Monday, July 21, 2014

The Way Forward [Updated: Obama announces opposition to a blank check.] (2008)

Let us speak of rights and reason. Of rights we have to begin from the final humiliation against a free people a proposal to grant dictatorial powers to an outgoing administration. In effect, the ability to hide all of the financial wrong doing of the last 8 years.

However, what is important now is a solution. What we need now, is reason in action, as we already have reason to act.

[Updated: Obama has announced opposition to the principles of the Paulson plan. Details after the fold.]

It would give Paulson not only the power to buy assets, but put terms in place which would make legal investigation of those arrangements impossible, and these contracts could not be questioned in a court of law. It is the Authorization for Use of Military Force, Protect America Act, and war spending votes all rolled into one. Having seen that it cannot assume theunitary executive since the Supreme Court rejected it, they are now turning to Article III to get a trembling Congress to accept it. There is a crisis, but there is no catastrophe. Even when the physical nexus of the financial world was directly attacked, there was no need for this kind of unlimited spending power.

The outlines of that solution are beginning to be accepted. It is a simpler, and broader, solution than has yet penetrated the minds of the interiors of power, because it is not about how to pay for a clean up within a functioning system, but how to change the system itself.

This is not a financial crisis in the end, as the Paulson Proposal shows, but a constitutional moment, where the very mandate of government is in play. Paulson wants the tax payer to be the fool of last resort, the group of people stupid enough to buy things that no one else on the planet is stupid enough to buy. We have reached the currency crisis which the election of 2000 implied would come. If we do not solve it now, it will only recur, in a worse form, soon enough.

The gut reaction on the Paulson proposal is a resounding Hell No. The word reviled is not to strong.

Even the University of Chicago's finance department cannot swallow the monster that has crawled from the cabinet.However Luigi Zingales mentions the key point. What is clogging the restructuring of debt are lynch pins that tie speculative money to ultimately scarce assets that cannot grow any farther. In the case of the Great Depression, that asset was gold. Gold could no longer grow as fast as the economy, debts pegged to gold hobbled the global economy. FDR dispensed with this, and the Supreme Court agreed. Ultimately the government must enforce contracts, and contracts which bring an end to government itself, must, therefore fall.

It is self-evident, or at least has been to Americans since we were Americans and not British subjects in America, that government is instituted by the people, however construed, for the good of the people. There have been three long struggles since that moment. The first has been to acknowledge that all people are members of The People, the second is to establish broadly the good which they have a right to expect,  and the third is to provide more perfect instruments for the first to pursue the second.

Governments then have a basic mandate to enact the good, they have mechanisms to effect that mandate, one of which is money, and they have a relationship to the people which constitutes the meaning of government. The Paulson Proposal is, in effect, an amendment to the Constitution, which states that the executive, in its sole discretion, has a mandate to prop up the financial sector at whatever cost, without review. It states that it has the mechanism of unlimited and unfettered spending power. It asserts a meaning which is foreign to virtually every part of the political spectrum, libertarians, conservatives, centrists, liberals, and socialists alike have balked at this vast grab of power which violates separation of powers, accountability, and virtually every other principle advanced for the protection of a Democracy. This much is obvious, and is obvious to millions of people. The Paulson Proposal is a demand for economic servitude.

However, it is not enough to reject the wrong. It is important to assert the right, as, in the famous words of perhaps our greatest president, God gives us the grace to know the right. It is not enough to reject the Paulson proposal, but to assert that there is a clearer and better way forward.

The Red Queen's Race

The first step to doing this is to explain the present crisis clearly. This is because people are often aware of the lesser crimes that were instrumental to the greater crime, but not their meaning. It would be like banning shifting into reverse, because that is what the get away car did to escape from the mafia paid homicide. Many of the individual actions which have led here are neutral, or if not neutral, incidental, to the problems themselves. If not these mechanisms, then some others would have been taken. It is not wrong to ban some of the particulars, but only if, importantly, the root cause is also addressed.

The particular financial crisis began, so it is said, from sub-prime mortgages going wrong. This is in correct, in that those mortgages existed because of inflated money supply. That inflated money supply existed because of ultra-low interest rates produced by the Fed. Those interest rates existed because of the necessity of using them to pay for the Iraq war without increasing taxes on the wealthy.

However the Iraq war was not a individualized lurch rightward, nor were many of the actions which have led to this crisis taken by Bush. Glass-Stengall was repealed by Clinton, not Bush. Much of the financial system deregulation was written by Bob Rubin, not Hank Paulson. From this it has been theorized that there is a conspiracy of bankers out to suck the life out of the ordinary people. If only it were that simple.

The reality is that the reason people of both reactionary and progressive impulses alike have walked the road of perpetual consolidation, we are now down to two major investment banks from five, is that there has been an underlying necessity that has pushed them forward. There were other solutions, but once this one was chosen, there was no political will, nor any political capital for a different one. Here is what happened and why.

In the 1930's America abolished the gold standard for individual debts, and instead dollars were issued based on loans made on good assets in banks. A system of insuring and examining and regulating those banks was created, and investment banking and retail banking were separated, this was not done all at once, it was not done by design, it was however, within a paradigm or design pattern. Once the idea of stabilizing the anchors of the economy was come upon, and using promises of the people as the foundation for that stability, each additional step became easier and clearer. The feverish activity of the first week of what was to become the "Hundred Days," gave way to long and protracted political battles.

The new basis then, was the value of developed land. The incentive was for Americans to develop their cities and towns, and reap the rewards of increased home values and stability of their communities. This, in turn, created the ability of the government to print more dollars, relatively confident that if there was a dollar, then somewhere there was economic activity underneath it. There was, at least, someone with an address who could be taxed.

The model that we used for development was the automobile, and we saw the rise of the automobile city, which was far more sprawled out than the old industrial city. Old industrial cities have population densities of around 7000 to 10000 per square mile, where as automobile cities peak at around 3000 per square mile and often have as little as 750 per square mile. In short, the use a great deal more land, and a great deal more gasoline per capita to create and support. Suburban sprawl reaches a particular density, and then it sprawls outward farther.

As long as all the oil came from the US, it was not much of a problem. There were fights over who got to be part of the truly personal mechanized society, there were even more brutal fights over those on the margins of that society. Civil Rights were, at basis, the right to be part of the new age that was spreading across America.

However, in the late 1960's American oil production slowed. This was exacerbated by the Vietnam War, which created spending on activities that did not aid America, but the same wall was coming with or without the Gulf of Tonkin Resolution. At first there were attempts to stave this off, but, in the early 1970's the Arab oil producers enforced their role as the swing producer in the world, by using an embargo. Later there would be a war between Iran and Iraq. The intermediate steps, such as abandoning Bretton-Woods and creating a floating currency regime, deregulating the airlines, attempts to save gasoline, were all stopgaps until a new basis for the global economy came into being. That basis was the paper for oil economy. In this economy the United States generated paper based on development arbitrage and technology, which Arabs bought, and in return they sold us oil for that paper which we were to turn around and use to create more paper.

It served, in a way, both interests. First it gave the oil to the old sprawl system, and for the Arabs it provided an umbrella of protection and stability, as well as assets for the time when their oil no longer commanded the same premium that it did then. The internal response in the US was to create a Red Queen's Race, where it was made harder and harder to own the assets of America, at the same time, the Arab states grew socially conservative, and attempted to thwart the rise of a middle class that would demand imports and capitalization. It was an agreement by the conservative forces in both systems, and in turn both used it to drive their respective political systems to the right, even though underlying technological and social trends were for greater liberalization and freedom.

It is this dynamic, and not any of its subsidiary moves, that is important. The implementation of trade, banking deregulation, tax policy are all means by which the United States and the West tried to stay one step ahead of oil. The roots of this crisis are then the demand to keep the sprawlconomy going, the decision to engage in the paper for oil economy, and the de facto result of making it so that the wealthy, rather than the society as a whole, would hold the paper. In short, our rich, had to stay ahead of their rich. This created the most important race to the bottom: of top tax rates. It is impossible to tax our wealthy more than their wealthy taxed themselves.

The 1% Solution

The death of this system was that it worked too well, in that with the coming of the internet bubble it seemed as if the "New Economy" would replace "Bricks and Mortar." Oil prices plunged to their lowest real value since the coming of the petroleum age. Arab nations bled dollars, and were under pressure. The Clinton-Rubin dollar drought nearly capsized the conservative economies of Saudi Arabia and other oil states. Many responded, not by liberalizing, but by creating even more radical anti-Western ideologies, to hold of the wave of liberalization that would inevitably come should the become consumer states.

This dynamic threatened the very basis of the reactionary coalition in America. They had always assumed that they had stacked the deck for a permanent Republican majority and hold on power. Thwarted over and over again by Clinton in their attempts to secure power in the 1990's, it became evident that the left could play the paper for oil game better than the right could. This is because the left, not the right, had become the party of free markets, and since the left had much less concern over who got rich, it was able to open more opportunities. Free Trade, the dotconomy, a reduction in military spending and corresponding increase in civilian investment all altered the very composition of the small club of the Republican Party.

The dot bust that followed the dot boom was, to some extent, timed. Greenspan's rate raising campaign of 1999 and 2000 was not outside of the bounds of discretion as Fed chairman, but it was more aggressive than he had been with a Republican President in trouble, and was much less accommodating than he would be with a later Republican. In other words, what he did wasn't obviously manipulation of the election, but it was out of character.

It was in this environment that the election of 2000 occurred, American was on the cusp of, but not yet in, recession. It had had a brief period of broad prosperity, but not yet completely taken hold. It was also facing a massive crash in speculative equities. Enter George W. Bush.

His overt promise was to bail the wealthy out of their dot crash with tax cuts. These tax cuts satisfy the need of the Red Queen's Race, in that they gave money back to Americans, and much less to others. Thus preventing a situation where assets would be bought up cheaply while illiquid. However, the response of the oilarchies, at the bottom of the crash, was to sell. This was the brutal climax of a three year long bear market, which occurred in the summer of 2002. The plan had been to lower interest rates through the floor, pressure the yield curve to favor mortgages over industrial output, and buffer industry with a war. When the bubble popped, the insolvent banking system would be bailed out by ordinary people, leading to a frozen in place economy. This process I labelled Japanification. It would lead to a long period of stagnation, where the majority people would not live that badly, but they would have little hope of improvement, and face increasing pressures personally and financially.

Thus, it was not enough to bail out our rich, it was necessary for Bush, if he and others wanted a permanent reactionary state, to control a flow of oil to pour into their version of the sprawlconomy. This was the Iraq War, and the ultra-low interest rates that Greenspan provided, by his own admission, had two purposes. One was to get as many people to own homes as possible, the other was to finance the war. Both policy results were failures. The costs of the failure in Iraq are not necessary to go over here. What is more important is the housing bubble caused by the failure of the Fed to accept in 2005 that the Bush economy had failed, and take the economy into recession then, ending the building boom, and force the fiscal reckoning in Congress. Instead we received horse hockey hokum from Greenspan, even as the numbers he presented showed that almost all of the increase in debt was going to fuel short term consumption.

The 1% solution to the Red Queen's race was to allow our top 1% to pile up asset inflation to match the petro-dollar acquisition of assets. The Iraq war was a recognition that, to keep the Republican base, oil was needed, and to keep control of the top, it had to be in American hands.

"Financial Genius is Leverage and a Rising Market."

John Kenneth Galbraith quipped that financial genius is leverage, and a rising market. It is for this reason. among others that he had a suspicion of the "dubious magic of monetary policy." Monetary policy means that those who have, get. Monetary policy means that those first in line at the bank window, get to sell at a profit to those farther down that line. It is not a neutral market stimulus, but, in fact, a very specific one.

In our case leverage was provided not only by low interest  rates, but by the SEC relaxing leverage ratios, the failure of various regulatory agencies to enforce laws already on the books, let alone new laws that might have been desirable being passed.

The reason that mortgages were the basis for this vast mountain of instruments is relatively simple. The United States partially liberalized it's economy. Some people competed very directly against the rest of the world, while others did not. People naturally fled from competitive exporting, to non-competitive non-tradeables. One can't go to Singapore for a Big Mac tonight. One can't buy a house in Ireland to commute to a job in Topeka. One can't go to a hospital in Mumbai. And we don't let people build our aircraft carriers, such as the Ronald Reagan, George Herbert Walker Bush, or Gerald Ford.

As with many things, what we got was socialism, protectionism, Keynesianism and liberalism - for the Republican Coalition. This was the practical political realization of the post-Reagan Republican Party. They couldn't afford to buy landslides any more, but they could afford to buy enough of the cheap states to control Congress and the Presidency. With the occasional assist from the Supreme Court.

But mortgages had another magical property, and that is that they were the heart of the sprawlconomy, and no political party could be allowed to have them fail. Thus the bet was that if everything went wrong, there would be a massive bailout. The British fretted over the lack of "moral hazard." In finance terms, almost any position is better if you don't have to protect against the downside. In the circles I travelled in, this was known as the "eating babies" case. "Well if that happens the world has gone to hell and we are  all eating babies, so it doesn't matter." For example the effects of global thermonuclear war can be discounted, because we will have other things on our mind than the value of our Intel shares.

However, the trick was to systematically create investments which would all go wrong at once, and then proclaim that they could not. The catalog of financial games, for example, packaging sub-prime loans valued at the face value of the loan, which was highly unlikely to be paid, while at the same time packaging good loans at the default value of the house, which was virtually impossible to occur, because if the owner defaulted it would be because of a massive economic downturn, were just two of the tricks used in creating Collateralized Debt Obligations and derivatives that had no relation to reality.
The truth about finance is that it is about giving people permission to do things they otherwise would not be allowed to do. It is, therefore, a social utility. The key to controlling finance is not regulation per se, but in having a social project to which it is directed. Regulation then, is the way we tell that institutions are following the socially and politically agreed upon course. If the course is wrong, no amount of regulation will work, because even if it is still on the books, it is dead letter.

Thus with Greenspan, Bernanke, and others who were part of - not merely the broadly agreed upon paper for oil project, which both Democrats and Republicans signed on to - the project for a permanent Republican and reactionary order, regulations and indeed economic sobriety were out the window.

The reason Greenspan got the nick name "bubbles" was for his practice of finding a way to inflate the top level money supply, called M3, without it becoming consumer demand. Inflation was defined as "inflation of consumer goods." This is the inflation that our foreign bond holders care about, because it is their buying power from us. Thus, a simple policy measure was in place: make the broades measure of money supply, called M3, go up, without inflation in what America sells, called "core inflation" rising beyond a comfort zone. All this sounds bloodless and analytical, until you realize that it is impossible to sustain. This is because core inflation can only be contained by monetary policy if the money ordinary people have access to is expensive and scarce. A good measure of this money is called "M1." But M3 is just M1 on quaaludes. All of the bets made that are in M3, have to be paid back by M1.

Now you can do this for a little while by two expedients. One is to make it so people who buy assets accept less return on their investment, as measured by say "Price to Earnings Ratio" or interest rates. The other is to drain the savings rate of ordinary people, so that money is flying around faster and faster. This is called "the velocity of money."

However, both of these have limits. At a certain point buyers are getting the lowest returns they can accept, and consumers are not saving. In fact, by the marginal theory of utility, it will go on a bit longer than it should go on, because it takes a while for people to realize that no only are they losing money, they aren't going to make money. In this decade, the total annualized real return on the S&P 500 has been - negative. That's right, money put into the S&P, including dividends, has been behind inflation. And that's just in dollars. In this decade the US savings rate has turned - negative. That's right, we are spending down. In this decade American wages have been, in real terms, negative. And that's before we count in the housing bubble.

This then was the state of affairs at the time when Daniel Altman labelled this a revolutionary gamble to create a neoconomy

The Adventures of Captain Carnage

Benjamin Bernanke is an academic expert. Specifically, he is an expert in how to manage a crash in assets, without creating a situation where the rich will require a bail out from the public, and the public, in turn, demands real control over the society. His thesis was that the Federal Reserve in the Great Depression could have printed money to prevent deflation, and then used extra-ordinary means to prevent inflation. His argument was that FDR, in though not in so many words, could be prevented if only the right macroëconomic policies had been taken, followed up by using gaps in the system if need be.

Bernanke was, thus, obviously, the choice for Fed Chief after Greenspan. He has the misfortune of having had his policies put into practice, to borrow a quip from John Kenneth Galbraith. His failure was the attempt to impose microëconomic manipulation and market failure on macroëconomics. His papers do not hold together even as they are written, and I am happy to say I was busy calling him a fraud before it was fashionable. It will be a lot more fashionable very soon.

But for practical purposes, it is enough to note that starting in 2007, when the various positions began what Krugman labelled "The Great Unravelling". In financial terms, a position unravels when it's parts no longer work together. A sophisticated investment is not merely picking stocks you like, but in putting together different possible futures, and having something that will do well in all of them. A position unravels when the future doesn't coöperate.

The assumption that mortgages would not be allowed to unravel  met head on with the assumption that unlimited amounts of money could be created, so long as that money did not become demand for real things. This is the contradiction mentioned above. It is impossible for financial instruments to expand for ever, and for wages to stay flat forever, without bringing new people in to the system. It is impossible to do this with a basically constant amount of oil.

This problem is known to engineers as the problem of "scaleability." Can a solution be expanded, and if so what happens. Unlimited amounts of money cannot rest on limited amounts of oil. Even the total amount of oil is not important so much as the peak bandwidth of cheap oil. Oil at 140 dollars a barrel is not cheap enough for people run the sprawlconomy on.

Bernanke's attempts at bail outs failed, because with each failure, the financial people next in line could either accept the loses, or fail in turn. This is why each bail out has lead to another, bigger, bail out. From loans, to debt swaps, to outright guarantees, to the Freddie and Fannie bail out, to the Paulson Proposal, each bail out has gotten bigger, and been attached to money that is less and less likely to ever be seen again by the tax payer. The cost of 100 billion in loans is really the cost of the returns could have been done with that money for a few months. This is a few billion at most. The cost of 100 billion dollars in buying toxic assets, is probably 100 billion dollars give or take a few cups of coffee.

In July the plug was pulled on Captain Carnage's printing press, because the cost of oil was threatening to rattle apart the entire Republican coalition. North Dakota and South Dakota were in play on the Presidential level, with Montana leaning Democratic. The Republicans wanted liberalism on the cheap, and expensive gasoline put it out of reach. Thus, the plug was pulled. M3 began contracting rapidly, and oil fell as rapidly. This was expected, the cost of oil was not a problem of oil undersupply in particular, that's the chronic problem, but a problem of acute dollar oversupply. As soon as the dollars went away, so too did the inflation. Since then you have not heard much from Ben Bernanke, because he tried and failed.

Instead Paulson has come to the front, and he has presented a more traditional, bare knuckles, solution to the panic, one that would not have been unfamiliar to bankers of old: get the government to buy up the worst assets, send a few people out to pasture, and have life go on. It is thus Pauslon who has gotten the ball here. You can also bet that there will be no money left in the till by the election, because otherwise what would have happened is that Bernanke would have resigned as Fed Chair, Paulson would have been appointed, and the Fed, not the Treasury, would be given the blank check. The Fed has taken on hundreds of billions of toxic debt already, it could be empowered to take on even more.

Thus the book on Bernanke is that he printed dollars, polluted the Fed balance sheet, and could neither stop the financial crisis, nor prevent inflation, nor stop the one thing which he said needed to be stopped: the contraction of the money supply in the face of an economic downturn. Remember this is what right wing academics say was the cause of the Great Depression: the fed allowing the "great contraction" of money supply going into a down turn. We are now in a position to judge this theory and say that it is not the case, the Fed's actions of 1930 may have precipitated the economic crisis, but had they done differently the result would have been to pull the Fed chairman and put in someone in charge who would do the same thing in attempting to bail out the wealthy and stick everyone else with the bill.

Small Steps are not enough

In March of this year, economist Paul Davidson proposed that two agencies be used to solve the growing fiscal crisis. His proposal was to use a Home Owner's Loan Corporation model, a depression era program where the government bought unstable loans at a discount, and then cut the interest rate and the face value, allowing the homeowner to stay in the house. This is a "foreclosure in place" plan along the lines proposed in general by Larry Summers in February. By March the idea received attention in the press. From a fellow at the American Enterprise Institute.

Now think on this. This late this winter and early spring and respected academics were already clear on the need for debt relief - academics from the left Post-Keynesian Economics school of thought to the ultra-rightist American Enterprise Institute. In fact proposals for the return of an HOLC have been offered for sometime from the margins.

This idea has flowered in recent days, from Nouriel Roubini, and other writers. Hillary Clinton has taken up the HOLC banner.

The HOLC proposal would do two things. First it would offer a floor to the market. Second it would prevent homes from being dumped on the market just as this would create a contagion even for good loans. But it is not enough. Even after there is debt relief, that still leaves a host of other people in a great deal of trouble, For example, the people who do not qualify for debt relief, but are going to be even more upside down in their homes than they were before. It also means that some loans are going to unravel, since it is absolutely certain that an HOLC price for loans will be lower than what is offered.
In short the HOLC is not nearly radical enough. Instead, with the US already committed to stabilizing half of all mortgages in the US, it is only one small piece of what must be a wider restructuring of the financial markets.

But this gets us back to a very simple question, in a crisis of liquidity, the question is how to put money into the system, and then pull it out once the crisis has passed. In a financial crisis such as this one was some time ago, the question is how to borrow money to clean up the mess, and then impose regulations to prevent the exploitation of both the bail out, and the flaws in the system. However, we are not faced with either of these two smaller problems.

The problem is what, exactly, are we going to pay these loans off 
in? Remember the reason this is a crisis, and we can't just walk away, is that our money is based to no small extent on mortgages. We buy oil and import goods with this money. If the total money supply cannot expand, then it must mean that American living standards must drop dramatically in order to pay back the mortgages. The American people, in 2000 and 2004 were sold "a pig in a poke." They were not told what the differences were, nor were they told what the consequences could be. While it will be impossible to avoid having the penalties fall on the American public for what they bought and voted for - "You don't know what it is, and you're voting for it." - the greater blame must fall on elites. However, as long as elites can stay in power promising that the land casino will re-open after some clean up from the last party, there will be no such change.

A Constitutional Crisis

As Paulson's little demand for dictatorial powers makes clear, this is not really a financial crisis. Instead, it is a political and constitutional crisis. Paulson told Barney Frank that putting in an amendment to cap executive pay would be a "poison pill." If this were really a catastrophe in the making, one where the American public's money was needed right now, or else, then Paulson would have accepted almost any conditions, even if he intended to renege on them in practice. After all, with 700 billion to spend, it would have been trivial to make sure that a few billion sloshed to the people whose golden parachutes he took away. The defense department loses track vast sums of money. It would not have been hard to do that here. Clearly we are not in the moment of true catastrophic financial failure. Hence there is no reason to not make this as hard a bargaining process as possible.

The key to the constitutionality of this is that in order to pay back the massive sums of debt taken on by the failed Bush executive, which will probably amount to some 8 trillion dollars when all of the dust is finally cleared out of the air and everything is accounted for - some new source of value must be created. There is no way, with current rates of oil production, the global expansion of the middle class, and current rates of oil consumption, for the US to ever produce enough houses, at high enough prices, to print enough money to grow our way out of this debt. It is physically impossible, just as there ever being enough physical gold to pay off the debts of the First World War and its aftermath, because interest multiplies like rabbits, and gold does not.

Thus it is necessary, not merely to shift money around, but to change the very definition of money. This is why the "cram down" model is also wrong. There is no reason for the Arabs to accept a cram down, they can just raise the price of oil to the point where all of the surplus value created in the global economy flows to them. This gets them effectively what they paid for, even if the numbers are not correct. It would also mean that the center of the financial world would be Dubai, not New York, London, or even Shanghai.

This means that while HOLC/RTC proposals are useful the most important step right now is to meet the demands of the Treasury Secretary for arbitrary powers head on, and select a different entity to manage any bail out, and to forbid bailing out of specific securities, but only of whole entities. In short, before the public will by any more toxic assets, the public will have the authority to remove the people who bought, created, and sold those assets.

There is already an entity whose purpose it is to evaluate failed institutions, collect insurance, and merge institutions into healthy ones. That entity as Robert Reich correctly observed in a recent radio interview, is the Federal Deposit Insurance Corporation. Since we have, effectively, taken responsibility for the global financial system, it is time to accept that the principle of insurance, direction, and regulation is required. This process has been going on for some time, since, in fact, the response to the crash of 1987, when circuit brakers were put in place to prevent wide swings of the stock market.

However, as of this year, with the US having taken on the losses for the markets world wide, effectively, the solution must be that the financial system must pay for access and insurance in good times, so as to have funds in moments like this. That this principle has escaped 20 years of executive and legislative leaders is a sign of how far down the wrong road we have come.

This means that the FDIC needs to be expanded to have a reach not just for banks, but for securities as well, and for all funds held as securities. Since people already pay fees to mutual funds, it will not be difficult to shift some of this revenue from money managers, where it is buying brass nameplates and vacations, to an insurance fund. That insurance fund can be used to retire foreign debt as its means of accumulating interest.

After the FDIC has finished taking over entities, then individual mortgages can be assigned for debt relief to an HOLC, and individual assets which are saleable, but entangled in financial instruments, can be offloaded to an RTC to be run for some period of time and then sold when market conditions improve.
However the lynchpin is the acceptance that the US Dollar is now based on all equities, securities, and assets which are in the wider financial system denominated in dollars, and the expansion of the total capital system, and not just the suburban sprawl system, will be what the dollar is backed by. Since it has been true in effect, there will be no macroëconomic consequence to making it true in practice. The difference will be that it will be the public, and Wall Street and Riyadh, which will direct the use of the financial system.

In the very short term, then, what is necessary is to prevent American assets from being bought up cheaply by foreigners, and to radically reduce the value of current dollars without capsizing the economy. Fortunately there are several ways this can be done.

Part of the problem is that we have an executive which is illegally in place. This cannot be gotten around in coming up with proposals. If we had a legal President acting in good faith, as opposed to one who just sent a note to the Congress demanding a 700 billion dollar bribe or the economy will get it, then this would be a rather easy situation to deal with. The President could use the powers under the trading with the enemy act and the declaration of a national emergency to prevent US assets from being bought up by foreign entities. The strategic reserve would be tapped, rationing imposed on oil imports, and the market allowed to fall to a discovery point where only US national liquidity could be used to purchase assets. This would be done in the context of a promise to repeal the Bush revenue reductions retroactively by the new Congress, and the additional revenue devoted to back the bonds.

In short, if we had a President, as opposed to an illegal executive, there would be mechanisms in place by which a Congress could delegate sufficient authority to both bail out the financial system and prevent a short term fall in equities from becoming a permanent entrenchment. The public will, in a matter of weeks, be able to correct this problem, and in a matter of months an new government could be inaugurated. Thus all the Congress needs to do for now, is get to Zero Hour of the inauguration of a new President, and it will have the chance of doing so with the new Congres in January to authorize other short term measures as is necessary. While it is better to deal with the problem early, the problem is George W. Bush, and he is not going away until next year.

Thus the centerpieces of a counter congressional bill are:
  1. Expansion of the FDIC to include money market funds, brokerages, and other financial funds. Institutions which are out of this expansion, if any, will be allowed to fail as a class. Assign the CBO as the Congressional means of oversight and give the CBO authorization to extend credit to the FDIC, which can be waived if, after Congressional review, the money is justified. Basically, anything that Bush does on the way out the door must be subject to review by the incoming Congress and Administration.
  1. Authorization of an HOLC type cram down of mortgages with government liens, the profits of which are split between home owners and the mortgage system, now in taxpayer hands anyway. Place this process in the hands of the FHA, and have the CBO assigned to continuous oversight. Authorize some 20 billion dollars in stock to be purchased by the government.
  1. Declaration of a national emergency, without expansion of the debt ceiling, and also with explicit judicial review. In the national emergency specific authorization can be given to review any transfer of effective control of banks or other financial entites. In this declaration can be rationing of gasoline, imposition of conservation and other austerity measures.
  1. Dramatically expand safety net programs for the inevitable economic shock: food stamps, unemployment insurance, suspension of interest on student loans, loans to the government by members of the National Guard, active Military, or Reserve and so on.
That's all that is needed for today. For later? Yes, progressive taxation, green relief, federal debt restructuring and so on. But for today, that is all that is needed to stem the tide. When a new executive is in place, then Bernanke can be removed, the Fed restructured to be part of a joint Executive-Congressional control of monetary policy, green relief put in place, and a massive conservation drive funded.

But that is for tomorrow. Today what we need to do is to authorize the government to be the insurer of last resort and not theidiot of last resort. The short term problem is that interbank lending came to a near halt because banks didn't know which other banks were infected to what degree, and the fear that the money market funds would come unravelled. These can be provided for by the means above. If the Federal Government begins stepping and a dealing with problem banks, and buffers the inflationary hit, then we can go forward and deal with the larger crisis.


These events are not a short term bump on the road, but the culmination of the decision a generation ago to use paper to buy oil, to inflate that paper by allowing those at the very highest reaches of a social elite to engage in a "race to the top" with the suppliers of oil. This system was accepted by both parties, and it created a neo-liberal era where any restriction to creating paper wealth had to be removed. This was not a matter of left or right, everyone was a neo-conservative, and every one was a neo-liberal.

The failure of this system has been widely predicted, but there was neither a holistic replacement, nor the political will to replace it. Criticism of it was outside of the mainstream, or channelled into the form of arguing over the margins of the benefits of it. It accumulated massive debt, and that debt is the heart of the financial pressure.

In 2000 Bush entered office with the plan of bailing out those in the US who had bet badly on the stock market, and invading Iraq to break the impasse over control of oil. Both of these policies failed. The back stop for failure was the Greenspan/Bernanke plan of creating a housing bubble, and then when the burst came, to inflict the costs on the American public. This is "Japanification."

We are now at the point where Japanification is the question, and Paulson is trying to enforce it at gun point: do this or I will do nothing and let everything fall apart. Since the result of this will be a political catastrophe for the Republicans, the Democrats should propose an alternate bill, make no compromises, and let the Republicans Hooverize the name of George W. Bush.

The correct response is to expand the FDIC, begin taking over institutions as a whole, providing immediate debt relief through an HOLC, and declare a national emergency to enforce austerity and prevent any short term attempts to profit from the financial chaos. A windfall profits tax on oil companies isn't a bad idea either, since it would bring in tens of billions of dollars right when they are needed the most.

This solution, or some version of it, is in line with proposals from economists and political figures such as Robert Reich, Paul Davidson, Nouriel Roubini and others. It also leads to the correct solution to the larger fiscal crisis, which is removing the oil bottleneck to the growth of wealth, and therefore the growth of wages to pay financial instruments, and the cramming down of instruments which claimed the profits of a new economy, while at the same time tried to prevent it.

In that future come a great drive to reduce consumption, increase savings, increase exports, globalize opportunity for all and not just for some, and create a very different system of work. But that is another day. Today's purpose is to say no to dictatorship, and to craft a counter which is yes to insurance and accountability.

Updated: Obama announces opposition to the principles of the Paulson Plan

"Even if the Treasury recovers some or most of its investment over time, this initial outlay of up to $700 billion is sobering.  And in return for their support, the American people must be assured that the deal reflects some basic principles.
  1. No blank check. If we grant the Treasury broad authority to address the immediate crisis, we must insist on independent accountability and oversight. Given the breach of trust we have seen and the magnitude of the taxpayer money involved, there can be no blank check.
  1. Rescue requires mutual responsibility. As taxpayers are asked to take extraordinary steps to protect our financial system, it is only appropriate to expect those institutions that benefit to help protect American homeowners and the American economy. We cannot underwrite continued irresponsibility, where CEOs cash in and our regulators look the other way.  We cannot abet and reward the unconscionable practices that triggered this crisis. We have to end them.
  1. Taxpayers should be protected. This should not be a handout to Wall Street. It should be structured in a way that maximizes the ability of taxpayers to recoup their investment.  Going forward, we need to make sure that the institutions that benefit from financial insurance also bear the cost of that insurance.
  1. Help homeowners stay in their homes. This crisis started with homeowners and they bear the brunt of the nearly unprecedented collapse in housing prices. We cannot have a plan for Wall Street banks that does not help homeowners stay in their homes and help distressed communities.
  1. A global response. As I said on Friday, this is a global financial crisis and it requires a global solution. The United States must lead, but we must also insist that other nations, who have a huge stake in the outcome, join us in helping to secure the financial markets.
  1. Main Street, not just Wall Street. The American people need to know that we feel as great a sense of urgency about the emergency on Main Street as we do the emergency on Wall Street. That is why I call on Senator McCain, President Bush, Republicans and Democrats to join me in supporting an emergency economic plan for working families – a plan that would help folks cope with rising gas and food prices, save one million jobs through rebuilding our schools and roads, help states and cities avoid painful budget cuts and tax increases, help homeowners stay in their homes, and provide retooling assistance to help ensure that the fuel-efficient cars of the future are built in America.
  1. Build a regulatory structure for the 21st Century. While there is not time in a week to remake our regulatory structure to prevent abuses in the future, we should commit ourselves to the kind of reforms I have been advocating for several years. We need new rules of the road for the 21st Century economy, together with the means and willingness to enforce them.
These points are utterly incompatible with any version of the Paulson plan. We should tell our Democratic representatives to back the next President of the United States, and only pass enough authority to get past the election and to the new Congress.

The people have spoken, Barack Obama has listened, and it is time that the Congress hears what is a nearly unanimous cry across the political spectrum for a comprehensive, fair, and effective restructuring of the financial system.

blog of the day

A thought

 there is a gift to dying last  of all,  of everyone who wants know the story.

America Thermidor II (2005)

    Sunday 17 April 2005

    Why did the "New Economy" fail to create the "long boom" that was promised?

    Before I go further, let me say that I have enormous respect for Former Treasury Secretary Robert Rubin - he is a genius in understanding the financial markets, and stands along with Bill Woodin and Alexander Hamilton at the top rank of individuals who have ever held the post. However, history is what happens when one is making other plans, and the economic program of Bill Clinton's presidency is a perfect example of how close one may come to success, and yet fall short.

    The "New Economy" is the term applied to the digital economy, and particularly to the use of the internet; as with the phrases "New Politics" and "New Media," it points at the enormous potential of the world of digital communications to change how people live and participate in society. The "New Economy" rose in response to the flow of technology, much of it developed by government, and to an economic program which history will call "Rubinomics." What was Rubinomics, and what contribution did it make to the period of prosperity in the 1990s? And why did it end with a bubble and a radical change in the direction of American politics?

    The key to understanding what the Clinton administration did is to remember what the vicious cycle consists of: America must import energy, this causes a trade deficit. The trade deficit, in turn, means that the US must sell assets abroad, this creates an investment deficit. To bring investment in means that one must also cut taxes on the wealthy, so that companies remain under the control of Americans, rather than being bought up by foreigners, particularly those from nations that do not have internal economies. This creates a budget deficit.

    The investment deficit and budget deficit together create conditions in which real wages do not increase as quickly and there is less growth in the kind of upwardly mobile employment that people need. This situation also creates incentives for government to tax consumption, both because this reduces the trade deficit, and because the wealthy cannot be taxed. This creates a wages deficit. The wages deficit, in turn, gives people an incentive to borrow more, particularly against their homes. This creates a wealth deficit, with increasing inequality in assets. The solution to the wealth deficit is for people to use gasoline to shop around for better bargains, and to buy homes further from where they work, and in areas that do not have to pay the carrying costs of large metropolitan areas. This means they burn more energy, and this loops back around to the beginning of the cycle. The whole cycle then is: 

  1. Energy deficit creates trade deficit.
  2. Trade deficit creates investment deficit.
  3. Investment deficit creates budget deficit.
  4. Investment deficit and budget deficit creates wages and wealth deficit.
  5. Wages and wealth deficits create pressure to use energy to generate housing wealth, which starts the cycle over again.
    Each stage pushes the next along, because at each stage there is a group of people that can benefit by pushing the problem to the next group of people.

    Democratic politics since 1978 has consisted of a series of attempts to find a way to break this cycle. Carter tried direct conservation, to end the energy deficit. Mondale wanted to raise taxes and investment in the US, to break the wages and wealth deficit. By the time Clinton was elected, however, there was a broad consensus that there could not be a direct attack on these problems. Clinton himself tried to attack the problem directly by proposing an energy tax, but this met with tremendous resistance and was dropped. While he was able, because of the high deficits created both by the borrowing Reaganomics had engaged in, and by the collapse of the Savings and Loan System, which was an unintended consequence of lowering energy prices, he did not have the political capital to go farther along this line than he did.

    Instead, the solution was to find a different kind of paper to sell abroad for energy: instead of running a chronic budget deficit and selling bonds, Robert Rubin shifted borrowing to short-term borrowing at lower interest rates, easing the budget crunch. This created more money for investment, and the ability of the Federal Reserve to keep interest rates lower than it otherwise would have. And into this environment, with an America looking for a new engine of growth, came the internet, and "The New Economy."

   The internet created a whole new class of assets for foreigners to buy; because they began rising so quickly, much of the world's savings poured into the United States. This created a "dollar shortage," and produced a series of financial crisis points around the world, as money that had been flowing to other nations flowed into the US to take advantage of the internet boom. How much of this was intentional is open to question; many of the economics team thought that the Clintonian program of free trade would lead to more investment in developing nations, rather than in the US. Instead, the US became the focus of a global stock market boom.

    This dollar shortage continued to push the price of oil down, as demand for dollars went up. The higher demand for dollars, and the increasing size of their circulation, in turn, allowed the Federal Reserve to hold rates slightly below what they would have been, and created what Alan Greenspan called a "virtuous cycle" of investment and growth.

    So what happened?

    In one sense nothing unusual - all expansions come to an end sooner or later. The New Economy did not repeal the business cycle, and despite, or perhaps because of, the vigorousness of the expansion, the contraction that followed it was almost inevitable. But when historians of economics look back at the 1990s, they will see three factors that made the change in direction afterwards almost inevitable.

    The most obvious is the Asian financial crisis that started in 1997 and expanded in 1998. The Clinton program had created a dollar shortage, and in 1997 that shortage became acute, as the "hot money," which is normally invested in high risk growth in developing countries, shifted to the NASDAQ in the US. While there are mechanical details that involve how Russia's economy had been shifted to an economic oligarchy, how Asian nations financed their banking systems, how Europe created a single currency and so on, the essential dynamic was general, and would, in all likelihood, have played out even if financial institutions had been differently structured. This is because money seeks the best mix of risk and reward - why invest in countries that have financial difficulties for high returns, when Intel and Microsoft were putting up double-digit gains every year?

    This led to the second problem, that the Federal Reserve had little choice but to flood the world with dollars to prevent illiquidity from causing otherwise healthy companies to collapse, and otherwise strong economies to choke for lack of dollars to pay their creditors. The same dollar shortage that drove oil down to just above $11 a barrel made many economies starved for money to pay their creditors. While many people blame Greenspan for easing so dramatically, there is little doubt that almost any central banker would have done the same thing. Faced with a crisis, he acted. However, this very action meant that the US economy, which had been growing quickly, but not too quickly, kicked into a much higher gear. In 1998, commodity prices, which had been falling for almost 15 years, started to rise. Inflation of basic materials prices entered into the economy.

    And this is the real third problem. The United States could have used what economists call "fiscal policy" to offset the forced easing by the Federal Reserve; that is, they could have raised taxes on capital gains, in order to prevent the economy from overheating. But there was no political will for this, certainly not from a Congress that hates taxes the way LBJ hated poverty, but also from a President who had just emerged from a series of political scandals involving his sex life. But this lack of political will is rooted in something deeper, and that is that the New Economy itself had gone in the wrong direction. Instead of producing growth without using more imported energy, as Clinton, Gore, Greenspan and many others, had hoped, it was directed at getting people to consume more, particularly travel, and it created people with enough stock gains to buy new houses farther from where they worked. The New Economy was used to produce a web interface to the old economy. Instead of reducing energy costs of retailing, it went into overnight shipping. While the new economy had lowered the cost of buying and selling stock, the real hope of companies was that it would make people buy more.

    This then was the real failure of the Clinton policies, that while they slowed the deficit cycle, and improved real wages, instead of redirecting growth towards information, they made it so that people rushed even faster to create home wealth and use more oil. Because the vicious cycle had been stopped, but not broken, people assumed that this was the best chance in a generation to jump on, not off, the trading of gasoline for land values. To jump on, and not off, the reduction in US savings rates. Even as America poured money into the internet, the new companies saw this as a way of competing with "bricks and mortar" stores, and finding ways of marketing old goods in new packages.

    Economic historians will debate what could have been done: what, in an ideal world, needed to happen to ameliorate the effects of the world financial crisis. Doubtless some will find clever solutions that involve changing rules, that would have headed off exactly what did happen. But this, as with the collapse of the gold standard in the late 1920s, ignores that the collapse was driven not by dead numbers, but by living people taking advantage of circumstances, and that different rules would probably have ended in the same place, because that is where people wanted to go: no one wanted the bubble slowed down, because they knew it was a once in a generation chance to make a great deal of money. No politician could have opposed it and survived, because that was what people wanted, one last throw at the crap game before it was raided.

    And faced with this, Albert Gore, running for President in 2000, knowing that the clock was against him as a recession came ever closer, could not speak to what needed to be done. He and his major opponent both acted as if there were surpluses to spend, when the handwriting on the wall was quite clear. In American politics, it is often the case that he who tells the truth first, loses. Mondale admitted that taxes would go up, and they did. He was also at the bottom of one of the largest landslides in American history.

    Albert Gore could not speak the truth, except obliquely, about the need to end the dependency of transportation on gasoline. He talked about ending the era of the internal combustion engine, but he had to tread softly, lest he convince Americans that he was going to stop them from having a chance to make a great deal of money from selling their homes. After the bubble burst on the market, it was the only road to a comfortable retirement that many people had.

    And so America allowed George Bush into the race, and allowed him into the White House, simply because he promised not to break the vicious cycle of energy deficits, and instead reignited it with greater fury by pushing through a series of revenue reductions that made sure that the US was shortly back in the cycle of deficits again. The Clinton economic program - which had woven its way through so many points of danger, and which rested on some of the most brilliant work done by any economic team, was washed away within two years of his leaving the White House.