Category Archives: Michael Hudson

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Debt deflation resulting from a distorted “financialized” economy

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

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

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

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

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

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

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

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

Deficit reduction

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Putting Mr. Obama’s speech in perspective

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

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

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

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

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

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

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

Two opposing lines of advice to Mr. Obama

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

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

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

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

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

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

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

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

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

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

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

You almost could hear the bankers heave a sigh of relief when Haiti’s earthquake knocked the Financial Crisis Inquiry Commission hearings off the front pages and evening news broadcasts last week. At stake, after all, is Wall Street’s power grab seeking to centralize policy control firmly in its own hands by neutralizing the government’s regulatory agencies. The first day – Wednesday, January 15 – went innocuously enough. Four emperors of finance were called on to voice ceremonial platitudes and pro forma apologies without explaining what they might be apologizing for. Typical was the statement by Goldman Sachs chairman Lloyd C. Blankfein: “Whatever we did, it didn’t work out well. We regret the consequence that people have lost money.”

Their strategy certainly made money for themselves – and they made it off those for whom the financial crisis “didn’t work out well,” whose bad bets ended up paying Wall Street’s bonuses. So when Paul Krugman poked fun at the four leading “Bankers without a clue” in his New York Times column, he was giving credibility to their pretense at innocent gullibility.

Recipients of such enormous bonuses cannot be deemed all that clueless. They blamed the problem on natural cycles – what Mr. Blankfein called a “100-year storm.” Jamie Dimon of JPMorgan Chase trivialized the crisis as a normal and even unsurprising event that “happens every five to seven years,” as if the crash is just another business cycle downturn, not aggravated by any systemic financial flaws. If anything, Wall Street accuses liberal government planners of being too nice to poor people, by providing cheap mortgage credit to the uninitiated who could not quite handle the responsibility.

But the Wall Street executives were careful not to blame the government. This was not just an attempt to avoid antagonizing the Congressional panel. The last thing Wall Street wants is for the government to change its behavior.

I think the Wall Street boys are playing possum. Why should we expect them to explain their strategy to us? To understand their game plan, the Commissioners had to wait for the second day of the hearings, when Sheila Bair of the Federal Deposit Insurance Corp. (FDIC) spelled it out. Their first order of business is to make sure that the Federal Reserve Board is designated the sole financial regulator, knocking out any more activist regulators – above all the proposed Consumer Financial Products Agency that Harvard Professor Elizabeth Warren has helped design. Wall Street also is seeking to avert any thought of restoring the Glass-Steagall Act in an attempt to protect the economy from having merged retail commercial banking with wholesale investment banking, insurance, real estate brokerage and kindred arms of high finance.

Perception – and exposure – of this strategy is what made the second day’s hearing (on Thursday) so important. From Sheila Bair down to state officials, these administrators explained that the problem was structural. They blamed government and the financial sector’s short-run time frame.

The past few years have demonstrated just how thoroughly the commercial and investment-banking sector already has taken control of government. Having succeeded in disabling the Securities and Exchange Commission (SEC) to such an extent that it refused to act even when warned about Bernie Madoff, deregulators did not raise a protest against the junk accounting that was burying the financial system in junk mortgages and kindred accounting fraud.

The Comptroller of the Currency blocked local prosecutors from moving against financial fraud, citing a small-print rule from the Civil War era National Bank Act giving federal agencies the right to override state agencies. Passed in the era of wildcat banking, the rule aimed to prevent elites from using crooked local courts to protect them. But in the early 2000s it was Washington that was protecting national banking elites from state prosecutors such as New York attorney general Eliot Spitzer and his counterparts in Massachusetts and other states. This prompted Illinois Attorney General Lisa Madigan to remind the Angelides Commission that the Office of the Comptroller of the Currency and the Office of Thrift Supervision were “actively engaged in a campaign to thwart state efforts to avert the coming crisis.”*

By far the major enabler was the Federal Reserve Board (FRB). Acting as the banking system’s lobbying organization, its tandem of Alan Greenspan and Ben Bernanke fought as a free-market Taliban against attempts to introduce financial regulation. Working with the Goldman Sachs managers on loan to the Treasury, the Fed managed to block attempts to rein in debt pyramiding.

Mr. Bernanke ignored the very first lesson taught in business schools. This was the lesson taught by William Petty in the 17th century and used by economists ever since: The market price of land, a government bond or other security is calculated by dividing its expected income stream by the going rate of interest – that is, “capitalizing” its rent (or any other flow of income) into what a bank would lend. The lower the rate of interest, the higher a loan can be capitalized. At an interest rate of 10%, a $10,000 annual income is worth $100,000. At 5%, this income stream is worth $200,000; at 4%, $250,000. Mr. Bernanke thus rejected over three hundred years of economic orthodoxy in testifying recently that the Fed was blameless in fueling the real estate bubble by slashing interest rates after 2001. Financial fraud also was not to blame. Anointed with the reputation for being a “student of the Great Depression,” he showed himself to be clueless.

He is not really all that clueless, of course. His role is to play the “useful idiot” whom financial elites can blame to distract attention from how they have gamed the system. Wall Street’s first aim is to make sure that the Fed remains in control as the government’s central regulator – or in the present case, deregulator, able to disable any serious attempt to check Wall Street’s drive to load down the economy with yet more debt so as to “borrow its way out of the bubble.”

Public relations “think tanks” (spin centers adept in crafting blame-the-victim rhetoric) use simple Orwellian Doublethink 101 tactics to call this “free market” policy. Financial self-regulation is to be left to bankers, shifting economic planning out of the hands of elected representatives to those of planners drawn from the ranks of Wall Street. This centralization of authority in a public agency “independent” from control by elected representatives is dubbed “market efficiency,” with an “independent central bank” deemed to be the hallmark of democracy. The words “democracy,” “progress” and “reform,” are thus given meanings opposite from what they meant back in the Progressive Era a century ago. The pretense is that constraints on finance are anti-democratic, not public protection against today’s emerging financial oligarchy. And to distract attention from the road to debt peonage, financial lobbyists accuse governments strong enough to check the financial interest” of threatening to lead society down “the road to serfdom.”

Avoiding regulation by having the Fed “regulate,” with neoliberal deregulators in charge

All that is needed is to reduce the number of regulators to one – and to appoint a deregulator to that key position. The most dependable deregulator is the commercial banking system’s in-house lobbyist, the Federal Reserve. This requires knocking out potential rivals. But at the Federal Deposit Insurance Corporation (FDIC), Sheila Bair is not willing to relinquish this authority. Her testimony last Thursday was buried on the back pages of the press, and her most trenchant written arguments lost in the hubbub caused by the earthquake in Haiti. Not reported by the media-of-record, her testimony should have been welcomed as intellectual dynamite.

For Ms. Bair the task requires blocking three key battles that the financial sector is waging in its war to control and extract tribute from the “real” economy of production and consumption. Her first policy to get the economy back on track is to ward off any plans that politicians might harbor to keep Wall Street unregulated. “Over the past two decades, there was a world view that markets were, by their very nature, self-regulating and self-correcting – resulting in a period that was referred to as the ‘Great Moderation’ [Mr. Bernanke’s notorious euphemism]. However, we now know that this period was one of great excess.” **

Banks are using the ploy familiar to readers of the Uncle Remus stories about B’rer Rabbit. When the fox finally catches him, the rabbit begs, “Please don’t throw me in the briar batch.” The fox does just that, wanting to harm the rabbit – who gets up and laughs, “Born and bred in the briar patch!” and hops happily away, free. This is essentially what the financial scenario would be under Federal Reserve aegis. “Not only did market discipline fail to prevent the excesses of the last few years, but the regulatory system also failed in its responsibilities. There were critical shortcomings in our approach that permitted excessive risks to build in the system. Existing authorities were not always used, regulatory gaps within the financial system provided an environment in which regulatory arbitrage became rampant …”

No more damning reason could be given for Congress to reject Mr. Bernanke out of hand, if not indeed to set about restructuring the Fed to bring it back into the Treasury, from which it emerged in 1914 in one of the most unfortunate Caesarian births of the 20th century. In detail, she explained how the Fed had acted as an agent of the commercial banks perpetrating fraud, protecting their sale of toxic mortgage products against consumer interests and indeed, the solvency of the economy itself. Nobody can read her explanation without seeing what utter folly it would be to put Creditor Fox in charge of the Debtor Henhouse.

Blocking creation of a Consumer Protection Agency

Ms. Bair’s second aim was to counter Wall Street’s attempt to block enactment of the Consumer Protection Agency. Its lobbyists have had a year to disable any real reform, and Washington obviously believes that it can be safely jettisoned. But Ms. Bair spelled out just how willful and egregious the Fed’s refusal to use its regulatory powers – and indeed, its designated responsibilities – has been. “Federal consumer protections from predatory and abusive mortgage-lending practices are established principally under the Home Ownership and Equity Protection Act (HOEPA), which is part of the Truth in Lending Act (TILA). TILA and HOEPA regulations are the responsibility of the Board of Governors of the Federal Reserve System (FRB) and apply to both bank and non-bank lenders,” she explained. “Many of the toxic mortgage products that were originated to fund the housing boom … could have been regulated and restricted under another provision of HOEPA that requires the FRB to prohibit acts or practices in connection with any mortgage loan that it finds to be unfair or deceptive, or acts and practices associated with refinancing of mortgage loans that it finds abusive or not otherwise in the interest of the borrower.”

This was not done. It was actively thwarted by the Fed:

This was closing the barn door after the horses had fled, of course. “The rule imposes an ‘ability to repay’ standard in connection with higher-priced mortgage loans. For these loans, the rule underscores a fundamental rule of underwriting: that all lenders, banks and nonbanks, should only make loans where they have documented a reasonable ability on the part of the borrower to repay. The rule also restricts abusive prepayment penalties.”

Warning that “the consequences we have seen during this crisis will recur,” Ms. Bair reiterated a recommendation she had earlier made to the effect that “an ability to repay standard should be required for all mortgages, including interest-only and negative-amortization mortgages and home equity lines of credit (HELOCs). Interest-only and negative-amortization mortgages must be underwritten to qualify the borrower to pay a fully amortizing payment.” The Fed blocked this common-sense regulatory policy. And by doing so, it became an enabler of fraud.

As Paul Volcker recently suggested, financial “innovation” did not contribute much to production. Packaging junk mortgages and organizing CDO swaps made real estate more debt-leveraged, while adding higher debt balances to the economy’s homes and office properties. But “the regulatory capital requirements for holding these rated instruments were far lower than for directly holding these toxic loans,” Ms. Bair explained. “Many of the current problems affecting the safety and soundness of the financial system were caused by a lack of strong, comprehensive rules against abusive lending practices applying to both banks and non-banks.”

The absence of proper consumer protection was a major contributing factor to the present financial meltdown, for “it has now become clear that abrogating sound state laws, particularly regarding consumer protection, created opportunity for regulatory arbitrage that resulted in a regulatory ‘race-to-the-bottom.’” Mortgage fraud became rife as bank regulators failed to protect consumers or the economy at large. This is why an independent agency is needed rather than hoping that the Federal Reserve somehow can change its spots. “If the bank regulators are not performing this role properly, the consumer regulator should retain backup examination and enforcement authority to address any situation where it determines that a banking agency is providing insufficient supervision.”

Summarizing her 54-page written testimony orally, Ms. Bar commented that, “looking back, I think if we had had some good strong constraints at that time, just simple standards like … you’ve got to document income and make sure they can repay the loan . . . we could have avoided a lot of this.”*** But the same day on which her testimony was capsulized, the Wall Street Journal leaked the story that “Senate Banking Committee Chairman Christopher Dodd is considering scrapping the idea of creating a Consumer Financial Protection Agency … as a way to secure a bipartisan deal on the legislation,” that is, a deal with “Richard Shelby of Alabama, who has referred to the Consumer Financial Protection Agency as a ‘nanny state.’ … The banking industry has spent months lobbying aggressively to defeat the creation of the CFPA. ‘One of our principal objections all along is that you would have a terrible conflict on an ongoing basis between a separate consumer regulator and the safety and soundness regulator, with the bank constantly caught in the middle,’ said Ed Yingling, chief executive of the American Bankers Association trade group.”**** The idea is that a “conflict” between an institution seeking to protect consumers – and indeed, the economy – from an in-house banking lobbying institution (the Fed), backed by the Treasury safely in the hands of Goldman-Sachs caretakers on loan is “inefficient” rather than a necessary democratic safeguard! But the paper gave more space crowing over the likely defeat of the Consumer Financial Protection Agency than it did to Ms. Bair’s eloquent written testimony!

Avert any thought of re-enacting Glass-Steagall

On the institutional level, Wall Street’s managers want to ward off any threat that the Glass-Steagall legislation might be revived to separate consumer deposit banking and money management from today’s casino capitalism. This is what Paul Volcker has urged, but it is now obvious that Pres. Obama appointed him only for window dressing, much like that of Pres. Johnson said of J. Edgar Hoover: he would rather have him inside his tent pissing out than outside pissing in. Appointing Mr. Volcker as a nominal advisor effectively prevents the former Fed Chairman from making hostile criticisms. Pres. Obama simply ignores his advice to re-instate Glass-Steagall, having appointed as his senior advisor the major advocate of the repeal in the first place – Larry Summers, along with the rest of the old Rubinomics gang taken over from the Clinton administration.

Ms. Bair explained why Wall Street’s preferred “reforms” along the current line – maintaining the “too big to fail” financial oligopoly intact, along with the Bush-Obama deregulatory “free market” ideology – threatens to return the financial system to its bad old ways of crashing. To Wall Street, of course, this is the “good old way.” Wall Street is consolidating the finance, insurance and real estate (FIRE) sector across the board into oligopolistic conglomerates “too big to fail.”

But being realistic under the circumstances, Ms. Bair avoided taking on more of a battle than likely can be won at this time. “One way to address large interconnected institutions,” she proposed, “is to make it expensive to be one. Industry assessments could be risk-based. Firms engaging in higher risk activities, such as proprietary trading, complex structured finance, and other high-risk activities would pay more” for their deposit insurance, to reflect the higher systemic risks they are taking. This suggestion is along the lines of proposals (made for over half a century now) to set different reserve requirements or capital adequacy requirements for different categories of bank loans.

Alas, she acknowledged, the Basel agreements regarding capital adequacy standards are being loosened rather than tightened. “In 2004, the Basel Committee published a new international capital standard, the Basel II advanced internal ratings-based approach (as implemented in the United States, the Advanced Approaches), that allows banks to use their own internal risk assessments to compute their risk-based capital requirements. The overwhelming preponderance of evidence is that the Advanced Approaches will lower capital requirements significantly, to levels well below current requirements that are widely regarded as too low.” She criticized the new, euphemistically termed “Advanced Approach” as producing “capital requirements that are both too low and too subjective.” The result is to increase rather than mitigate financial risk.

The need for tax reform to accompany financial reform

Beyond the scope of the FDIC or other financial regulatory agencies is the symbiosis between financial and fiscal reform.

The problem is that U.S. financial and fiscal policy has institutionalized the financial sector’s short-term outlook,“distorting of decision-making away from long-term profitability and stability and toward short-term gains with insufficient regard for risk.” For example, money managers are graded every three months on their performance against the norm. Ms. Bair focused on how employee compensation in the form of stock options tended to promote short-termism. “Formula-driven compensation allows high short-term profits to be translated into generous bonus payments, without regard to any longer-term risks. Many derivative products are long-dated, while employees’ compensation was weighted toward near-term results. These short-term incentives magnified risk-taking.” In sum, “performance bonuses and equity-based compensation should have aligned the financial interests of shareholders and managers. Instead, we now see – especially in the financial sector – that they frequently had the effect of promoting short-term thinking and excessive risk-taking that bred instability in our financial system. Meaningful reform of these practices will be essential to promote better long-term decision-making in the U.S. corporate sector.”

Conclusion: Pushing the economy even deeper into debt beyond the ability to pay

The banking system’s marketing departments have set their eyes on the economy’s largest asset, real estate, as its prime customer. The major component of real estate is land. For years, banks lent against the cost of building, using land (tending to rise in value) as the borrower’s equity investment in case of downturn. This was the basic plan in lending 70%, then 80% and finally 100% or even more of the real estate price to mortgage borrowers. The effect is to make housing even more expensive.

Suppose that Wall Street succeeds in its strategy to re-inflate the Bubble Economy. Will this create even larger problems to come, by making the costs of living even higher as labor and industry become even more highly debt leveraged? That is the banking sector’s business plan, after all. The aim of bank marketing departments – backed by the Obama administration – is to steer credit to re-inflate the bubble and thus save financial balance sheets from their current negative equity position.

This policy cannot work. One constraint is the balance of payments. The competitive power of U.S. exports of the products of American labor is undercut by the fact that housing costs absorb some 40% of labor’s family budgets today, other debt 15%, FICA wage withholding 12%, and various taxes another 20%. U.S. labor is priced out of world markets by the economy’s FIRE sector overhead even before food and essential needs of life are bought. The “solution” to the financial sector’s negative equity squeeze thus threatens to create even larger problems for the “real” economy. Ms. Bair appropriately concluded her written testimony by commenting that the context for the present discussion of financial reform should be the fact that “our financial sector has grown disproportionately in relation to the rest of our economy,” from “less than 15 percent of total U.S. corporate profits in the 1950s and 1960s … to 25 percent in the 1990s and 34 percent in the most recent decade through 2008.” While financial services “are essential to our modern economy, the excesses of the last decade” represent “a costly diversion of resources from other sectors of the economy.”

This is the same criticism that John Maynard Keynes levied in his General Theory, citing all the money, effort and genius that went into making money from money in the stock market, without actually contributing to the production process or even to tangible capital formation. In effect, we are seeing finance capitalism autonomous from industrial capitalism. The problem is how to restore a more balanced economy and rescue society from the financial sector’s self-destructive short-term practices.

*Sewell Chan, “A Call for More Regulation at Fiscal Crisis Inquiry,” The New York Times, January 15, 2010. William Black provides the classic narrative in The Best Way to Rob a Bank is to Own One. He documents how the FBI’s anti-fraud teams and those of other agencies were reduced to merely skeleton levels, overseen by do-nothing deregulatory ideologues of the sort who served as enablers to Wall Street’s Bernie Madoffs.

**Statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation on the Causes and Current State of the Financial Crisis before the Financial Crisis Inquiry Commission; Room 1100, Longworth House Office Building, January 14, 2010. http://www.fdic.gov/news/news/speeches/chairman/spjan1410.html.

***Tom Braithwaite, “Deposits regulator points finger of blame at Fed,” Financial Times, January 15, 2010.