?” Naked Capitalism, March 15, 2011

[6] “Banks 1, Portugal 0,” Financial Times editorial, April 7, 2011.

4 Trust Funds, 3 Problems: Why is the Other one so “Healthy”?

By Stephanie Kelton

Every year, the Trustees of Social Security and Medicare issue an annual report that examines the financial status of the various “trust funds” that purportedly sustain these vital programs. Social Security’s (OASI) and (DI) Trust Funds, as well as Medicare’s (HI) Trust Fund all face chronic problems, some in the not-too-distant future.  In contrast, Medicare’s (SMI) Trust Fund always receives a clean bill of health. Why is that?

The answer is so simple it apparently escapes notice, but here it is, straight from the annual report:

The Hospital Insurance (HI) Trust Fund is expected to remain solvent until 2029. The Disability Insurance (DI) fund is projected to become exhausted in 2018. And the Old-Age and Survivors Insurance (OASI) Trust Fund is considered adequately financed until 2040.  In contrast:

Part B of Supplemental Medical Insurance (SMI), which pays for doctors’ bills and other outpatient expenses, and Part D, which pays for access to prescription drug coverage, are both projected to remain adequately financed into the indefinite future because current law automatically provides financing each year to meet the next year’s expected costs.

In other words, it is sustainable — INDEFINITELY — because the government is committed to making the payments. Indefinitely.

And, as we have argued many times on this site (and elsewhere), the same commitment can easily be made to sustain Social Security (OASI and DI) and Medicare (HI) in their current form.  There is no economic justification for cuts to either program.  The decision is entirely political.

The American people must realize this before it is too late.

Modern Budget Cutting Hooverians Want a Return to the 1930s

By L. Randall Wray

In a Wall Street Journal article this week three Hoover Institute economists (Gary Becker, George Schultz and John Taylor) endorsed Republican efforts to make large federal government budget cuts.  I will not address all the arguments made in defense of a “Hooverian” approach to economics (we tried that in the early 1930s!). Here I want to focus on the two main points made:

  1. “When private investment is high, unemployment is low. In 2006, investment—business fixed investment plus residential investment—as a share of GDP was high, at 17%, and unemployment was low, at 5%. By 2010 private investment as a share of GDP was down to 12%, and unemployment was up to more than 9%. In the year 2000, investment as a share of GDP was 17% while unemployment averaged around 4%. This is a regular pattern.”
  2. “In contrast, higher government spending is not associated with lower unemployment. For example, when government purchases of goods and services came down as a share of GDP in the 1990s, unemployment didn’t rise. In fact it fell, and the higher level of government purchases as a share of GDP since 2000 has clearly not been associated with lower unemployment.”

The authors supply a graph showing investment and government spending as a share of GDP to demonstrate these two points. Based on that data, these economists argue that the solution is to cut federal spending and then to hold its growth rate below that of GDP. This will allow the share of government spending to fall—while economic growth will let tax revenues rise a bit faster so that the budget will move toward balance.

By framing their argument in terms of ratios to GDP, the authors provide a misleading characterization of cause and effect. It is true that high investment spending tends to increase GDP while lowering unemployment—that is the Keynesian “multiplier” at work. High growth of GDP, in turn, lowers the ratio of government spending to GDP so that we will observe a correlation between falling unemployment and a falling government share of GDP—but that is a correlation of no causal significance. When an investment boom collapses—as it did in 2006-2007—GDP growth then falls and the government share of a smaller GDP will rise. Our Hooverians interpret that as “proof” that a rising government share does not help to fight unemployment.

In fact, however, relatively stable government spending over a cycle helps to cushion a private sector “bust”. While it is hard to prove the counterfactual—how bad would things have been without sustained government spending—it is hard to believe their argument that a loss of 8% of GDP due to reduction of private spending would not have led to a much deeper recession (or depression) without the stabilizing force of our government spending.

Let us take a look at the components of GDP over the past two decades. Recall from your Econ 101 course that the aggregate measure of a nation’s output of goods and services (GDP) is equal to the sum of consumption, private investment, government purchases, and net exports (for the US that is of course negative). We can further divide investment into residential (housing) and nonresidential (investment by firms). Finally, we can divide government spending between federal government and state and local government. The following chart graphs the domestic components of GDP (net imports are left out), indexing each component to 100 in 1990. (This makes the scale easier to show in the graph, and simplifies comparison of growth by component. For example, if consumption spending doubles between 1990 and 2000, its index increases from 100 to 200.)

What we see in this graph is that the slowest growing component over the two decades was federal government spending—it actually did not grow much until the term of President George W. Bush. (A substantial portion of federal government growth since 2000 can be attributed to our multiple wars, as well as to domestic spending on security.) By 2010, federal government spending was just over 2.3 times bigger (in nominal terms) than its spending in 1990. Private consumption as well as state and local government spending grew steadily, increasing by about 267% before the deep recession led to some retrenchment. By contrast, residential investment boomed in the real estate bubble, growing by 350% until 2005. It then collapsed so that it stood at an index of just 150 in 2010 (fifty percent higher than in 1990). Nonresidential investment shows a clear cyclical nature, and it too collapsed in the aftermath of the global financial collapse. Viewed in this light, it is not at all surprising that when total investment (residential plus nonresidential) is growing rapidly, unemployment tends to fall; but when investment spending collapses we lose jobs at a stupendous pace.

This has long been the concern of Keynesian economists: investment by its very nature is highly cyclical, subject to what J.M. Keynes called “whirlwinds of optimism and pessimism”. That is not all bad. J. Schumpeter referred to the “creative destruction” that makes capitalism dynamic—waves of innovation generate new investment, wiping out firms that get left behind. But if an entire economy is whipped about by unstable investment, we oscillate between the extremes of boom and bust. That is why we need some spending that is more stable—better yet, we need a source of spending that can act in a countercyclical manner to offset the swings of investment.

And that is precisely what we created in the aftermath of the Great Depression. First, we grew the federal government—from about 3% of GDP in 1929 to above 20% after WWII. As the chart above shows, federal government spending is not subject to the wild swings that afflict investment, so it helps to stabilize GDP and jobs. Second, we put in place a variety of federal government programs that help to stabilize household consumption (unemployment benefits, Social Security retirement, and “welfare” for households, firms, and farms). That is, again, reflected in the chart above—even when the financial sector crashed and unemployment exploded, consumption dipped only slightly, thanks in large part to government “transfer” payments like unemployment benefits.

Our modern Hooverians would like to return to the “good old days” of President Hoover, when the government was smaller and both unwilling and unable to offset the swings of private investment spending. Back then, when investment collapsed unemployment did not go to 9 or 10 percent, it went all the way to 25 percent. Hooverian economics would turn back the clock to ring in another Great Depression with the same old pre-Keynesian ideas that failed us in the 1930s.

The Fake Social Security Solvency Crisis Is Congress’s Fault!

By Joe Firestone

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability)

Ah…. my fellow Americans, be very, very, afraid of the terrible Social Security crisis that will sink us as a nation. According to Government projections, we won’t be able to pay full Social Security benefits, in 2037 and beyond, unless we cut benefits now, because the Social Security “Trust Fund” will be short of money.

So, say Paul Ryan, Peter Peterson and his minions, Mike Pence, Alice Rivlin, Erskine Bowles and Alan Simpson, and also many other deficit hawks. In reply, the most liberal of the deficit doves say that even though there will be a solvency crisis in 2037; it’s really nothing to worry about because all we have to do to end it is to lift “the cap” on FICA contributions entirely, so that wealthier income earners are paying the same rate on their total earnings, as workers whose wages or salaries are below $106,800 per year.

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Stephen Moore’s ode to the American Workers his Policies Harm

By William K. Black

(cross-posted with

My next columns address three writings by Stephen Moore, the Wall Street Journal’s “senior economics writer.”

White Collar Witch Hunt: Why do Republicans so easily accept Neobolshevism as a cost of doing business? [The article appeared in the American Spectator in September 2005.] “Bullish on Bush: How the Ownership Society Is Making America Richer.” [Madison Books, 2004.] We’ve Become a Nation of Takers, Not Makers. [Wall Street Journal, April 1, 2011.]

Moore’s column deplores the debasement of the American economy by government employees.

“More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined. We have moved decisively from a nation of makers to a nation of takers.”

The claim that employees involved in making physical things that are purchased in the markets are uniquely valorous is an odd argument for someone with his professional career (Moore ran the ultra conservative, “supply side” anti-tax group, the Club for Growth). The trade and tax policies he embraces encouraged U.S. businesses to export their manufacturing plants (and their jobs) to low-wage/low-tax nations and to import food produced in those low-wage/low-tax nations. Moore has praised both states and nations that serve as tax havens. He has singled out the Texas model – low wage, low tax, low government services, and hostile to safety rules. Moore has worked for years to punish the “makers” and produce the condition he deplores in which the number of U.S. “makers” has fallen sharply. His column decries the budgetary crises in states and localities, but it was the Great Recession driven by the criminogenic environment his anti-regulatory policies created together with the anti-tax hysteria generated by his repeatedly falsified fantasy that slashing taxes for the rich increases tax revenues that drove that budgetary crisis. Architects of the crisis like Moore who write primarily to excuse their consistent failures should stop. They have done enough damage to the world for a dozen lifetimes.

Consider the implications of Moore’s assertion that people who do not work in manufacturing and farming are “takers.” Under this dichotomy the world is divided between “makers” and “takers,” the biggest “takers” in the world work on Wall Street, the City of London, and the worst kleptocracies – the Wall Street Journal’s core readership. If “makers” of manufactured goods and crops are uniquely valorous, then Moore’s logic requires that it is the workers in these sectors – not the managers, professionals, and clerical workers – who are the actual “makers” who embody that unique valor. (Again, it is passing strange that Moore has dedicated his life to rewarding these uniquely valorous Americans by exporting their jobs and leaving them unemployed or employed at lower wages.) If one can claim to be a “maker” by performing functions that merely assist the actual “makers” make things, then we are all “makers.”

Moore, however, implicitly makes two assertions about government employees – all government employees are “takers” and only government employees are “takers.” Moore doesn’t attempt to support any of his assertions, and they are logically inconsistent. These truths are apparently self-evident to Mr. Moore – people are not created equal. Americans who choose to be government employees are inferior because they are not endowed by their creator with an adequate taste for risk.

“Surveys of college graduates are finding that more and more of our top minds want to work for the government. Why? Because in recent years only government agencies have been hiring, and because the offer of near lifetime security is highly valued in these times of economic turbulence. When 23-year-olds aren’t willing to take career risks, we have a real problem on our hands. Sadly, we could end up with a generation of Americans who want to work at the Department of Motor Vehicles.”

In Moore’s world, an American who wishes to work as a “maker” and develops the skills to be a “maker” has no inalienable right to a job as a “maker” at a living wage. Why? If (1) there really is something particularly virtuous about working in manufacturing or farming, (2) there are too few Americans working in those industries, and (3) the Americans who wish to work in those industries embrace “tak[ing] career risks” and have prepared themselves by education to be able to be productive “makers” why not commit the U.S. to ensure that these virtuous, risk-loving young people can find jobs in manufacturing and farming in the U.S.

Moore is not strong on nuance. All government employees are “bureaucrats” in his parable of “makers” and “takers.” No corporations are bureaucratic. Moore’s fable is crude propaganda. Let us add some reality. Our largest group of federal employees provides national security (DoD, CIA, NSA, DHS, DOJ/FBI, VA, etc.). Many of these “bureaucrats” are living their parasitical life of ease as “takers” in Iraq and Afghanistan. (The virtuous Taliban are busy being “makers” – cultivating poppies.) I do not recommend telling our troops that they are risk-averse “takers” and bureaucrats. The exact number of federal employees engaged in national security is unknown because many employees in other agencies, e.g., NASA, actually work on national security under various degrees of deliberately misleading information. There are over a million federal military personnel. DoD, Homeland Security (DHS), and the VA have nearly a million civilian employees.

The only other federal sector with very large numbers of employees is the Postal Service (around 600,000 – less than one-third the size of the federal workforce in the national security sector). The Postal Service, of course, provides a productive service – communications. Moore does not even attempt to explain why our federal troops or our federal communications workers are supposedly parasitical “takers.” Moore does not even attempt to prove that Americans choose to work for the nation or their State because they fear taking risks. I took far more risks as a federal employee than as a private sector employee. Charles Keating hired private detectives twice to investigate me. He sued me for $400 million in my individual capacity. Another fraudulent CEO also sued me for millions of dollars. Speaker of the House James Wright sought to get me fired. One of the presidential appointees running my agency conducted what he claimed was an investigation of me with the hope that he would be able to get me fired or sued. Charles Keating gave a “secret file” to senior members of my agency that he purported had adverse information about me. The agency excluded me from meetings with Keating and removed our jurisdiction over Lincoln Savings. The head of my agency attacked me publicly in the press and in congressional testimony. (I returned the favor – he resigned in disgrace.) I was a mere financial regulator.

The overwhelmingly dominant sectors of state and local governmental employment are teaching, police, fire, and prison officers and staff. Each of these jobs would be shunned by those afraid to take risks. Moore views this hypothetical as his nightmare of American decline:

“Sadly, we could end up with a generation of Americans who want to work at the Department of Motor Vehicles.”

I have never met a college graduate (the context of this excerpt from Moore’s column) who aspires to work at DMV. I doubt that Moore has ever met one with that career goal. Moore chooses DMV as his example in order to disparage government and government employees. Moore believes that government workers are mediocre. Too scared and too incompetent to work in real jobs, government workers are parasitical “takers.”

“One way that private companies spur productivity is by firing underperforming employees and rewarding excellence. In government employment, tenure for teachers and near lifetime employment for other civil servants shields workers from this basic system of reward and punishment. It is a system that breeds mediocrity, which is what we’ve gotten.”

Ah, yes, the “rank and yank” system and executive and professional compensation have been a brilliant success in “private companies.” Private systems have worked so brilliantly that they destroyed tens of trillions of dollars of wealth by creating a criminogenic environment in which private incentives became so perverse that they drove the epidemic of accounting control fraud that produced a massive financial crisis and the Great Recession. Moore thinks that failed private system should be our model for the public sector. Moore has been disastrously wrong about nearly every major economic policy issue of importance. He has learned nothing useful from his failures.

Mr. Raines explained in response to a media question what was causing the repeated scandals at elite financial institutions:

We’ve had a terrible scandal on Wall Street. What is your view?

Investment banking is a business that’s so denominated in dollars that the temptations are great, so you have to have very strong rules. My experience is where there is a one-to-one relation between if I do X, money will hit my pocket, you tend to see people doing X a lot. You’ve got to be very careful about that. Don’t just say: “If you hit this revenue number, your bonus is going to be this.” It sets up an incentive that’s overwhelming. You wave enough money in front of people, and good people will do bad things.

Mr. Raines was speaking on behalf of the Business Roundtable, which picked him as its spokesperson to explain to the media why the epidemic of Enron-era accounting control frauds was occurring. (You can’t compete with unintended self-parody.) Raines knew what he was talking about – as Fannie’s CEO he employed an executive compensation system that created these perverse incentives. During the crisis, the fraudulent CEOs running the fraudulent liar’s lenders deliberately created intense, perverse incentives among their loan brokers, loan officers, appraisers, auditors, and rating agencies by creating a “Gresham’s” dynamic in which bad ethics drove good ethics out of the marketplace. They were exceptionally effective in achieving the desired results. The CEOs were consistently able to get overstated appraisals, overstated borrower income, clean opinions for financial statements that were not prepared in accordance with GAAP, and “AAA” ratings for toxic waste. CEOs can and do use compensation for good or evil.

Moore’s discussion reveals more about him than about government employees. He can’t imagine employee excellence not based overwhelmingly on fear or quasi-bribery. He can’t imagine anyone wanting to be a teacher, a regulator, a soldier, a firefighter, a CDC scientist, a VA doctor, an FBI special agent, or a police officer. He can’t imagine people who voluntarily accept lower pay than they could get in the private sector because they want to protect people from harm. He can’t even imagine people who want a job in the local prison because they live in rural areas with high unemployment and the prison job is the best way to continue to live and work where they can help a sick mother. People work for the government for myriad reasons. Effective leaders, whether they are in the private or public sector, do not rely on threats or bribes to motivate their teams. They choose good people, train them, praise them, and give them constructive feedback. Effective leaders demonstrate through their actions integrity and dedication to the mission. Accomplishing that mission – teaching a child to read, closing fraudulent banks, putting out fires, arresting rapists, preventing a terrorist attack, or preventing criminals from escaping prison – becomes a matter of the best kind of pride and purpose. Government employees often work far longer hours than required for no additional compensation. This is, for example, overwhelmingly true of teachers.

Why does Moore believe that human capital is so unimportant? His supposed “takers” are the leading “makers” and protectors of the “makers” he claims epitomize valor. It is teachers that help us become productive (and civilized). The police, firefighters, CDC, and the FDA safeguard lives. Does Moore find that unproductive?

The literature on performance pay shows that even when it is not used deliberately by fraudulent leaders to create perverse incentives it can often disrupt work teams and make them less effective by creating divisiveness. It is as if a mother declared that certain of her children were superior to others.

The effort to create performance pay is also perverse because it leads to demands for quantification of performance. Moore errs when he claims the government does not use performance pay. The “Reinventing Government” movement (championed by Vice President Gore and (then) Texas Governor Bush as well as many academics was premised on applying private sector management practices in the public sector. For example, Moore’s column complains about students’ test scores not improving. Student test scores did, infamously, improve dramatically in Houston, as did graduation rates, in response to performance pay tied to test performance and dropout rates. The Houston “miracle” led to Bush’s education program (“No child left behind”). The miracle was actually a fraud. The dropout rates were scammed by the Houston leadership and teachers simply taught to the test.

The SEC and Justice Department use “objective” performance measures to determine bonuses. This increases the perverse incentive to bring cases against minor wrongdoers rather than against the most damaging frauds in which it is far more difficult and time-consuming to obtain convictions.

The other bright idea of Reinventing Government was to order the bank regulators to refer to the banks they were supposed to regulate as their “customers.” That too was a direct steal from private sector management. It is a destructive practice in the regulatory context.

Moore claims that the private sector is always more efficient in providing services.

“Most reasonable steps to restrain public-sector employment costs are smothered by the unions. Study after study has shown that states and cities could shave 20% to 40% off the cost of many services—fire fighting, public transportation, garbage collection, administrative functions, even prison operations—through competitive contracting to private providers. But unions have blocked many of those efforts. Public employees maintain that they are underpaid relative to equally qualified private-sector workers, yet they are deathly afraid of competitive bidding for government services.”

Yes, there are badly designed studies that make these claims, and then there is the reality of privatization. For example, some studies on prison operations find that private prisons are cheaper than public prisons. The problem is that these studies compare average costs of public imprisonment with the costs of private prisons for the lowest risk prisoners. Security drives prison expense, so these studies are meaningless. Privatization can also create perverse incentives. The most notorious example is the CEO of the private prison who bribed judges to sentence innocent juveniles to extensive imprisonment in order to increase the CEO’s compensation.

The private sector can always cream skim some aspects of public services at what appears to the uninformed to be a saving. A private school that does not provide services to special needs students is not more efficient – it is simply taking advantage of a cross subsidy from the public sector.

Privatization does not typically lead to “competitive bidding for government services” by “equally qualified private-sector workers.” The sales of public assets are often not competitive and are not made at market prices. Privatization tends to be a giveaway, making the cronies with the strongest political connections wealthy (think Mexico). I have provided examples of why the “government services” provided under privatization of prisons and schools are often not equivalent because the private sector cream skims the lowest cost aspects of those services, which does nothing to reduce overall costs. The private parties often do not provide “equally qualified private-sector workers.” In college education, for example, GAO studies have found that “for profit” schools have a terrible reputation for endemic fraud. They do not provide equally qualified staff. Private prisons often do the same. Private military contractors are more expensive than government troops and produce recurrent scandals because of their CEOs’ perverse incentives.

American workers do fear the dynamic Moore has long championed. What is the American worker supposed to do if the outsourcing to the private sector is to India and the wages there are one-twentieth of the U.S. wages? That dynamic would lead to the impoverishment of tens of millions of American workers.

In the regulatory world we have just run a real world experiment with applying private sector management theories to the private sector. We privatized many regulatory activities by adopting self-regulation. We used “early outs” to shrink the FDIC (losing many of our most experienced federal employees). We shrank the FDIC by more than three-quarters. The FDIC adopted “MERIT” (non) examination of banks (the “M” and “E” stood for “maximum efficiency). We brought the bank lobbyists “inside the tent” in financial rulemaking, i.e., in creating Basel II. We gave performance bonuses to senior FDIC officials for dramatically reducing FDIC employees. We preempted the State regulators and AGs seeking to protect consumers from predatory nonprime lenders. Each of these actions contributed to the abject regulatory failure.

To sum it up, private sector financial employees, due to the perverse incentives their CEOs put in place and that Moore wishes to spread, were far worse than “mediocre” at hundreds of lenders. The incentives became so perverse that they produced multiple epidemics of fraud and led our most prestigious professionals to aid those frauds. The results were catastrophic. Moore wants to spread those perverse compensation systems and incentives throughout the public sector, where they are even more inappropriate and destructive. We have a catastrophe because the private sector incentives were perverse and the political leaders appointed anti-regulatory leaders to run the agencies. Moore invariably bases his solutions to the problems of the public sector on the private sector approach without examining the problems of the private sector approach or whether that approach makes sense in the public sector. Moore’s theme song is a straight steal from My Fair Lady: “Why can’t a woman be more like a man?” Real men (“makers”) embrace risk and work in the private sector. If only government workers (“takers” – women and men too scared to take those risks) could be made more like the private sector employees all would be solved. In the movie, the song is satire designed to expose male prejudice. Moore doesn’t get the satire.

Randall Wray and Mike Tanner Debate the Implications of the Federal Deficit

Randall Wray and Bill Mitchell Interviewed

Mr. Greenspan takes it all back. His Old Time Religion was right after all.

By Michael Hudson

It all seems so long ago! On October 23, 2008, Alan Greenspan choked up a mea culpa for his deregulatory policy as Federal Reserve Chairman. “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform. “The whole intellectual edifice, however, collapsed in the summer of last year.”
For a moment he seemed to be rethinking his lifelong assumption that the financial sector would seek to protect its reputation by behaving so honestly that its customers would gain from dealing with it. “I had been going for 40 years with considerable evidence that it was working exceptionally well” – the idea that regulation was not needed because bankers would seek to protect their reputations and their “counter-parties” would look to their own interest.
“Were you wrong?” Congressman Henry Waxman prompted him to elaborate.
“Partially,” the Maestro replied. “I made a mistake in presuming that the self-interest of organizations, specifically banks, is such that they were best capable of protecting shareholders and equity in the firms.” The fact that they simply sought predatory gains for themselves – in the form of losses for their customers and clients (and it turns out, taxpayers”) was “a flaw in the model that I perceived is the critical functioning structure that defines how the world works.”
But the past two or three years evidently have given Mr. Greenspan enough time for a re-think. In Wednesday’s Financial Times (March 30, 2011) he returns to his old job proselytizing for deregulation. His op-ed, “Dodd-Frank fails to meet test of our times,” is a mea culpa to his co-religionists for his apostate 2008 mea culpa. “The US regulatory agencies will in the coming months be bedevilled by unanticipated adverse outcomes,” he warns, “as they translate the Dodd-Frank Act’s broad set of principles into a couple of hundred detailed regulations.” The Act “may create … regulatory-induced market distortion,” because neither lawmakers nor “most regulators” understand how “complex” the financial system is.
But Mr. Greenspan refused to acknowledge the obvious: If Wall Street’s collateralized debt obligations (CDOs) and other derivatives are too complex for regulators to understand, they also must be too complex for buyers and other counterparties to evaluate. This negates a key free market assumption. How can one make an informed choice without understanding the market and the consequences of one’s action? On this logic regulators would follow free market orthodoxy in rejecting derivatives and other such “complex” products.

Many critics would say that CEOs of the banks that went bust don’t understand the complexity that led to their negative equity either. Or, they know all too clearly that they can take a gamble and be bailed out by the government, simply by threatening that the alternative would be monetary anarchy that would drag down consumer banking along with casino banking. The problem is not so much complexity, but gambling – increasingly with computer models and fast mega-trading of swaps and derivatives. This is how investment bankers have made (and often lost) their money.
But they want the game to continue. That is the bottom line. On balance, even if they lose, they will be bailed out. So of course they are all for “complexity” that enables them to make gains at the economy’s expense (Mr. Greenspan’s “flaw” in the system).
But alas, he does not acknowledge the fact that Wall Street blackballs regulators who do understand how the financial system works. An ideological blind spot free-market style is a precondition for deregulators such as Mr. Greenspan. It’s as if he still doesn’t understand that this is precisely why he was hired for his job at the Fed! After rejecting Brooksley Born’s attempt to regulate credit-default swaps at the Commodity Futures Trading Commission in 1998, he served his banking benefactors by passionately supporting Robert Rubin and Larry Summers in pressing the Clinton Administration to repeal Glass-Steagall, opening the door to make consumer banking dependent on wild financial gambling by the likes of Citibank and what has become Bank of America. This self-imposed blindness cost to the economy trillions of dollars and has left a dysfunctional commercial banking system. (At least former S.E.C. Chairman Arthur Levitt has apologized to Ms. Born.)
Mr. Greenspan’s euphemism for dysfunctional is “complex.” His op-ed says what priests or nuns tell parochial school pupils who ask about how God can let so many bad things happen here on earth. The answer is simply to say: “God is too complex for you to understand. Just have faith.” Nobody has sufficient skills to be “entrusted with forecasting, and presumably preventing, all undesirable repercussions that might happen to a market when its regulatory conditions are importantly altered.” Just look at how Bush Administration happy-face appointees at the FDIC and IMF expressed faith that risks were declining in 2007-08. “Regulators were caught ‘flat-footed’ by a breakdown we had erroneously thought was more than adequately reserved against.” Who could have seen that fraud was going on? Certainly nobody that was let into the Fed’s policy meetings.
Federal Reserve Board Governor Ed Gramlich’s warning about subprime mortgage fraud is ignored as an anomaly here. When Mr. Greenspan says “we” in the above quote he means the useful idiots that Wall Street insists that the government hire – true believers in the deregulatory kool-aid being doled out on behalf of their financial god too complex for mortals to know. “The problem is that regulators, and for that matter everyone else, can never get more than a glimpse at the internal workings of the simplest of modern financial systems.” But the “regulators who never got more than glimpse” were co-religionists headed by Bubblemeister Greenspan himself. He bears his failure to “more than glimpse” like a badge of honor.
It seems that only bankers really understand what they’re selling, but you must trust Wall Street to do the right thing. (If Mr. Greenspan mouthed such a claim in Wisconsin, where five school districts were suckered into borrowing $200 million in addition to their original investment in CDOs, he would meet with considerable ridicule.) If bankers do not make money for their customers, they will lose their trust. Why would bankers and financial institutions act in such a way as to profiteer at their customers’ expense (and that of the overall economy for that matter)?
The reason, of course, is that the financial sector notoriously lives in the short run. Countrywide Financial, Lehman Brothers, WaMu, Bear Stearns, A.I.G. et al. gave their managers enormous salaries and even more enormous bonuses to turn themselves into a new power elite with fortunes large and “complex” enough to endow their heirs for a century.
The Federal Reserve Bank of Minneapolis has just published statistics showing that the wealthiest 1% of America’s population doubled its share of wealth over the decade ending in 2007 as the bubble reached its peak. No doubt this polarization is widening as the economy shrinks under the weight of its debt overhead. Mr. Greenspan acknowledges criticisms that Wall Street has used TARP and other bailout money simply to maintain “the outsized (to some, egregious) bankers’ pay packages.” But he points out that “small differences in the skill level of senior bankers tend to translate into large differences in the bank’s bottom line.” Skill is expensive.
What amazes me about mismanagers like Countrywide’s chairman Angelo Mozilo and his counterparts is that when the S.E.C., F.B.I. and state attorneys general open a investigation to see whether to charge them with criminal felonies, the bankers always insist that they were out of the loop, had no idea of what was going on, and are shocked, shocked, to find out that there’s gambling going on in this place.
If they are so unknowledgeable to be even more blind than the regulators and economists who warned about what was happening that has required a $13 trillion government bailout, how can they insist that they are worth whatever they can grab? For that matter, how did they manage to avoid jail terms? This is the real question that “free market” economists should be asking.
Most Wall Street firms have paid substantial settlements, and Mr. Mozilo recently paid the Securities and Exchange Commission $67.5 million to avoid going to trial for civil fraud and insider dealing. But only Martha Stewart became an insider jailbird. For Wall Street, paying a civil fine “without acknowledging wrongdoing” blocks victims from recovering civil damages in the event that they try to sue to get their money back. Evidently the Obama Administration believes that to make the banks pay would simply require yet further bailouts of “taxpayer money.” By refraining from prosecuting, Mr. Geithner at the Treasury and other regulators thus can claim to be saving taxpayers – while permitting the large banks to have grown 20 percent larger today than they were when the bailouts began, by extorting high credit card fees and penalties, and using tax breaks and almost free Fed credit such as the $600 billion QE2 to make money by fleeing the dollar to speculate in foreign currencies and make casino capitalist bets.
Mr. Greenspan insists that the economy would be even poorer under financial regulation. “One of the [Dodd-Frank] law’s provisions,” he criticizes, “made credit-rating organisations legally liable for their opinions about risks.” To avoid killing business with such regulation, “the Securities and Exchange Commission in effect suspended the need for a credit rating.” The idea was to save the ratings agencies from having to take responsibility for the tens of billions of dollars lost as a result of their pasting AAA ratings on junk mortgages.
It is as if fraud is simply part of the free market. In this respect, I find his Financial Times op-ed more damning than his evidently temporary burst of candor in his October 2008 Congressional testimony. Mr. Greenspan has rejoined his flock. And to show how thoroughly he has been cured from his temporary apostasy from free market religion, he belittles the fact that: “In December, the Federal Reserve … proposed to reduce banks’ share of debit card fees associated with retail transactions, leading many lenders to contend they would no longer be able to afford to issue debit cards.”
But can there be a better logic to promote the “public option” and have the Treasury issue credit cards as well as debt cards? The rake-off charged by banks from sellers and buyers alike (not to mention late fees that yield the card companies even more than their interest charges these days) has been a major factor eating into retail profits and personal incomes.
The banks are arguing, in effect: “If we can’t earn back enough profits to cover the losses we’ve made on our junk loans, we’ll organize our own lockout of customers – to force you to pay whatever we demand to cover our costs, pay our salaries and bonuses.” This has been their threat ever since the Lehman Brothers meltdown. They threaten to create financial anarchy if the government does not save them from loss, by shifting it onto taxpayers!
The problem is that the bankers’ solution – the inevitable result of Mr. Greenspan’s policy of shifting central planning onto Wall Street – is that it will culminate in the anarchy of debt deflation, deepening unemployment, more real estate foreclosures, and capital flight out of the dollar. So why not let the government say, “OK, we’ll provide a public-option alternative. And if this works, we’ll use it as a model for our public health insurance option. And then we will look to public banking options, and perhaps to Dennis Kucinich’s American Monetary Act to turn you commercial banks back into savings banks to stem your wild speculation at the economy’s expense.” (Just a modest proposal here for argument’s sake to quiet down the bankers’ threats.)
Mr. Greenspan argues that if banks are regulated to reduce the risk they pose to the economy, they may pack up and take their dealings to London: “concerns are growing that without immediate exemption from Dodd-Frank, a significant proportion of the foreign exchange derivatives market would leave the US.” My own response is to say fine, let them leave. Let Britain’s Serious Fraud Office and bank regulators pick up the pieces from their next opaque gamble “too complex” to understand.
Most slippery is Mr. Greenspan’s attempt to divert attention away from the instability that financial deregulation causes – the extreme and rapid polarization of wealth, the mushrooming of bad debt beyond the ability to pay, and the impoverishment of the economy as a result of its debt overhead. Don’t look there, he says; look at how “the global ‘invisible hand’ has created relatively stable exchange rates, interest rates, prices, and wage rates.” But real estate prices have not been stable – they have been inflated with debt, and then crashed the net worth of hapless borrowers. Employment is not stable, wealth distribution is not stable, nor are commodity prices, especially not the price of Mr. Greenspan’s beloved gold bullion.
Nevertheless, Mr. Greenspan concludes, there can be no such thing as a science of regulation. “Financial market behaviour is subject to so wide a variety of ‘explanations,’ especially in contrast to the physical sciences where cause and effect is much more soundly grounded.” But what sets the physical sciences apart from junk economics is the fact that it is not directly self-interested. There are no huge financial rewards for having a blind spot (except of course for scientists denying global warming or that nuclear power might be dangerous or deep-water oil drilling a risky proposition). There is method in the madness of today’s free market orthodoxy opting for GIGO (garbage in, garbage out) financial models that sing along with maestro Greenspan that Wall Street wealth will all trickle down.
“Is the answer to complex modern-day finance that we return to the simpler banking practices of a half century ago?” he asks rhetorically. By “simpler” banking practices of days of yore, he really means more honest practices, subject to knowledgeable public regulation. It was a world where banks held onto the mortgages they made rather than flipping them to third parties without any responsibility for truth in lending – or in selling, for that matter. “That may not be possible if we wish to maintain today’s levels of productivity and standards of living.” So regulation will make us poorer, not save us from financial fraud and $13 trillion bailouts.
Postulating an admittedly “as yet unproved tie between the degree of financial complexity and higher standards of living,” Mr. Greenspan suggests that wealth at the top is the price to be paid for rising living standards. But they are not rising; they are falling! have Instead of being job creators, bankers are debt creators – and debt deflation is pushing the economy into depression, raising unemployment and driving housing prices further down.
So it sounds like Mr. Greenspan today would do just what he did years ago, and reject warnings that the Fed should regulate reckless bank lending and outright fraud. His mantra is still that the invisible hand is too complex to regulate. It sounds like Willy Sutton bemoaning the fact that policemen keep interfering with his business!
For further commentary on Mr. G’s remarkable “I take it all back” op-ed, I recommend the excellent column of Yves Smith, “OMG, Greenspan Claims Financial Rent Seeking Promotes Prosperity!” Naked Capitalism, March 30, 2011. And if you still believe that Mr. Greenspan can be trusted to provide objective help to today’s financial policy makers, Google the name Brooksley Born and watch the Frontline show “The Warning.” Describing how ferociously Mr. Greenspan and his deregulatory Rubinomics colleagues fought against her attempts to provide information about derivatives so that they might be regulated (saving the U.S. government trillions of dollars), Ms. Born told her interviewer: “They were totally opposed to it. That puzzled me. What was it that was in this market that had to be hidden?”
We now know the answer. Investment bankers were making fortunes at what turned out to be public expense. And that is the real flaw in today’s financial system: most fortunes today, as in past centuries, are made by privatizing wealth from the public domain. To the grabbers, nothing must be allowed to stop that. They insist that is too complex for the regulators to cope with.

The Perfect Fiscal Storm: Causes, Consequences, Solutions

Approximately a decade ago I wrote a paper with a similar title, announcing that forces were aligned to produce the perfect fiscal storm. What I was talking about was a budget crisis at the state and local government levels. I had recognized that the economy of the time was in a bubble, driven by what I perceived to be unsustainable deficit spending by the private sector—which had been spending more than its income since 1996. As we now know, I called it too soon—the private sector continued to spend more than its income until 2006. The economy then crashed—a casualty of the excesses. What I had not understood a decade ago was just how depraved Wall Street had become. It kept the debt bubble going through all sorts of lender fraud; we are now living with the aftermath.
Still, it is worthwhile to return to the “Goldilocks” period to see why economists and policymakers still get it wrong. As I noted in that earlier paper:
It is ironic that on June 29, 1999 the Wall Street Journal ran two long articles, one boasting that government surpluses would wipe out the national debt and add to national saving—and the other scratching its head wondering why private saving had gone negative. The caption to a graph showing personal saving and government deficits/surpluses proclaimed “As the government saves, people spend”. Almost no one at the time (or since!) recognized the necessary relation between these two that is implied by aggregate balance sheets. Since the economic slowdown that began at the end of 2000, the government balance sheet has reversed toward a deficit that reached 3.5% of GDP last quarter, while the private sector’s financial balance improved to a deficit of 1% of GDP. So long as the balance of payments deficit remains in the four-to-five percent of GDP range, a private sector surplus cannot be achieved until the federal budget’s deficit rises beyond 5% of GDP (as we’ll see in a moment, state and local government will continue to run aggregate surpluses, increasing the size of the necessary federal deficit). [I]n recession the private sector normally runs a surplus of at least 3% of GDP; given our trade deficit, this implies the federal budget deficit will rise to 7% or more if a deep recession is in store. At that point, the Wall Street Journal will no doubt chastise: “As the people save, the government spends”, calling for a tighter fiscal stance to increase national saving!

Turning to the international sphere, it should be noted that US Goldilocks growth was not unique in its character. [P]ublic sector balances in most of the OECD nations tightened considerably in the past decade–at least in part due to attempts to tighten budgets in line with the Washington Consensus (and for Euroland, in line with the dictates of Maastricht criteria). (Japan, of course, stands out as the glaring exception—it ran large budget surpluses at the end of the 1980s before collapsing into a prolonged recession that wiped out government revenue and resulted in a government deficit of nearly 9% of GDP.) Tighter public balances implied deterioration of private sector balances. Except for the case of nations that could run trade surpluses, the tighter fiscal stances around the world necessarily implied more fragile private sector balances. Indeed, Canada, the UK and Australia all achieved private sector deficits at some point near the beginning of the new millennium.

As we now know, my short-term projections were not too bad, but the medium-term projections were off. The Bush deficit did grow to 5% of GDP, helping the economy to recover. But then the private sector moved right back to huge deficits as lender fraud fueled a real estate boom as well as a consumption boom (financed by home equity loans). See the following chart (thanks to Scott Fullwiler):

This chart shows the “mirror image”: a government deficit from 1980 through to the Goldilocks years is the mirror image of the domestic private sector’s surplus plus our current account deficit (shown as a positive number because it reflects a positive capital account balance). During the Clinton years as the government budget moved to surplus, it was the private sector’s deficit that was the mirror image to the budget surplus plus the current account deficit. This mirror image is what the Wall Street Journal had failed to recognize—and what almost no one except MMT-ers and the Levy Economic Institute’s researchers understand. After the financial collapse, the domestic private sector moved sharply to a large surplus (which is what it normally does in recession), the current account deficit fell (as consumers bought fewer imports), and the budget deficit grew mostly because tax revenue collapsed as domestic sales and employment fell.  

Unfortunately, just as policymakers learned the wrong lessons from the Clinton administration budget surpluses—thinking that the federal budget surpluses were great while they actually were just the flip side to the private sector’s deficit spending—they are now learning the wrong lessons from this crash. They’ve managed to convince themselves that it is all caused by government sector profligacy. Especially, spending on public sector workers.

For example, Wisconsin Governor Walker’s attack on workers has been taken on the pretext that state employee wages and pensions have driven the budget into deficit. We all know that is ridiculous. The reality is simple: Wall Street crashed the economy, crashed state revenues, and crashed workers’ pensions. Washington responded with a massive bail-out for Wall Street—perhaps $25 trillion worth. It gave a mere pittance to “Main Street” in its $1 trillion stimulus package. Since the recession manufactured on Wall Street cost the economy a lot more than that, Main Street is not on the road to recovery. No one is projecting that jobs will return for many more years. It is delusional to believe that economic recovery can really get underway until we have added 8 million jobs.

In other words, the fiscal storm that killed state budgets is the same fiscal storm that created federal budget deficits. You cannot lose about 8% of GDP (due to spending cuts by households, firms and governments) and over 8 million jobs without negatively impacting government budgets. Tax revenue has collapsed at an historic pace. State governments really do need to balance their budgets, and they really do need tax revenue to finance their spending or to service debt. The federal government, as the sovereign issuer of the currency is in a different situation. I will not go through the MMT approach to sovereign currency spending as all readers here are familiar with that. My point is that states really are facing a funding crisis. The federal government does not face a solvency constraint and it can always afford to buy anything for sale in dollars. Still, as we all know, Washington Beltway insiders have manufactured a fake budget crisis to serve political ends.

State spending cuts (or tax increases) will not restore their budgets. Just take a look at the results of austerity in Greece or the UK. Budget-cutting in a downturn does not reduce deficits significantly. The reason is obvious: austerity slows the economy and reduces tax revenue. Art Laffer’s supply siders were onto something, although they mostly got it the wrong way around. Yes, a booming economy will generate a movement toward balanced government budgets. They thought that tax cuts are always the answer to everything—cut tax rates and you get more tax revenue. I would not say that that never works, but it didn’t when Presidents Reagan and Bush tried it. However, if we get the Laffer Curve the right way around, we can use it to explain why austerity in a downturn just makes budget deficits worse.
In truth, state budgets will not recover before the economy recovers. And state austerity will just make the economy worse. So, as a Thatcher might say: TINA: there is no alternative–to federal government stimulus, that is. I realize that goes against the deficit hysteria in Washington. But it is the truth.
What kind of stimulus makes the most sense? I think we need another trillion dollars, minimum. This can be split equally between aid to the states and extension of the payroll tax holiday. The federal government should provide $500 billion in block grants to the states, on a per capita basis. On the condition that they stop attacking state workers. The funds would be used to replace lost tax revenue—to cover operating expenses (and where possible, to actually increase spending on priority projects). This program would continue until economic growth and job creation reaches established thresholds. Let us say 10 million more jobs or a measured unemployment rate of 4%.

The payroll tax holiday would also be expanded, with a moratorium on taxes for both workers and employers until those thresholds are reached. Why penalize job creation with an employment-killing payroll tax? Reward firms for providing jobs by giving them tax relief. Let workers keep more of their hard-earned pay. This is the quickest and best way to give significant tax relief to most Americans. In addition, we need to stop the attacks on unemployment compensation. To be sure, jobs should always be favored over unemployment compensation—but until we get the jobs we must extend the unemployment benefits. Cutting benefits will just prevent the jobs from coming back.

These measures are only a first step. We still have a lot of damage to repair—damage caused by Wall Street’s excesses. And we will need to reign-in and prosecute the fraudsters, otherwise they will blow up the economy again. Actually, they are already trying to do that—creating yet another commodities market speculative bubble. It is looking an awful lot like 2006 all over again. However this time, we are down by 8 million jobs and trillions of dollars of household wealth. Wall Street is bubbling up even as the economy as a whole is in the trenches. This bubble will not last long. It is going to crash. That will expose the huge accounting holes in the bank balance sheets. Wall Street will want another 25 trillion dollar bail out. This time, we’ve got to follow Nancy’s dictum: just say no.