When the GOP starts screaming "vote fraud," reach for your ballot. It's a smokescreen for their upcoming attempt to challenge the vote tally.
17 October 2008
16 October 2008
In any decent society, there must be enough money to take care of sick and old people in our total economy, and if there isn't, that's ultimately a failure of the system, not of "entitlement programs" as such.
You can read up on Walker here. Since he's now the President and CEO of something called The Peter G. Peterson Foundation -- and Peterson was a Bush Pioneer -- which was set up by an investment firm called The Blackstone Group, I smell a rat. I think it's the same class-warfare rat we've always had, but this one stems specifically since David Stockman and the Reagan Reaction. That is, use conscious fiscal irresponsibility, and pure lies, to scare the non-rich into shifting capital from themselves to the rich.
And, lo and behold, Peterson is indeed a rat: Vicious Ideologue Renews Attack on Social Security.
Now, on the heels of a huge fiscal crisis caused by private investment banks, these bastards, who have balls the size of asteroids, now start screaming that "government" is fucking up our finances. And thus we must kill the Social Security insurance program -- I mean, privatize it. Yes, that means handing that over to the geniuses who just nearly destroyed the world's financial system. It's another handout, is all, to corporations and banks.
Medicare, as Krugman points out, is another problem, but one solvable by icing out the private healthcare sector. You know, single payer. But that would hurt the upper class, so, no, we can't have 4-ish% overhead, as Medicare has; we need 13-ish%, like most private care has. It's a total joke, and yet another example of "disaster capitalism" -- a redundancy, in my opinion.
Some articles by Krugman and others below, but first the propaganda:
Pretty scary, huh? Don't wet yourself; look at some reality instead:
Volume 52, Number 4 · March 10, 2005
America's Senior Moment
By Paul Krugman
The Coming Generational Storm: What You Need to Know About America's Economic Future, by Laurence J. Kotlikoff and Scott Burns, MIT Press, 274 pp., $27.95; $16.95 (paper)
Two Problems, Not One
America in 2030 will be "a country whose collective population is older than that in Florida today." It will be in "desperate trouble" because the expense of caring for all those old people will cause a fiscal crisis. The nation will be plagued by "political instability, unemployment, labor strikes, high and rising crime rates." That's the picture painted in The Coming Generational Storm by Laurence Kotlikoff and Scott Burns, a book that has helped to feed a rising tide of demographic alarm.
But is that picture right? Yes and no. America does have an aging population, and a res
ponsible government would take preparatory action while the baby boomers are still in the labor force. America also has very serious long-run fiscal problems. But these issues aren't nearly as closely linked as much of the discussion would lead you to believe. The view of demography as destiny is only a half-truth, and in some ways it's as damaging as a lie.
In this essay I'll try to set the record straight. Unfortunately, I can't do that by following Kotlikoff and Burns closely. Kotlikoff is a fine economist, one of the world's leading experts on long-run fiscal issues. His book with Burns is full of valuable information and sharp insights. Yet in their effort to grab the lay reader's attention, Kotlikoff and Burns do little to alert readers to the distinction between two quite different issues—an aging population and rising spending on health care. And their failure to make that distinction grossly distorts their discussion.The demographic problem is, of course, real. It is, however, of manageable size—exaggerating the problem by confounding it with the problem of medical costs just gets in the way of dealing with it. The problem posed by rising medical costs, on the other hand, would be there even if the population weren't aging—and misrepresenting the problem as one of demography gets in the way of confronting it.
I'll start here by looking at the demographic problem—the aging population—which mainly concerns Social Security, then at proposals for Social Security "reform"—the scare quotes are there because the scheme currently under discussion would undermine our social insurance system, not save it. At the end I'll talk briefly about the much bigger, more intractable issue of paying for the expanding quality and quantity of health care, and the current state of political debate.
Social Security and the Demographic Challenge
Chapter 1 of Kotlikoff and Burns's book is called "From Strollers to Walkers"—a catchy way to describe the aging of the US population. It's followed with a chapter called "Truth Is Worse Than Fiction," centered on a chart familiar to everyone who has looked at this issue: long-run projections from the Congressional Budget Office showing the combined expense of Social Security, Medicare, and Medicaid rising from less than 8 percent of GDP now to more than 20 percent by 2075. It seems natural to assume that the grim cost projections follow directly from the aging of the population, and the book doesn't tell you that this assumption is wrong.
One way to describe the truth is to say that there is no program called Socialsecuritymedicareandmedicaid: these are separate programs with separate problems. Look at the accompanying chart which shows the same CBO projection that Kotlikoff and Burns present, but breaks it down by program. Yes, the total rises drastically—but Social Security, although it is the biggest of the programs now and the only one of the three programs whose costs are driven mainly by demography, accounts for only a small part of that rise. That tells us that demography is not the main driver of these long-run projections.
How big is the demographic challenge? Pundits who want to sound serious love to contrast Social Security as it was in 1950, when sixteen workers were paying in for every retiree drawing benefits, with Social Security as it will be once the baby boomers have retired, with only two workers per retiree. But most of the transition from sixteen to two happened a long time ago. Since the mid-1970s there have been about three workers per retiree—and Social Security has been running a surplus. The real issue is what happens when three goes to two. How big a problem is that?
The answer is, medium-sized. As you can see in the chart, the aging of the population will cause Social Security spending to rise from its current level of 4.2 percent of GDP to a little over 6 percent by 2030, at which point it will stabilize. If demography were the only factor driving rising Medicare spending, it would rise in roughly the same proportion, from 2.7 to around 4 percent of GDP. So if demography were the whole story, we'd be looking at an eventual demography-driven rise in spending of between 3 and 3.5 percent of GDP by 2030, and no further increase after that. That's not a trivial increase, but it's also not overwhelming; a tax increase big enough to cover that rise in spending would still leave overall taxation in the United States well below the average for other advanced countries.
Still, a responsible government would prepare for the aging of America. Textbook fiscal economics says that when a government knows that its expenses will rise in the future, it should start running a surplus now. At first, this surplus should be used to pay off debt, which reduces the government's future interest costs. If the government runs out of debt to pay off, it can start to invest in assets such as stocks and bonds, which will yield future income. That's exactly the path the Social Security system, though not the government as a whole, has been following.Social Security has its own budget, with its own dedicated revenue base. In 1983, following the recommendations of a commission headed by Alan Greenspan, Congress tried to prepare the program to deal with the baby boomers: it raised the payroll tax, so that Social Security would run a surplus, with the express intention of building up a trust fund to help pay benefits once the baby boomers had retired. At first, it seemed that this action, together with some changes in benefits, had done the job: "For the next 75 years, the OASDI program is estimated to be in close actuarial balance," declared the Social Security trustees in their 1985 report. Later, the trustees lowered their estimates; the public's impression of a looming Social Security crisis largely dates from the mid-1990s, when they were predicting exhaustion of the trust fund by 2029. But the trustees have lately become more optimistic again: they now say the trust fund will last until 2042. The Congressional Budget Office says 2052, and many economists now think that the original optimism was right after all: if the economy grows as fast over the next fifty years as it did over the past fifty years, Social Security will be sound for the foreseeable future. And if the economy doesn't grow that fast, by the way, the high rate of return on stocks needed to make privatization work can't possibly materialize, either.
At this point a loud chorus on the right insists that such estimates are irrelevant, because the Social Security trust fund is just a meaningless piece of bookkeeping: it's a claim by one part of the government on another part of the government. The real crisis will come much earlier than 2042, that chorus says, because payroll tax receipts will no longer cover the full cost of providing Social Security benefits as early as 2018.Let's take this argument a step at a time. There are two ways to look at Social Security: you can view it as a stand-alone program with its own funding, or you can view it as just part of the federal budget. These aren't mutually exclusive views. On one side, Social Security has always been run as an independent program, and the independence of its budget has considerable legal and political force. On the other side, Social Security is, of course, part of the federal government, and its benefits must ultimately be paid out of the government's revenue. Depending on the question, it's sometimes useful to focus either on Social Security's specific finances or on its role in overall budgeting. What one can't do, however, is switch views in mid-argument. If you want to discuss the budget of the Social Security system, the trust fund and the interest paid on that fund must be part of the picture. If you want to discuss Social Security's role in the overall federal budget, well, you have to talk about the federal budget as a whole; the fact that one particular tax brings in less revenue than one particular category of spending has no significance.
What the crisis-mongers do, however, is switch between views to suit their convenience. For example, in his magisterial survey of Social Security issues in The New York Times Magazine of January 16, Roger Lowenstein caught Michael Tanner of the Cato Institute red-handed. Mr. Tanner's estimate of a $26 trillion deficit for Social Security turned out to be the result of a calculation based on the principle of heads I win, tails you lose: when Social Security runs a surplus, Mr. Tanner doesn't count it, because the system is just part of the government, but when Social Security runs a deficit, he treats Social Security as an independent entity.
If all this seems metaphysical, let's put it this way: What will actually happen when payroll tax receipts no longer cover 100 percent of benefits? The answer, quite clearly, is nothing.
There are only two ways Social Security could be unable to pay full benefits in 2018. One would be if Congress voted specifically to repudiate the Social Security trust fund, that is, not to pay interest or principal on the trust fund's bonds, which would in effect be a decision not to honor debts to retirees. In 2018 the payments on the trust fund's bonds would be sufficient to cover Social Security benefits. Repudiation of those payments is pretty much inconceivable as a political matter; writing in the periodical The Economists' Voice, David Kaiser of the National War College suggests that such a repudiation might even violate the Constitution. In that sense, the trust fund is as real an obligation of the US government as bonds held by Japanese pension funds. The other way would be if the United States found itself in a general fiscal crisis, unable to honor any of its debt. Given the size of the current deficit and the prospect that the deficit will get much bigger over time, that could happen. But it won't happen because of Social Security, which is a much smaller factor in projected deficits than either tax cuts or rising Medicare spending.
The grain of truth in questions about the meaning of the trust fund is that the rest of the federal budget has not been run responsibly. The Social Security surplus should have been kept in a "lockbox." Although this term has come in for a lot of derision, it was a useful shorthand way of saying that the federal government as a whole should in an average year run budget surpluses at least equal to the surplus of the Social Security system. And this in turn was a shorthand way of saying that the federal government as a whole should do the responsible thing and try to prepay some of the costs of an aging population.
In the 2000 campaign both candidates pledged to honor the lockbox. President Bush clearly never had any intention of honoring that pledge; his first tax cut would have broken the lockbox all by itself, and his insistence on pushing through another major tax cut after launching the Iraq war made it clear that this wasn't a fluke. But that's not a Social Security problem. Viewed on its own terms, Social Security has been run responsibly and is a sustainable system.
And the policy implication of that observation is also clear: the problem isn't with Social Security, it's with the rest of the budget. Social Security has already taken the steps needed to cope with an aging population; at most, it needs some minor tinkering. The main thing we need to do to cope with the demographic challenge is for the rest of the federal government to do its part, by dealing with the huge deficit we already have in the general fund.
What About Privatization?
Let's now turn to the sort-of plan ("sort-of" because the administration still hasn't provided key details) to partially privatize Social Security, diverting part of payroll taxes from their current uses, paying benefits and building up a trust fund, and placing them in private accounts instead.
The administration's rationale for privatization is that it is needed because Social Security is in crisis. As we've seen, that's a huge exaggeration, and many of the things President Bush says—such as his assertions that the system will be "flat broke, bust" when the trust fund runs out—are just plain false. Also, the administration pretends that the core of our failure to prepare for an aging population resides in the finances of Social Security; again, as we've seen, Social Security has actually done a lot to prepare for the baby boomers. Mr. Bush's own actions—above all, his insistence on cutting taxes while waging war—are largely responsible for the real problem, the huge deficit in the general fund.
But even if a drastic change in how Social Security operates isn't necessary, there's still the question of whether such a change is a good idea.
When they aren't warning that only privatization can save us from doom, privatizers often make their case with the argument that people can do better investing their own money than the deal they get from Social Security. Here's a classic example of the genre: during the 2000 campaign, then-candidate Bush urged his listeners to "consider this simple fact: even if a worker chose only the safest investment in the world, an inflation-adjusted US government bond, he or she would receive twice the rate of return of Social Security." Vice President Cheney made a similar comparison, although he spoke about investing in stocks rather than bonds, just a few weeks ago.
As I pointed out at the time Mr. Bush made his remarks:
That's an amazing fact; it's even more amazing when you realize that the Social Security system invests all its money in, you guessed it, US government bonds. But the explanation—which Mr. Bush's advisers understand very well, even if [Bush himself] does not—is that today's workers are not only paying for their own retirement, but are also supporting today's retirees.
Or to put it a different way, you could equally well say that my family would have more cash on hand if we took all my mother-in-law's money and let her starve. Somebody must pay the cost of caring for retirees and older workers, whose own payroll taxes went to support a previous generation. If the payroll taxes of younger workers are no longer available for that purpose because they are being placed in private accounts, some other source of money must be found. This problem is often summarized with the deceptively innocuous term "transition costs," but it's an enormous one.
Kotlikoff and Burns offer a privatization plan that doesn't try to fudge the issue of transition costs. They call for a 12 percent national sales tax to pay benefits to current retirees and older workers. This tax would gradually be reduced as the beneficiaries of the current system died off, but it would remain high for a long time. That should give you an idea of what a responsible privatization scheme would entail.
I'd argue that even if we had some way to pay the transition costs, it would be a mistake to privatize Social Security: it was always intended to be an insurance program, not a 401(k), and we need that insurance more than ever in the face of growing economic insecurity. In any case, however, Mr. Bush isn't about to propose a tax increase on that scale or any other.
Instead, he proposes covering the costs of paying benefits to older Americans by borrowing the money. Private accounts would be created using payroll taxes that are currently used to pay for benefits; the government would therefore have to borrow to make up for lost revenue. The government would offset this loss of revenue in the long run by gradually reducing benefits relative to those under current law. These future benefit cuts supposedly wouldn't hurt workers, however, because they would be more than offset by the growth in their personal accounts.
Such schemes come wrapped in fine phrases about the "ownership society," but stripped down to their essence they are equivalent to an investment adviser telling you that you won't have enough money when you retire, but that you should make up for this shortfall not by saving more but by borrowing a lot of money, investing it, and trusting in capital gains.
Even if this strategy were successful, the payoff would be a long time coming. A Congressional Budget Office analysis of "plan 2" from Mr. Bush's social security commission, which is widely believed to be what Mr. Bush will eventually propose, found that it would increase the budget deficit every year until 2050. A similar analysis in last year's Economic Report of the President concluded that the debt incurred to establish private accounts, which would peak at almost 24 percent of GDP, wouldn't be paid off until 2060.
It's likely that financial markets would be made very nervous by borrowing on that scale, with the prospect of repayment so far in the future. Bear in mind that the debt incurred during the four decades of increased deficits would be a real, legally binding promise to repay, while the claim that privatization would save money in the long run depends on the assumption that whoever is running America half a century from now will follow through on benefit cuts, even if private accounts have performed poorly and left many retirees in poverty. In the real world, the bond market would consider the solid fact of soaring debt a lot more significant than projections of savings through politically determined benefit cuts many decades in the future. In practice, privatization would significantly increase the risk that international investors will stop lending to the United States, provoking a fiscal crisis, sometime in the not too distant future.
Even if we ignore the danger of provoking a fiscal crisis, the claim that borrowing to create private accounts will somehow benefit everyone is a remarkable exercise in free-lunch thinking. If nobody suffers any pain, where does the gain come from? If private accounts were invested in government bonds, as Mr. Bush suggested back in 2000, there would be no possible gain; the interest earned by private accounts would be completely offset by the interest paid on the government borrowing to fund these accounts. So the claim that there will be gains from privatization always comes down to this: part of the private accounts will be invested in stocks, and privatizers insist that stocks are more or less guaranteed to yield a much higher rate of return than the government bonds issued to pay for the creation of those accounts.
As Michael Kinsley of the Los Angeles Times has pointed out, there's something very peculiar about that assertion: if stocks are a clearly better investment than government bonds, why would anyone out there be willing to sell all the stocks that would end up in private accounts, and buy all the bonds the government would have to issue along the way? Are politicians pushing for privatization asserting that they know more about future rates of return than investors making decisions about where to put their own money?In response to such questions, privatizers duck the conceptual issue, and take refuge in history: stocks have, in fact, been a much better investment than bonds in recent decades. But as the mutual fund ads say, "Past performance is no guarantee of future results." Stocks are much more expensive relative to underlying profits than they were in the past, which means that they can be expected to yield a lower return. The best bet, suggested both by a look at the numbers and by basic economic theory, is that prospective returns in the form of dividends and capital gains on stocks are somewhat higher than those on bonds, but not much higher—and that the higher expected return on stocks is offset by higher risk. That's why prudent investors hold portfolios containing both stocks and bonds, and why borrowing to buy stocks—which is, to repeat, what Bush-style privatization boils down to—is a very bad idea.
Taking away the assumption that stocks will yield very high rates of return fatally undermines the arithmetic of privatization. Again, consider the analogy of borrowing and using the money to buy stocks: if those stocks end up yielding a lower rate of return than the interest rate on the loan, you've made yourself worse off. Even if your best guess is that the return on stocks will somewhat exceed the interest rate, you can't be sure of that, and you'll be in a lot of trouble if your guess proves wrong. Most privatizers assume, when selling their schemes, that stocks will yield about 7 percent a year on average after inflation, while the interest rate after inflation will be only 3 percent. If the equity premium—the spread between the average return on stocks and the average return on bonds—really were that large, borrowing to buy stocks wouldn't be a sure thing, but the odds would be strongly in favor of coming out ahead. But if the expected rate of return on stocks is only 5 percent or less, which many economists think is more reasonable, the chances that borrowing to buy stock will end up being a losing proposition are quite high—especially if one takes mutual fund fees into account.
Privatizers hate it when you talk about fees—about the fact, for example, that the much-touted Chilean system has administrative costs about twenty times those of Social Security, or that according to Britain's Pensions Commission, "providers' charges" in that country's privatized system reduce the size of retirement nest eggs by between 20 and 30 percent. But when we're talking about the narrow equity premium produced by realistic expectations of future yields, fees become a central issue.
The plan of Kotlikoff and Burns for personal accounts is useful as an example of what would be necessary to keep fees minimal: it calls for a system in which workers have no control at all over how their personal accounts are invested. Instead, all accounts would be placed in a global index fund administered by the government: "a single computer, situated in the Social Security Administration, would be programmed to buy and sell securities." In essence, the government, not individuals, would be doing the investing, and the personal accounts would simply be an accounting device. The administrative costs of running this system would be very low.But it's very unlikely, if Social Security is privatized, that the system will look like that. For one thing, the advertising for privatization stresses "choice." In fact, in 2002 the Cato Institute quietly renamed its Project on Social Security Privatization the Project on Social Security Choice (focus groups said that "privatization" had negative connotations). It's hard to see how to reconcile that advertising with a system in which a computer programmed by bureaucrats does all the choosing. Also, as a matter of political reality, the investment management industry isn't going to accept the idea that a huge pool of money and potential profits is off-limits. Investment companies gave lavishly to the inaugural celebrations, and are major contributors to the lobbying organizations that have been set up to push privatization. They aren't spending that money simply because they think privatization is in the public interest.
Suppose that we end up with a system like that of Britain or Chile, in which mutual funds compete to attract private accounts. In that case, there's every reason to believe that fees will take a large bite. In 2003, the average "expense ratio" on US stock funds—the ratio of all the various fees charged by management to the amount invested—was 1.5 percent. In Britain, providers' charges used to take more than 2 percent off the return of the average retirement account; new regulations have reduced that, but only to about 1.1 percent. Put fees of that magnitude plus a realistic rate of return on stocks into a typical numerical model of privatization, like the one in the CBO report on plan 2, and privatization quickly turns into a sure-fire losing proposition: the government borrows to establish private accounts that if anything yield an expected rate of return lower than the rate the government pays on its bonds; yet those accounts introduce a major new element of risk.
If Bush-style privatization actually goes through, the end game is fairly predictable: it's what is happening in Britain now. A couple of decades from now, it will be obvious to everyone that the returns on private accounts have fallen far short of expectations, and that America is about to experience a resurgence of poverty among the elderly. There will be irresistible demands for the government to call off cuts in benefit levels. (Remember, the over-sixty-five population will be an even larger share of the electorate than it is now.) And the result will be to make the fiscal outlook much worse than it would have been without privatization: the government will have borrowed trillions of dollars with the promise of future budget savings, but those savings will never materialize.
Medicare, Medicaid, and the Health Care Challenge
If demography is only a medium-sized problem, why do long-run federal budget projections look so scary? The answer is that they assume that the long-term historical tendency of health care spending to rise faster than gross domestic product will continue. That trend has not reflected runaway government spending: private spending on health care has risen almost as fast as government spending. (In 1980, private health spending was 5 percent of GDP, and government health spending was 3.8 percent. By 2003 the numbers were 8.3 and 7.0, respectively.) Nor is it a case of runaway inflation: rising medical costs have not historically been driven by rising prices for existing medical procedures. There is plenty of gouging and waste in the US health care system, but there always has been, so that's not a big factor in the trend. The main reason health care is continuing to absorb a larger share of the economy is innovation: that the range of things that medicine can do keeps increasing.
A good example of what drives rising health care spending is the recent decision by Medicare to pay for implanted cardiac devices in many patients with heart trouble, now that research has shown them to be highly effective. Should this be considered a cost increase? Only if we're careful about what we mean by "cost." It doesn't increase the cost of providing the same care as before; Medicare is spending more to take advantage of a new opportunity to save lives.
Because rising health care spending is, for the most part, driven by increased opportunities, it's not clear that a rising share of health care spending in the economy should be considered a bad thing. Here's what the Congressional Budget Office, the source of those frightening long-term projections, had to say:
Although the rise in health care costs is a serious concern for many policymakers, it largely reflects private choices.... As income rises, consumers may prefer to allocate a larger share of their resources to health care and a smaller share to other goods and services.
Still, there is a problem—but it is social and moral as much as economic: How much inequality in the human condition are we prepared to accept? In Charles Dickens's Britain there were huge class differences in health and longevity, because only the well-off had access to adequate nutrition and, if living in urban areas, to a more or less sanitary environment. Today those differences still exist but are much narrower, in part because of economic growth (which means that more people can afford an adequate diet), but also in large part because of public spending on sanitation, disease control, and health insurance systems that try, however, imperfectly, to provide essential care to everyone.But what do we do as medical advances make it possible to extend lives or greatly improve their quality, but only at a very high cost? Today we expect the public sector to pay for essential care when individuals cannot pay, and we do so for good reason. Imagine the inequalities that would already exist in America if Medicare wasn't there: high-income Americans would receive hip replacements and bypass surgery in their old age, while low-income Americans would find themselves crippled or dead. Yet the cost of preventing fundamental inequalities in medical care will grow over time.
This isn't just, or even primarily, a question of whether we are prepared to raise federal taxes to pay for rising Medicare and Medicaid spending. The clear and present dangers, health economists tell me, are the inability of state governments to pay their share of Medicaid, and the threat to private health insurance, which is gradually unraveling in the face of rising costs. Between 2001 and 2004, according to the Kaiser Family Foundation, the percentage of American workers receiving health insurance through their employers fell from 65 to 61, and this decline will continue unless the government starts helping out. (John Kerry's plan to have the government pay catastrophic health costs was an example of the sort of thing that may be required, but even that would have provided only limited relief.)
The problem of rising medical costs is much harder to resolve than that of an aging population. In the long run, in fact, it may be impossible to resolve. But there are things we could do to postpone the day of reckoning. One would be to prepay some of those future medical costs; at the very least, we ought to be building up a Medicare trust fund to deal with the demographic component of rising costs, i.e., the increase resulting from the rising proportion of people over sixty-five.
Another would be to find ways to make the US health care system more efficient. For the most part, that's a subject for another essay [see below, Doug], but it seems worth making one point: when it comes to health care, the free-market ideology that currently dominates American political discourse seems utterly wrong. Systems that provide universal coverage, like those of France or Canada, are much cheaper to run than our market-based system, yet they yield better results with respect to life expectancy and infant mortality. Or if you don't trust foreign examples, consider the remarkable renaissance of the Veterans' Administration hospital system, described in an important article by Phillip Longman in the February Washington Monthly: he shows that the VA system's centralization of information and control over resources allow it to provide better care at lower costs than any private system.
In other words, whatever the current administration and congressional majority propose to deal with the health care crisis—you can be sure they'll declare a crisis as soon as they're done with Social Security—will actually move our system in the wrong direction.
Back to the Future
Unless something very unexpected happens, Kotlikoff and Burns's vision of an America that in 2030 has an older population than Florida today will come to pass. It's also quite possible that the state of the nation will be as bad as they suggest in their opening account. But one won't be the result of the other, and in a perverse way exaggerating the demographic challenge makes that grim future more likely.
Here's how the debate is really playing out, in four easy steps:
1. Talking heads and other opinion leaders perceive the issue of an aging population not as it is—a middle-sized problem that can be dealt with through ordinary changes in taxing and spending—but as an immense problem that requires changing everything. This perception is, alas, fueled by books like The Coming Generational Storm, which blur the distinction between the costs imposed by an aging population and the expense of paying for medical advances.
2. Because the demographic problem is perceived as being much bigger than it really is, the spotlight is off the gross irresponsibility of current fiscal policy. As you may have noticed, right now everyone is talking about Social Security, and nobody is talking about the stunning shift from budget surplus to budget deficit since Bush took office.
3. The focus on Social Security—the one part of the federal budget that is actually being run responsibly—is, in practice, offering the architects of our budget deficit an opportunity to do even more damage.
4. Finally, we're not having a serious national discussion about the bigger problem of paying for health care, and we probably can't in today's ideological climate.
Four years ago, I and many other economists urged policymakers to think about the future cost of Social Security benefits, not because we thought there was anything wrong with Social Security itself, but because we regarded the future costs as a compelling reason not to cut taxes even if the overall budget was in surplus. Today, with the overall budget deep in deficit, and the administration considering "tax reform" that will amount to even more tax cuts for the well-to-do, it all seems a moot point. The first priority is to do something about the fiscal crisis we have right now, not worry about the fiscal crisis we might face a generation from now.
—February 10, 2005
 See www.ssa.gov/history/reports/trust/ trustyears.html, pp. 2–3.
 See www.cbo.gov/showdoc.cfm?index= 4916&sequence=2.
 Phillip Longman, "The Best Care Ever," Washington Monthly, February 2005.
LettersApril 7, 2005: Laurence J. Kotlikoff, A Problem & A Crisis
And more here from
Makes waaaaaaaay too much sense to be in the race, I know. (The link above should launch Windows Media Player automatically.)
14 October 2008
We are now entering the financial End Time. Bailout “Plan A” (buy the junk mortgages) has failed, “Plan B” (buy ersatz stocks in the banks to recapitalize them without wiping out current mismanagers) is fizzling, and the debts still can’t be paid. That is the reality Wall Street avoids confronting. “First they ignore you, then they denounce you, and then they say that they knew what you were saying all the time,” said Gandhi. The same might be said of today’s overhang of debts in excess of the economy’s ability to pay. First the policy makers pretend that they can be paid, then they denounce the pessimists as spreading panic, and then they say that of course students have been taught for four thousand years now how the “magic of compound interest” keeps on doubling and redoubling debts faster than the economy can squeeze out an economic surplus to pay.
What has ended is the idea that “the magic of compound interest” can make economies rich without having to work and without industry. I hope we have seen the end of derivatives formulae seeking to make money by playing in a zero-sum game. A debt overhang always ends either in foreclosure of the debtor’s property, or in a debt annulment to preserve the economy’s overall freedom and equity.
This means that the postmodern economy as we know it must end – either in financial polarization and debt peonage to a new oligarchic elite, or in a debt cancellation, a Jubilee Year to rescue society. But when the government says that it is reviewing “all” the options, this reality is not one of them. Treasury Secretary Henry Paulson’s first option was to buy packages of junk mortgages (collateralized debt obligations, CDOs) to save the wealthiest institutional investors from having to take a loss on their bad bets. When this was not enough, he came up with “Plan B,” to give money to banks. But whereas Britain and European countries talked of nationalizing banks or at least taking a controlling interest, Mr. Paulson gave in to his Wall Street cronies and promised that the government’s stock purchases would not be real. There would be no dilution of existing shareholders, and the government’s investment would be non-voting. To cap the giveaway to his cronies, Mr. Paulson even agreed not to ask executives to give up their golden parachutes, exorbitant annual bonuses or salaries.
Plan A (the $700 billion to buy mortgage-backed junk that the private sector will not buy) failed partly because it let financial institutions avoid putting a fair value on the debt packages they were selling. Instead of telling the truth about their financial position by marking assets to market prices), they can “mark to model,” Enron-style. We have seen the result: A solid week of plunging stock market prices. The public media call this a panic, but there is nothing irrational about it. Who in their right mind would buy securities or buy into a bank without knowing what the securities were worth? Faith in junk mathematical models has ended.
So we still await a public response to the problem of how to write down debts. Whose economic interest will have to give: that of debtors, as increasingly has been the case over the past eight centuries; or that of creditors, which have fought back to create a neoliberal economy controlled by the FIRE sector?
It is not too late to decide which road to take, but Wall Street bankers and creditors have taken the lead in positioning themselves. Seeing which way the political winds were blowing, they moved to empty out the Treasury before the November 3 elections much like medieval citizens fleeing a horde of Mongolian raiders under Genghis Khan. “We’re moving. Clean out the cupboards,” much as Lehman Brothers emptied out their foreign bank accounts in Britain and elsewhere just before declaring bankruptcy, taking what they could and steering it to their best friends.
The pretense was that a bailout was needed to restore confidence. But the ensuing week showed that the claims were false. It didn’t turn the stock market around as promised. The Dow Jones Industrial Average fell 2,200 points from Wednesday, October 1 through the following Friday October 10 – eight straight trading days, not even pausing for the usual zigzags. Friday’s plunge was 100 points a minute for the first seven minutes – a 690 point drop to under 8000. Each 100 points was more than a 1 percent drop, which was reflected on the NASDAQ. Nothing could withstand the pressure of so many Americans cashing in their mutual funds overnight and so many foreigners in earlier time zones putting in sell-at-market orders.
Short sellers made one of the largest and quickest fortunes ever, and then covered their positions by buying back the stocks they had pre-sold. This pushed prices up even into positive territory just before 10:30 AM when George Bush began to speak. Half the financial stocks showed gains – a sign that the Plunge Protection Team had jumped in. But Mr. Bush said nothing helpful and stocks went back into freefall, ending down another 128 points despite the upcoming weekend G7 meeting. There was no talk at all of reducing debt levels – only of giving more money to banks, insurance companies and other money managers, as if “pushing on a string” somehow would lead them to lend yet more to an already debt-ridden economy.
If Congress really wanted to restore confidence, here’s what it might have done: First, mark to market, not to model. Investors no longer believe America’s Enron-style accounting, debt rating agencies or monoline risk insurers. They don’t trust U.S. banks to be honest about their financial positions. They worry about the fraud charges brought by attorneys general in eleven states against predatory lenders such as Countrywide and Wachovia that Citibank, JPMorgan Chase and Bank of America were so eager to buy.
So is it too late for Congress to change its mind and repeal the giveaway? If the $700 billion handout didn’t stabilize the unsalvageable for small investors, pension funds and even the financial sector itself, what did it do?
What the Fed has been doing while the media have not been looking?
Let’s put the giveaway in perspective. While Senators and Congressmen subject to voters’ choice were debating $700 billion for the major Wall Street contributors to both parties (admittedly only for starters, Mr. Paulson explained), the Federal Reserve already had given even more, without any public discussion and without the major media noticing. Since Bear Stearns failed in March, the Federal Reserve has used the small print of its charter to go outside its normal customers (which are supposed to be commercial banks), to give investment banks, brokerage houses and now large corporations almost indiscriminately some $875 billion in “cash for trash” swaps. (The statistics are released each week in the Fed’s H41 report.) Like Aladdin offering new lamps for old, the Fed has exchanged Treasury securities for junk mortgages and other securities that brokerage houses and investment banks did not have time to pawn off onto OPEC, Asian sovereign wealth funds or other investors.
The press lauds Mr. Bernanke as “a student of the Great Depression.” If he were, he should know that what led to the 1929 collapse were harsh U.S. Government creditor policies toward its World War I Allied governments. This created a situation where the Federal Reserve had to provide easy credit to hold interest rates artificially low so as to encourage U.S. investors to lend to Britain and Germany, which would use these dollar inflows to pay their Inter-Ally arms and reparations debts. Mr. Bernanke’s predecessor, Alan Greenspan, promoted easy credit simply for ideological reasons, to enrich Wall Street by enabling it to sell more debt.
A student of the Great Depression would understand the conflicts of interest between retail commercial banking and wholesale investment banking and money management that led Congress to pass the Glass-Steagall Act in 1933 – conflicts unleashed once again when Pres. Clinton backed then-Fed Chairman Alan Greenspan and Republican leader (and McCain hero) Senator Phil Gramm in leading the repeal of this act, opening up the floodgates to today’s financial double-dealing that has cost the American economy so much.
If Mr. Bernanke does know this history, his behavior is simply that of an opportunistic student of the art of political self-advancement, toadying to Wall Street in campaigning for one last great rip-off before the Bush Administration goes out of business. The Fed has given Wall Street newly minted Treasury bonds, added to the national debt out of thin air. It has done this without feeling any need to rationalize it by drawing absurd public-relations pictures about how the government may “make a profit for taxpayers.”
The Fed Chairman is not elected democratically. He traditionally is designated by the Wall Street financial sector that the Fed is supposed to regulate, acting as its lobbyist for creditor interests – the top 10 percent of the population – against that of the indebted “bottom 90 percent.” This “independence of the central bank” is trumpeted as a hallmark of democracy. But it is undemocratic, precisely by being isolated from public control.
The Age of Oligarchy
Treasury Secretary Paulson has no such luxury. The Treasury is supposed to represent the national interest, not that of bankers – even though its head these days is drawn from Wall Street and acts as its lobbyist. Mr. Paulson presented his almost totalitarian giveaway gruffly to Congress on a take-it-or-leave it basis, announcing that if Congress did not save Wall Street from taking losses on its mountain of bad loans, the banks were willing to crash the economy out of spite. “Please don’t make us wreck the economy,” he said in effect. As Margaret Thatcher used to say while selling off the British government’s crown jewels in the 1980s, TINA: There is no alternative.
In making this bold threat Mr. Paulson behaved as arrogantly as Lehman’s CEO Richard Fuld did when he tried to bluff Korea and other prospective investors into paying the full, fictitiously high book value for his company. (His bluff failed and Lehman went bankrupt, wiping out its shareholders, including the employees and managers who held 30 percent of its stock.) There turned out to be an alternative after all. Responding to the loudest public condemnation in memory, Congress called Mr. Paulson’s bluff.
What made his $700 billion Troubled Asset Relief Program (TARP) so much more visible to the media than the Fed’s actions is that Congress is involved, and this is an election year. The level of deception and false argument is therefore enormous – along with a few tradeoffs and tax cuts to distract attention. Erstwhile Republican opponent Sen. Jeff Sessions of Alabama came right out and said that “This bill has been packaged with a lot of very popular things to give it even more momentum,” so that (as The New York Times explained), “instead of siding with a $700 billion bailout, lawmakers could now say they voted for increased protection for deposits at the neighborhood bank, income tax relief for middle-class taxpayers and aid for schools in rural areas where the federal government owns much of the land.”
Left behind while Wall Street’s believers in the rapture of free markets were swept up to heaven by “socialism for the rich” have been mortgage debtors, student-loan debtors, the Pension Benefit Guarantee Corporation (PBGC, some $25 billion short), the Federal Deposit Insurance Corporation (FDIC, about $40 billion short), as well as Social Security which, we are warned, may run up a trillion dollar deficit thirty or forty years down the line. Only the wealthiest have been beneficiaries, not voters, homeowners and other debtors.
Still, Congress was panicked into acting on Friday, October 3, because a week earlier, September 26, stocks fell 777 points after Congressmen responded to an unprecedented volume of voter protest against the bailout. “This sucker could go down,” Pres. Bush warned as Wall Street’s lobbyists blamed the market downturn to the failure of Congress to preserve the “monetary system,” and specifically the banks and insurance companies that already had lost their net worth and were plunging deeper into Negative Equity territory. Democratic leaders Barney Frank and House Speaker Nancy Pelosi said, in effect, “Look what you’ve done! You irresponsible politicians are grandstanding on principle, and wiping out peoples’ stock market savings and threatening their pension funds. If you don’t give Wall Street firms enough money to cover their losses so that everyone wins, they’ll kill the economy until they get their way.” Well, they didn’t quite say this, but that was basically their message. It certainly was Wall Street’s message: “Wall Street to Economy: Your money or your life.”
So Congress gave in. Democrats ran like lemmings to “save the economy.” Yet the stock market fell a few hundred points, and kept on plunging all week long, much worse and much faster than had occurred right after Congress had initially defeated the bill.
The “Reality Problem”
What did the “free market” theory underlying the giveaway leave out of account? For starters, “the monetary system” turns out to be a euphemism for the fortunes of financial gamblers using junk mathematics (the Merton-Scholes derivatives formula) based on junk economics (blessed with Nobel Prizes) to buy, speculate and even to insure junk mortgages, junk bonds and junk commercial paper and derivatives based on their relative prices. So what is left out first of all was full knowledge of the value of what is being bought and sold. Mark-to-market models leave the price up to the investment bankers. If trust existed and there really was honor among these thieves, a government bailout would not be necessary, because “the market” could clear.
“Free market” ideology assumes that each party will act in his or her self-interest. If this is so, why should foreign governments accumulate more dollar claims on the U.S. Treasury, which already owes their central banks $4 trillion? When there hardly were enough Treasury securities to go around even as the United States ran unprecedented federal budget deficits, U.S. officials urged these banks and sovereign wealth funds to buy packaged mortgages yielding a higher rate of return. And at least by buying these bonds, foreign governments would not be accused of funding America’s war in Iraq that most of their voters opposed. But investors made a fatal mistake in believing U.S. representations of the value of their junk-mortgage packages. This trust has now been lost, all the more so since the bailout’s permission to keep on “marking to market.”
Congress thought that its $700 billion would distract attention at least until the November 4 election. But to no avail. Markets fell 157 points on Giveaway Friday, and kept on going down another 800 points on Monday, October 6 (to about 9500) before bouncing 500 points off the floor, only to fall even more through Friday. So the giveaway failed in its stated purpose to rescue stock market investors (“peoples’ capitalism”) or their pension funds. But that was not its real purpose. The time simply had come to clear out and take whatever one could.
Making banks and insurers in the zero-sum derivative game whole, so that winners can collect their bets while losers can sell their bad investments to the Treasury, is supposed to re-inflate the credit pyramid. The idea is to solve the debt problem with yet more debt to prop up housing prices once again to unaffordable levels! This is not a long-term solution, but it would give insiders enough time to arrange a do-over and get out of the game more quickly, to sell out their junk mortgages and junk bonds to the proverbial “greater fool” – in this case, the “greater fool of last resort,” the U.S. Treasury, as long as it can be run by Mr. Paulson or, under Mr. Obama, perhaps the former Goldman-Sachs official Robert Rubin.
The banks are to “earn” their way out of their negative equity position by selling more of their product – credit – to increase the economy’s debt levels and hence receive more interest payments. The problem is that most families are already “loaned up.” They have no more discretionary income to pledge to carry more debt. Without writing down their debts, there will be no fresh lending, and hence no source of credit and purchasing power for new autos, appliances, goods and services in general. Debt deflation is being imposed on the “real” economy. Creditors and speculators alone are to be made whole.
If no revenue was available for future Social Security, public health care and repair the nation’s depleted infrastructure before this giveaway, think of how bare the cupboard must be now that the government has run up the recent trillions of dollars in new debt rather than writing off a penny of the bad mortgage debts being blamed for causing the debacle.
We can see where this is leading. The wealthiest 1 percent of the population will come into possession of even more returns to wealth than the 57 percent that they are now taking. In contrast to the Statue of Liberty’s inscription “give me your poor … yearning to breathe free,” the Fed – and now the Treasury, with Congressional blessing – is taking from the public purse and giving to America’s wealthiest investors and insiders. This “Robin Hood in Reverse” program is being done without strings, without asking banks to stop paying dividends, exorbitant executive salaries and golden parachutes, and without taking over banks with negative net worth of the kind that many homeowners are experiencing.
Nobody is talking about a debt write-down or moratorium. The subprime mortgage problem could have been solved by writing down just $1 or $2 trillion of the face value and interest rates of predatory loans. Instead, the $10+ trillion in financial-sector damage in recent weeks reflects Wall Street’s fraudulent packaging and sale of junk mortgages at unrealistically high prices, using junk mathematics to calculate junk derivatives and sell them to gullible investors who believe that the pretenses these mathematics, credit ratings and projected income have a basis in reality.
The amazing feature of today’s crash is how many Wall Street firms actually believed that the game of musical financial chairs could go on before they had to stop dancing and indeed, escape from the room. I remember one day back in the 1970s when I warned Frank Zarb of Lazard Freres about the likelihood of Third World debt defaults, and suggested that the firm should do an ability-to-pay analysis. “We don’t have to do any such thing,” he replied. “We have the schedule of what they owe right here in this IMF report.” It was a thick printout of the scheduled debt service for an African country that soon became insolvent. But Wall Street’s mentalité was that of Herbert Hoover on the eve of the Great Depression: A debt is a debt, and that is that. The response is to blame the victim, as if the irresponsibility lies with debtors rather than creditors.
No reversal of the Bush tax cuts is offered to re-inflate the economy, no move toward more progressive taxation of Wall Street speculators who pay only a 15 percent “capital gains” tax rate instead of the much higher income-tax and FICA withholding rates that wage-earners pay. (Wall Street has its own golden parachute program, so why should it pay for Social Security for the rest of society?) There is to be no reduction in the special tax benefits for real estate, whose tax favoritism led to the crisis by “freeing” more income from the tax collector to be pledged to mortgage bankers as interest. The Bubble Economy is to be re-inflated by Fannie Mae, Freddie Mac and the FHA lending to help buyers bid up housing and commercial office prices once again to a rate that promises to impose debt peonage on homeowners.
The budget deficit will soar, without any prosecution of tax evasion scams by UBS or KPMG. Instead of a fiscal or regulatory comet driving these dinosaurs to extinction, the climate has turned more conducive to their proliferation. Our Age of Deception is to be locked in even more tightly. The Congressional bailout’s suspension of mark-to-market rules to rely on Wall Street’s “self-regulation” should win a prize for Oxymoron of 2008 as investors have no clue as to what financial assets are worth. No wonder lending has dried up, especially to banks themselves.
Just as financial victims fail to vote and support their self-interest, predators also turn out to pursue self-defeating “free market” strategies. The financial sector’s short-termism is the greatest enemy to its survival. It has translated its wealth into a fatal political control of its legal climate, blocking [with the explicit support of Barack Obama, Editors] Congressional efforts to rewrite the oppressive bankruptcy laws that credit-card banks lobbied so hard to pass, [with vital help from Joe Biden, the senior senator from credit card company HQ, the state of Delaware, Editors] crucial. These hard bankruptcy terms prevent the courts from renegotiating homeowner debts to keep property occupied, accelerating the real estate price collapse. The result is today’s negative equity, posing the question of just who is to bear the cost of bring debts back in line with the economy’s ability to pay. Will it be the financial institutions that sponsored asset-price inflation and lobbied for deregulation of lenders? Or, will it be the debtors who thought they were riding the wave to get an inflationary free lunch?
Instead of requiring creditors to absorb losses on the excess of debts over what can be paid, the debts are being kept in place, not scaled back to what the economy can pay. The government is to make creditors and computerized derivatives speculators whole – and will act as collecting agent for the overhead of bad debts the economy has run up.
Today we can see the debt-fueled bubble of asset-price inflation that Alan Greenspan trumpeted as real wealth creation for what it really is – credit creation to bid up real estate, stock market and packaged-debt prices. Tangible capital formation has been left out of account, as if postindustrial economies no longer need it.
Will voters see the asymmetry in Congress’s failure to offer debt relief for homeowners as real estate prices plunge below the mortgages that are owed? Will its members be blamed for not rewriting the nation’s bankruptcy laws to free families from debt peonage – and free housing markets from the price declines that result from today’s proliferation of foreclosure sales? For that matter, will there be no relief for corporations having to cut back investment in order to service their junk bonds and other debts with which Wall Street’s corporate raiders and “shareholder activists” have loaded then down?
Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, email@example.com
The derivatives markets of today have become a high stakes casino of unimaginable magnitude. Wall Street's bets have gone bad, and now the whole financial system is in peril. In a best-case scenario, it appears, the taxpayers will be required to rescue the system from itself. This is why Warren Buffett labeled derivatives "weapons of financial mass destruction."
Amazingly, there seems to be some lingering sense that current-day derivatives properly perform an insurance function.
Case in point: Alan Greenspan, the former Federal Reserve Chairman. Greenspan says the world is facing “the type of wrenching financial crisis that comes along only once in a century,” but, reports the New York Times, "his faith in derivatives remains unshaken." Greenspan believes that the problem is not with derivatives, but that the people using them got greedy, according to the Times.
This is quite a view. Is it a surprise to Alan Greenspan that the people on Wall Street -- said to be ruled only by the opposing instincts of greed and fear -- "got greedy?"
This might be taken as just a bizarre comment, except that, of course, Alan Greenspan had some considerable influence in driving us to the current financial meltdown through his opposition to regulation of derivatives.
A series of deregulatory moves, blessed by Alan Greenspan, helped immunize Wall Street derivatives traders from proper oversight.
In 1995, Congress enacted the Private Securities Litigation Reform Act (PSLRA) of 1995, which imposed onerous restrictions on plaintiffs suing wrongdoers in the stock market. The law was enacted in the wake of Orange County, California's government bankruptcy caused by abuses in derivatives trading. An amendment offered by Rep. Ed Markey would have exempted derivatives trading abuse lawsuits from the PSLRA restrictions. In defeating the amendment, then-Representative and now-SEC Chairman Chris Cox quoted Alan Greenspan, saying “it would be a grave error to demonize derivatives;” and, “It would be a serious mistake to respond to these developments [in Orange County, California] by singling out derivative instruments for special regulatory treatment.”
The New York Times reports how the Commodity Futures Trading Commission aimed for some modest regulatory authority over derivatives in the late 1990s. Strident opposition from Treasury Secretary Robert Rubin and Alan Greenspan spelled doom for that effort.
Senator Phil Gramm helped drive the process along with the Commodities Futures Modernization Act of 2000, which deregulated the derivatives market.
Defenders of deregulation argued that sophisticated players were involved in the derivatives markets, and they could handle themselves.
It's now apparent that not only could these sophisticated players not handle themselves, but that their reckless gambling has placed the entire world's financial system at risk.
It seems to be then a remarkably modest proposal for derivatives to be brought under regulatory control.
Warren Buffett cut to the heart of the problem in 2003: "Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons," he wrote in his annual letter to shareholders. "This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counterparties. Imagine, then, that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a corporate meltdown."
That is to say, our current problems were foreseeable, and foreseen. There is no excuse for those who suggest that present circumstances --what many are calling a once-in-a-hundred-years event -- were unimaginable during earlier debates about regulation.
Some ideologues continue to defend derivatives from very strict government control. As Congress moves to adopt new financial regulations next year, hopefully the proponents of casino capitalism will be given no more credence than those insisting that the sun revolves around the earth.
Ralph Nader is running for president as an independent.
Governments got religion after peering into the systemic meltdown abyss: aggressive and comprehensive policy action is now likely, Nouriel Roubini
...but significant downside risks to markets will remain
I spent the weekend in Washington attending the IMF annual meetings and giving a series of talks in a variety of public and private fora (IADB talk, C-Span interview, Euro 50 Group meeting, IMF panel, etc.). After last week crash in stock markets and financial markets (and it was indeed a crash as during the week equity prices fell as much as the two day crash of 1929) policy makers finally realized the risk of a systemic financial meltdown, they peered into the systemic collapse abyss a few steps in front of them and finally got religion and started announcing radical policy actions (the G7 statement, the EU leaders agreement to bailout European banks, the British plan to rescue – and partially nationalize - its banks, the European countries plans along the same lines, and the Treasury plan to ditch the initial TARP that was aimed only buying toxic assets in favor of plan to recapitalize – i.e. partially nationalize – US banks and broker dealers. While many details of these plans are fuzzy and there will be some national variants the contour of the approach are similar and close to the recommendations that I made in this forum. Here are the main policy actions that will be undertaken:
- Preventing systemically important banks and broker dealers from going bust (i.e. the U.S. made a mistake letting Lehman fail; so Morgan Stanley and other systemically important financial institutions will be rescued) (“Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure” as in the G7 statement )
- Recapitalization of banks and broker dealers via public injections of capital via preferred shares (i.e. partial nationalization of financial institutions as it is already occurring in the UK, Belgium, Netherlands, Germany, Iceland and, soon enough the U.S.) matched by private equity injections (“Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses”)
- Temporary guarantee of bank liabilities: certainly all deposits, possibly interbank lines along the lines of the British approach, likely other new debts incurred by the banking system (“Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail depositors will continue to have confidence in the safety of their deposits”)
- Unlimited provision of liquidity to the banking system and to some parts of the shadow banking system to restore interbank lending and lending to the real economy (“Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses”)
- Provision of credit to the corporate sector via purchases of commercial paper (certainly in the US, possibly in Europe)
- Purchase of toxic assets to restore liquidity in the mortgage backed securities market (U.S.) (“Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.”)
- Implicit triage between distressed that are solvent given liquidity support and capital injection and non-systemically important and insolvent banks that will need to be closed down/merged/resolved/etc.
- Use of the IMF and other international financial institutions to provide lending to many emerging market economies – and some advanced ones such as Iceland - that are now at risk of a severe financial crisis.
- Use of any other tools that is available and necessary to avoid a systemic meltdown (including implicitly more monetary policy easing as well as possibly fiscal policy stimulus “We will use macroeconomic policy tools as necessary and appropriate.”).
At this stage central banks that are usually supposed to be the "lenders of last resort" need to become the "lenders of first and only resort" as, under conditions of panic and total loss of confidence, no one in the private sector is lending to anyone else since counterparty risk is extreme. Only over time private lending will recover.
While most of the economic and financial damage is already done and the global economy will not be able to avoid a painful recession, financial and banking crisis (i.e. the V-shaped short and shallow 6-month recession is now out of the window and we will experience a severe and more protracted 18 to 24 months U-shaped recession) the rapid and consistent implementation of these and other action will prevent the US, European and global economies from experiencing a systemic financial meltdown and entering in a more severe L-shaped decade long stagnation like the one experienced by Japan after the bursting of its real estate and equity bubble.
Are we close to the bottom of this financial crisis? Today stock markets – and other financial markets - will rally on the news that terrified policy makers peering into the abyss got religion and started to do in a consistent way what is necessary but financial markets will remain volatile with significant downside risks over the next few weeks as:
- details of these plans are still very fuzzy and ambiguous and with uncertain effects on various assets classes (common shares, preferred shares, unsecured debt of financial institutions, etc.);
- macro news will surprise on the downside as the economies sharply weaken and contract while fiscal policy stimulus is lagging;
- earnings news for financial and non financial firms will surprise on the downside;
- the damage done to confidence and to levered investment is already severe and the process of deleveraging of the shadow financial system will continue;
- major sources of future stress in the financial system remain; these include the risk of a CDS market blowout, the collapse of hundreds of hedge funds, the rising troubles of many insurance companies, the risk that other systemically important financial institutions are insolvent and in need of expensive rescue programs, the risk that some significant emerging market economies and some advanced ones too (Iceland) will experience a severe financial crisis, the ongoing process of deleveraging in illiquid financial markets that will continue the vicious circle of falling asset prices, margin calls, further deleveraging and further sales in illiquid markets that continues the cascading fall in asset prices, further downside risks to housing and to home prices.
More aggressive and consistent and rapid implementation of the policy plans will increase the likelihood that risky asset prices will bottom out sooner rather than later and then start recovering. A key policy tool – that is currently missing in the G7 and EU plans is to use fiscal policy to boost aggregate demand. Indeed, given the current collapse of private aggregate demand (consumption is falling, residential investment is falling, non-residential investment in structures is falling, capex spending by the corporate sector was falling already before the latest financial and confidence shock and will now be plunging at an even faster rate) it is urgent to provide a boost to aggregate demand to ensure that an unavoidable two-year recession does not become a decade long stagnation. Since the private sector is not spending and since the first fiscal stimulus plan (tax rebates for households and tax incentives to firms) miserably failed as households and firms are saving rather than spending and investing it is necessary now to boost directly public consumption of goods and services via a massive spending program (a $300 bn fiscal stimulus): the federal government should have a plan to immediately spend in infrastructures and in new green technologies; also unemployment benefits should be sharply increased together with a targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend old fashioned traditional Keynesian spending by the government is necessary. It is true that we are already having large and growing budget deficits; but $300 bn of public works is more effective and productive than spending $700 bn to buy toxic assets. Is such fiscal stimulus plan is not rapidly implemented any improvement in the financial conditions of financial institution that the rescue plans will provide will be undermined – in a matter of six months – with an even sharper drop of aggregate demand that will make an already severe recession even more severe. So a fiscal stimulus plan is essential to restore – on a sustained basis – the viability and solvency of many impaired financial institutions. If Main Street goes bust in the next six months rescuing in the short run Wall Street will still lead Wall Street to go bust again as the real economy implodes further.
Moreover, the US government will need to implement a clear plan to reduce the face value of mortgages for distressed home owners and avoid a tsunami of foreclosures (as in the Great Depression HOLC and in my HOME proposal). Households in the US have too much debt (subprime, near prime, prime mortgages, home equity loans, credit cards, auto loans and student loans) while their assets (values of their homes and stocks) are plunging leading to a sharp fall in their net worth. And households are getting buried under this mountain of mounting debt and rising debt servicing burdens. Thus, a fraction of the household sector – as well as a fraction of the financial sector and a fraction of the corporate sector and of the local government sector – is insolvent and needs debt relief. When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction and is then able to resume fast growth; when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment, production and growth; when a household is financially distressed it also needs debt relief to be able to have more discretionary income to spend. So any unsustainable debt problem requires debt reduction. The lack of debt relief to the distressed households is the reason why this financial crisis is becoming more severe and the economic recession - with a sharp fall now in real consumption spending – now worsening. The fiscal actions taken so far (income relief to households via tax rebates) do not resolve the fundamental debt problem because you cannot grow yourself out of a debt problem: when debt to disposable income is too high increasing the denominator with tax rebates is ineffective and only temporary; i.e. you need to reduce the nominator (the debt). During the Great Depression the Home Owners’ Loan Corporation was created to buy mortgages from bank at a discount price, reduce further the face value of such mortgages and refinance distressed homeowners into new mortgages with lower face value and lower fixed rate mortgage rates. This massive program allowed millions of households to avoid losing their homes and ending up in foreclosure. The HOLC bought mortgages for two year and managed such assets for 18 years at a relatively low fiscal cost (as the assets were bought at a discount and reducing the face value of the mortgages allowed home owners to avoid defaulting on the refinanced mortgages). A new HOLC will be the macro equivalent of creating a large “bad bank” where the bad assets of financial institutions are taken off their balance sheets and restructured/reduced.
A large fiscal stimulus plan and a plan to reduce the debt overhang of distressed home owners will also ease the political economy of the financial bailout: as the debate in Congress showed the US public is mad about a system where gains and profits are privatized while losses are socialized, a welfare system for the rich, the well connected and Wall Street. Bernanke and Paulson and the US administration did a lousy job in explaining why partially bailing Wall Street is necessary to avoid severe collateral damage to Main Street in the form of a most severe recession and a risk of an even more severe economic stagnation. At least the redesign of the TARP into a program that will recapitalize banks with public capital (and thus provide the US government and the taxpayer with some upside potential) makes this bailout more socially fair and acceptable.
But the current collapse of private aggregate demand makes it fair, necessary and efficient to directly help Main Street with a direct fiscal stimulus program and with a plan to reduce the debt burden of distressed home owners. Those two additional policy actions are necessary and fundamental – together with the rescue and recapitalization of financial institutions – to minimize the damage to the real economy and to the financial system.
Post-Scriptum: Many many congrats to Paul Krugman for his very well deserved Nobel Prize in economics. While the prize was awarded to Paul for his contributions to trade theory his work in international macro/finance (currency and financial crises, currency target zones, reserve currencies, pass-through of exchange rates to import prices, contractionary effects of devaluations, sovereign debt crises, etc.) is as important and seminal. And his economic commentary is as incisive and deep as his more analytical research work.
13 October 2008
Max Blumenthal on Sarah Palin’s Radical Right-Wing Pals and Her Ties to the Pro-Secessionist Alaskan Independence Party
As the McCain campaign continues to focus on Senator Obama’s alleged ties to former Weather Underground member William Ayers, a new investigation in Salon.com sheds light on how Governor Palin’s ties to the radical right are far deeper than previously thought. Journalists Max Blumenthal and David Neiwert detail how Palin was elected Mayor of Wasilla over a decade ago with the help of activists from the Alaska Independence Party and the John Birch Society. They allege that she tried to return the favor later by attempting to appoint one of them to an empty city council seat. [includes rush transcript–partial]
Former McCain Supporter Accuses the Senator of "Deliberately Feeding the Most Unhinged Elements of Our Society the Red Meat of Hate"
Frank Schaeffer is the bestselling author of Crazy for God: How I Grew Up as One of the Elect, Helped Found the Religious Right, and Lived to Take All (or Almost All) of It Back. He is the son of the late evangelist Francis Schaeffer and considered himself a lifelong Republican. He voted for John McCain in 2000, and McCain even endorsed one of Schaeffer’s earlier books on military service. But on Friday, Schaeffer published an open letter to McCain excoriating the Arizona senator.
“From Republicans at political rallies to GOP lawmakers on TV talk shows, McCain-Palin supporters are angry, very angry—and they seem to think their anger justifies whatever they do: from calling Barack Obama a ‘terrorist’ to shouting ‘kill him’ and ‘off with his head’—to getting huffy when their violent rhetoric is challenged,” writes investigative reporter Robert Parry, editor of ConsortiumNews.com.