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Brooksley Born vs. Greenspan, Rubin, and Summers: An Epic Battle Behind Closed Doors


From The Warning:

“We didn’t truly know the dangers of the market, because it was a dark market,” says Brooksley Born, the head of an obscure federal regulatory agency — the Commodity Futures Trading Commission [CFTC] — who not only warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country’s key economic powerbrokers to take actions that could have helped avert the crisis. “They were totally opposed to it,” Born says. “That puzzled me. What was it that was in this market that had to be hidden?”

Time to Throw Some Water on The Deficit Hysteria Fire

CAN OR SHOULD THE FEDERAL GOVERNMENT BALANCE ITS BUDGET?
Yeva Nersisyan and L. Randall Wray

Nowadays the only thing on everybody’s mind is the level of government deficit and national debt. Deficit hysteria is being fueled by reports that the US budget deficit will reach “an all time high” this year. President Obama is going to appoint his own commission to study how to reduce the deficit—since Congress failed in its attempt to establish one. He frets that we will leave crippling mountains of debts for our grandkids. The deficit hysteria hydra is too big to cover in one blog—but here we will address the “deficit cycle” and the possibility of ending it.

There seems to be a deficit mania cycle with hysteria arriving after every recession (because, as we show below, recessions always generate big deficits), only to recede when economic growth resumes and deficits fall. And the fact that there is a Democratic president in office and a largely Democratic congress frees the hands of conservative deficit hawks who complain about spending profligacy and growing national debt (they usually fail to recall that much of this spending and especially tax cuts have been generated under a Republic president and Congress, not to mention the 780 billion Paulson bailout of Wall Street). This deficit hysteria is also a useful tool for distracting people’s attention from really important matters, such as a 10% unemployment rate, the possibility of a double-dip recession, underwater home owners, and rising mortgage delinquencies.

Can the government really balance its budget and run continuous surpluses for a number of years as some politicians promise to do? Here is some data to help you decide that for yourself. Every time the government has tried to balance its budget, the economy has fallen into a recession which has caused the automatic stabilizers to kick in and grow the budget deficit. The graph below depicts the federal budget deficit (or surplus) as a % of GDP with signs reversed (a surplus is below zero, a budget deficit is shown as above zero) and recessionary periods for the entire post-war period. As can be observed in this graph, every budget surplus over this period has preceded a recession. The remaining recessionary episodes have been preceded by reduction of the deficit to GDP ratios. Further, every recession except the one in 1960 led to a budget deficit; the 1960 recession was followed by a reduction of the budget surplus.
These movements of the budget balance are due to automatic stabilizers. When the economy slides into a recession, tax revenues start falling as economic activity declines. Social transfer payments, particularly unemployment benefits, on the other hand, increase, again automatically, as more people loose their jobs. On the other hand when the economy begins to grow, tax revenues grow quickly, moving the budget toward balance or even to a surplus.
The graph below shows the rate of growth of tax revenues (automatic), government consumption expenditures (somewhat discretionary) and social transfer payments (again automatic) relative to the same quarter of the previous year:

While government consumption expenditures have remained relatively stable after a short spike in 2007-2008, the rate of growth of tax revenues has dropped sharply from 5 % growth to 10 % decline in just three quarters (from Q 4 of 2007 to Q 2 of 2008), reaching another low of -15% in Q1 of 2009. Transfer payments, as expected have been growing at an average rate of 10% since 2007. Decreasing taxes coupled with increased transfer payments have automatically pushed the budget into a larger deficit, notwithstanding the change in consumption expenditures. These automatic stabilizers and not the bailouts or much-belated and smaller-than-needed stimulus are the reason why the economy hasn’t been in a freefall similar to the Great Depression. As the economy slowed down, the budget automatically went into a deficit putting a floor on aggregate demand.

Conclusions: the federal government budget cannot be balanced or turned into surplus without killing the economy and causing another Great Depression, which again, will automatically cause the budget to turn into the negative territory. With the loss of 8 million jobs, and given the private sector’s unwillingness to go further into debt (it is now, finally, spending less than its income) there is no way that the federal budget can be balanced, unless the US becomes a net exporter, which is highly unlikely. So if a politician tells you that she is going to balance that budget, she either doesn’t understand what she is talking about or is trying to fool you to get elected.

Duke University Professor Calls on Obama to Guarantee Jobs for All


“US Is on Right Path to Banking Reform”

By James K. Galbraith [via The Sphere]

President Barack Obama took an important step in the right direction Thursday. How can one tell? Bank stocks fell. And on Bloomberg just afterward, the industry’s top lobbyist stated that the big bankers want “a civil, adult conversation” about reform. Great. They must be worried.

Oh, and there’s a third reason. Paul Volcker was there. He’s not corrupt. He’s not ambitious. He’s been around the political track a few times. If Volcker shows up to back the president on this one, that’s got to be a good sign.

The president’s speech established some important principles. First, size matters. We should not allow banks — or any other type of financial firm — to become “too big to fail.” A bank that big is too big to regulate, and too big for its own leadership to manage safely and effectively even if they want to. It is a “systemically dangerous institution.” It should not be allowed to grow, because as it becomes bigger, it becomes more dangerous still.

Second, proprietary trading is dangerous. Leveraged proprietary trading is a highly profitable, but exceptionally risky, form of gambling. It should not be done by institutions whose downside risk is publicly insured — either directly or indirectly — because they can blackmail the country when they go down. Get rid of it. John Reed, the former CEO of Citibank, agrees: In the 1980s and 1990s they didn’t do it, and they don’t need to do it now.

Third, the financial sector must be restructured. We have many viable small and medium-sized banks that didn’t get burned by the sub-prime debacle. They should grow and help rebuild America. The big banks right now are, largely, zombies. They are serving no public purpose, yet they remain dangerous. The “Volcker Rule” can help protect us, restoring something like the protections that helped keep us safe for a half century under Glass-Steagall.

The plan doesn’t do enough. But now that the president has set a direction, he can do more. To begin, he should use regulatory powers he already has. Last year’s stress tests were a farce, a public relations exercise to convey a simple message: that the government was going to back the banks, no matter what. That strategy didn’t work. And that’s no longer the message the government should want to send.

So let’s do those stress tests again. This time let the real regulators — the FDIC and not the Fed or Treasury — take the lead. Let’s have clean audits of the toxic assets at their market values, public exposure of the AIG e-mails — which are public property — and a serious review of the documents underlying all those bad mortgages and mortgage-backed-securities. The big banks should be made to shrink, under FDIC supervision. Outright bans and high taxes are the right deterrent for unsafe practices. And prosecution is the remedy for fraud.

Somehow I doubt that our big bankers want to go through this. Maybe they’ll simply retire, removing at a stroke the biggest eyesore on the American political scene — and a big obstacle to both financial reform and an effective economic recovery program.

Another good sign emerged today. According to The Washington Post, Treasury Secretary Timothy Geithner opposed Volcker’s approach, and he got beaten. This sentence is telling: “Industry officials … said they were startled and disheartened that Geithner was overruled, in part because they supported the more moderate approach Geithner proposed last year.”

“Startled” and “disheartened” are good signs. Even better, we have headlines this morning that the secretary is fighting back behind the scenes. ABC News reports: “Treasury Secretary Tim Geithner has reservations about President Obama’s new proposal to limit the size and scope of the nation’s banks, sources tell ABC News. Specifically, the sources say, Geithner is worried that the proposed limits could damage the competitiveness of U.S. firms with their global competitors.”

Competitiveness? That bit of malarkey is a big-bank lobby talking point, nothing more. Its use here reveals precisely the problem that has faced Team Obama from the beginning: They gave the Treasury to a close ally of the biggest banks.

With today’s news, Geithner’s loyalties are completely clear. The next step, in that matter, is up to the president.

So now the ball is rolling, at last, toward real financial reform. Keep it rolling, Mr. President; you’re on the right road now.

Mosler on Today’s Monetary Arrangements

Reader Note: This is the second entry from Warren Mosler in a debate with Jim Rickards about how to fix the economy. More on the authors here. This is a response to Rickards first piece. Mosler’s first piece is here.*

by Warren Mosler

Jim’s recommendations are “sound money, lower taxes, and light regulation.”

We do agree on lower taxes. My proposals include a full payroll tax holiday to support demand. And while Jim suggests a return to Glass-Steagall, my banking proposals are even more narrow and dramatically reduce the need for regulation. I also support price stability.

We also agree that the Monetarist concept of “velocity” is flawed, but our reasons differ. Jim’s derive from the long-dead gold standard where velocity is a calculation of how many times the given amount of money (gold) is used to buy and sell goods and services. Today, however, monetary expansion has nothing to do with money supply like it used to under the gold standard. The reason banks aren’t lending isn’t because they don’t have money to lend. Lending is constrained only by bank capital and the creditworthiness of willing borrowers, not by gold or any other concept of bank reserves. That’s why quantitative easing – i.e. the Fed printing money to buy securities – has no effect on bank lending.

Interest rate cuts transfer income from savers to banks, reducing overall spending. So while interest on savings dropped from over 5% to near 0%, borrower’s rates fell little if any. The wide yield curve means banks’ profit margins widened.

New Keynesian thought is also flawed, because it too presumes gold standard constraints. Today government never actually has nor doesn’t have dollars, and spends, taxes, and borrows simply by changing numbers in bank accounts at the Fed.

When it comes to the dollar, the US government is the scorekeeper. Unlike the gold standard days, the government can’t run out of money. Nor is it dependent on China to fund spending.

Under the old gold standard, taxes and borrowing did fund spending. Today taxes function only to regulate aggregate demand and to control prices. The federal deficit is merely the difference between the numbers changed upward when the government spends, and the numbers changed downward when it taxes. Taxes therefore function to regulate aggregate demand, not to raise revenue, per se. Tax cuts increase our spending power, tax hikes lower it. This is indisputable operational fact, not theory or philosophy.

Jim’s general warning is that too much spending or monetary stimulus might lead us to cross a “critical threshold where diverse actors reject dollars in a cascading collapse.” But this only applies to fixed exchange rate regimes such as the gold standard, where a weak currency results in gold outflows.

Today the dollar is a non-convertible currency. The exchange rate continually adjusts, always representing indifference levels with no gain or loss of gold reserves. I would note too that the U.S. is actively seeking to weaken the dollar vis-à-vis the Chinese yuan. Would Jim want the reverse?

Jim’s arguments are as good as gold. However, we are not on a gold standard, so they don’t apply. Today’s monetary arrangements call for my solutions to restore output, employment, and price stability.

* This post was first published on Rolfe Winkler’s blog.

Geithner-AIG scandal

NY Fed, AIG Emails Spark New, Bipartisan Criticism Of Geithner“. See the discussion here, here and here.
The video is here.

“Man of the year”

By Warren Mosler

I’m perhaps a bit harsher and more direct in my criticisms than Time Magazine when they named Chairman Bernanke their Man of the Year:
His latest speech shows he’s got ‘quantitative easing’ and monetary operations completely wrong as he believes the banks lend out reserves.
His alphabet soup of programs for the interbank lending freeze up completely missed the point that all the fed has to do is lend in the fed funds market which would have immediately solved the problem that never should have happened, and lingered for over 6 months and contributed to the last leg of the collapse.

He’s on the wrong side of fiscal policy, urging the Congress to balance the budget, at least longer term.

He’s on the wrong side of the trade issue, trying to engineer exports at the expense of domestic consumption, which is indeed happening, and causing our real terms of trade and standard of living to deteriorate.

He hasn’t even begun to consider the evidence that is showing lower rates to be deflationary rather than inflationary.

He still adheres to inflations expectations theory.

His unlimited dollar swapline program was an extraordinarily high risk policy that fortunately worked out, but never should have been done without discussion with Congress. In fact, last I read he still thinks it was low risk, not understanding that fx deposits at the foreign CB are not actual collateral.

If I had to select someone from outside the Fed for the next chairman Vince Reinhart is the only one I can think of that at least thoroughly understands monetary ops and reserve accounting, though we do have our differences on theory and policy.

*First published on Moslereconomics.com

Should Ben Bernanke be retained as Fed Chairman?

This week, we will be running a series of essays on TIME Magazine’s ‘Person of the Year’, discussing whether he deserves to be reappointed as Chairman of the Federal Reserve. The first of these installments – posted below – comes from Marshall Auerback. Tomorrow’s installment comes from Warren Mosler.

Failed Economics Creates Failed Families

By June Carbone
Edward A. Smith/Missouri Chair of Law, the Constitution and Society, University of Missouri-Kansas City

Where is the economics of the family when we need it? Family instability magnifies societal inequality and undermines the foundation for the next generation. Yet, the ideas that helped secure a Nobel Prize in economics for Chicago economist Gary Becker, which still provide the starting point for every discussion of the economics of the family, have been proved wrong in almost every respect – and lay the foundation for an economy that looks like Yemen’s.

Becker won the Nobel Prize, at least in part, because of his identification of marriage with specialization and trade: men “specialize” in the market and women in the home. His critical prediction: with the wholesale movement of women into the labor market, the gains from marriage would decline and family instability would rise.

Yet, Becker’s theory cannot explain why the only group in society whose marriage rates have increased are college-educated women or why, contrary to Becker’s predictions, the divorce rates of two career college-educated couples have returned to the levels of the early sixties. Nor does it make any attempt to account for how class now dictates family form, with family stability increasingly a product of education and income. (For more on this, see Naomi Cahn and June Carbone, Red Families v. Blue Families.)

It has no hope of explaining these factors because it misses the most significant developments of the day. The idea that men “specialize” in the market is absurd. The very idea of the market as separate from the home is a product of nineteenth century industrialization, and the specialization that occurred in that era was a much greater investment in middle class males that increased the returns to education, enhanced differentiation among male workers, and magnified income inequality. The idea that women “specialize” in the home is even loonier – the female homemaker is the very epitome of the generalist, cleaning, cooking, mending and providing child care. While my husband “specializes” in corned beef and cabbage in contrast to my salads and tomato sauce, no one would confuse the result with professional accomplishments that are the result of decades of education and experience. (For more on this, see June Carbone, From Partners to Parents: The Second Revolution in Family Law.)

Ideas, however, have consequences, and a major one that follows from getting this wrong is understating the importance of investment in women. The big story of the last half century is greater returns to investment in women, investment that is derailed by early marriage and childbearing. The second, more pernicious consequence is that Becker misses the fact that what he characterizes as specialization rationalizes domination. Women’s domestic roles – including younger average ages of marriage, multiple children born in close succession, and the lack of external sources of income – correspond closely to a lack of power in relationships. As Nicholas Kristof writes in his inspiring accounts of women from the developing world, give women just a little bit more education and independence and they leave or reform abusive mates, producing healthier children and a more productive society.

In contrast, the policies that have tried to bring back Becker’s specialized family – which include abstinence education, the shot gun marriage, and declining access to family planning – simply ensure the U.S.’s declining economic competitiveness. Teenage girls in the red states that place single-minded emphasis on marriage are MORE likely than their blue state sisters to have sex and get pregnant, marry early and get divorced, stop going to school and go to work, and end up raising their children in poverty.

Invitation to Live Webcast Seminars with UMKC Prof. L. Randall Wray

Our own Prof. L. Randall Wray will make a presentation and start off a discussion on the prospects for full employment and the potential application of employment guarantee programs in USA and other countries. See below how to participate. [via the WORLD ACADEMY OF ART & SCIENCE]

e-Conference on the GLOBAL EMPLOYMENT CHALLENGE
An inquiry into the root causes and remedy for the problem of unemployment

We cordially invite you to participate in the first GEC web seminar on November 10, 2009

L. Randall Wray is a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri–Kansas City. He is also a Senior Scholar at the Levy Economics Institute of Bard College in New York. His current research focuses on providing a critique of orthodox monetary policy, and the development of an alternative approach. He also publishes extensively in the areas of full employment policy and the monetary theory of production. With President Dimitri B. Papadimitriou, he is working to publish, or republish, the work of the late financial economist Hyman P. Minsky, and is using Minsky’s approach to analyze the current global financial crisis. He is the author of Money and Credit in Capitalist Economies, 1990, and Understanding Modern Money: The Key to Full Employment and Price Stability, 1998. He is also coeditor of, and a contributor to, Money, Financial Instability, and Stabilization Policy, 2006, and Keynes for the 21st Century: The Continuing Relevance of The General Theory, 2008.

For a complete list of Professor Wray’s publications and links to working papers, click here

Professor Wray will make a presentation and start off a discussion on the prospects for full employment and the potential application of employment guarantee programs in USA and other countries.

His presentation will be followed by panel discussion.

The entire two-hour seminar will be recorded as an audio/video webcast and hosted on the GEC conference site after the meeting.

What you need to participate:

To participate in the panel discussion – computer with webcam and skype audio or telephone access
To view and listen to the seminar – computer with headset or speakers
To listen to the seminar only – telephone uplink

If you will participate in the audio discussion by phone, please give the country code and phone number on which you want to be contacted

Send your reply to [email protected]

GEC
Program Info

GEC PROJECT TEAM
November 5, 2009