A Colossal Failure Of Governance: The Reappointment of Ben Bernanke
by Simon Johnson
Baseline Scenario
January 29, 2009
When representatives of American power encounter officials in less rich countries, they are prone to suggest that any failure to reach the highest standards of living is due in part to weak political governance in general and the failure of effective oversight in particular. Current and former US Treasury officials frequently remark this or that government “lacks the political will” to exercise responsible economic policy or even replace a powerful official who has clearly become a problem.
There is much to be said for this view. When a minister or even the head of a strong government agency is no longer acting in the best interests of any country – but is still backed by powerful special interests — who has the authority, the opportunity, and the fortitude to stand up and be counted?
Fortunately, our constitution grants the Senate the power to approve or disapprove key government appointments, and over the past 200 plus years this has served many times as an effective check on both executive authority and overly strong lobbies – who usually want their own, unsuitable, person to be kept on the job.
Unfortunately, two massive failures of governance at the level of the Senate also spring to mind: first, the strange case of Alan Greenspan, which stretched over nearly two decades; second, Ben Bernanke, reappointed today (Thursday).
Greenspan, as you recall, was worshiped as some sort of economic magician. Even his most asinine comments were seized upon by a legion of acolytes. Instead of providing meaningful periodic oversight, every Senate hearing was essentially a recoronation.
And now we can look back over 20 years and be honest with ourselves: Alan Greenspan contends for the title of most disastrous economic policy maker in the recent history of the world.
Some on Wall Street, of course, would disagree – arguing that the financial sector growth he fostered is not completely illusory, that we have indeed reached a new economic paradigm due to the Greenspan tonic of deregulation, neglect, and refusal to enforce the law. Prove the ill-effects, they cry.
What part of 8 million net jobs lost since December 2007 do you still not understand?
And now the same Greenspanians and their fellow travelers rally to the support of Ben Bernanke’s troubled renomination. Certainly, they concede that Bernanke was complicit in and continued many of Greenspan’s mistakes through September 2008. But, they argue, he ran a helluva bailout strategy after that point. And, in any case, if the Senate had refused to reconfirm him - financial sector representatives insist – there would have been chaos in the markets.
Take that last statement at face value and think about it. Have we really reached the situation where the Senate as a body and individual Senators – accomplished men and women, who stand on the shoulders of giants – must bow down before financial markets and high-ranking executives who are really just talking their book?
Here’s what markets really care about: credible fiscal policy, sufficiently tough monetary policy, and the extent to which big banks will be allowed to run amok – and then get bailed out again.
Reappointing Ben Bernanke solves none of our problems. In fact, given his stated intensions, a Bernanke reappointment implies larger bailouts in the future – thus compromising our budget further with contingent liabilities, i.e., huge payments that we’ll have to make next time there is a crisis. What kind of fiscal responsibility strategy is this?
Rather than messing about with a meaningless (or damaging) freeze for part of discretionary spending, the White House should fix the financial system that – with too big to fail at its heart – has directly resulted in doubling our net government debt to GDP ratio from 40 percent (a moderate level) towards 80 percent (a high level) in a desperate attempt to ward off a Second Great Depression.
If you think we can sort out finance with Ben Bernanke at the helm, it was sensible to reappoint him. But when the time comes for members of the Senate themselves to be held accountable, do not be surprised if people point out that pushing Bernanke through – come what may – was the beginning of the end for any serious attempt at reform.
Ultimately, sensible democratic governance prevails in the United States. Sometimes it takes a while.
Sunday, January 31, 2010
Simon Johnson pans Bernanke reapointment
The captain showed a steady hand at the tiller. Bravely ignoring the cries of fear from the crew, his steely eyes ... Well, we think they were on the banking sector. The captain sent the ship full force into the rocks. The Exxon Valdez captain should have had Congress as his employer. Here's what Simon Johnson says.
Saturday, January 30, 2010
Robert Kuttner: "What a week"
Completing our four-day political week on Demand Side, we offer Robert Kuttner's view prior to the state of the union.
Mixed Signals
by Robert Kuttner
January 25, 2010
What a week!
As so many of us writing for Huffington Post have been arguing for the past year, if President Obama did not cease behaving as the ally of Wall Street, the right wing would emerge as populist champion of the forgotten American. The election results in Massachusetts have now provided the exclamation point.
The loss of Ted Kennedy's former senate seat seems to have gotten the president's attention. Obama is belatedly getting in touch with his anger, as it were. He has turned up the rhetorical heat against the banks. But will he walk the talk?
Are we seeing a true shift in the Obama presidency where he revises his theory of change and discovers that political progress sometimes requires confrontation before you reach consensus? Or are these simply gestures of expediency and desperation?
So far, the signals are mixed. With the State of the Union Address getting drafted and re-drafted, debates are still raging inside the White House: Should Obama, after the Massachusetts wake-up call, be more conciliatory, or more feisty; more progressive or more centrist?
On the banking front, Obama has begun signaling a welcome populism. First, even before the Massachusetts vote, he called for a surtax on bank profits -- a relatively small and symbolic gesture than neither brings in a lot of money nor alters the banks' toxic business models, but a start.
Next, he intervened with Senate Banking Committee Chairman Chris Dodd to prevent Sen. Dodd from compromising away the House-passed consumer financial protection agency, one of the few provisions of the House version of financial reform that has some teeth. Literally the day before the president acted, Dodd had put out the word that he would have to throw the proposed agency under the bus in order to get Republican support for other provisions.
The agency has been a favorite of Obama's since last June, when it became part of the administration's June 17th White Paper on financial reform, despite skepticism from Geithner and Summers, only because Obama personally insisted on it. What's interesting about Obama's move last week is not just that he is supporting tough reform legislation, but that he got involved personally, calling Dodd to the White House and extracting his support. Until now, Obama has been mostly hands-off when it comes to financial reform, leaving the details to Tim Geithner and Larry Summers.
Even more significantly, Obama resurrected Paul Volcker as a senior adviser and embraced a Volcker proposal to revive the Glass-Steagall Act, an idea that Summers and Geithner have been resisting all year.
The 82-year old Volcker turns out to be one of the best organizers in Washington. In addition to forcefully speaking out about the need for a new Glass-Steagall, to keep commercial banks out of the business of speculating in securities, Volcker enlisted several other financial Brahmins to add their voices of support, including the Republican former chair of the SEC, Bill Donaldson, and the former CEO of Citigroup, John Reed.
Though Obama's public embrace of Volcker and Glass-Steagall was unveiled as part of the post-Massachusetts damage control, it has been in the works since before Christmas.
Geithner, who is again in political trouble because of investigations about his role in insisting that the government's bailout of AIG flow through to Goldman Sachs and other banks at 100 cents on the dollar, had his office quickly put out the word that Geithner had really been in support of Volcker's plan all along. But that's total malarkey.
The support for Volcker came mainly from Vice President Biden and from chief political adviser David Axelrod. In the White House debates, it was often Obama against most of his economic team, which has done its best all year to keep Volcker far away from Obama. Some dissenters on the economic team, such as Austan Goolsbee, sided with Volcker.
So Obama seems to get that he needs to be more populist both in tone and substance when it comes to the banks, though it remains to be seen how hard he'll fight. But banking reform is only one piece of the battle. Obama went the other way when it came to trying to salvage the re-nomination of Ben Bernanke to chair the Fed for a second term.
By the middle of last week, it looked as if the same popular revolt that gave Republicans Ted Kennedy's senate seat could take down Bernanke, who has emerged as a lightening rod for populist anger. Rejecting Bernanke's confirmation is an easy vote for senators who want to whack Wall Street, and there were murmurings of mass defections in the Senate Democratic caucus.
But with Bernanke's support crumbling, the White House pulled out all the stops. By Saturday, both Harry Reid and Dick Durban, the top two Democrat leaders in the senate, who have been wavering, pledged to vote aye. It now looks like Bernanke will survive, with more Republicans voting no than Democrats, and Democrats again looking like the party of high finance. The White House concluded that another political defeat for the president would be worse than the association with the unpopular Bernanke, who epitomizes the Obama alliance with Wall Street.
Even more ominously, Obama thus far is on the wrong side of the deficit-versus-jobs debate. Budget Director Peter Orszag and other deficit hawks in the administration have long been urging Obama to support a proposed fast-track commission that would bypass usual legislative procedures and compel an up-or-down vote on a compulsory deficit-reduction package designed to slash Social Security and Medicare spending.
This is, of course, appalling politics. It signals: we had to spend a ton of taxpayer money to rescue the banks and prop up the ruined economy. Now, gentle citizen, though you have paid once through the reduced value of your retirement plan and your house, you will pay again through cuts in Medicare and Social Security.
Since Christmas, Obama has been negotiating with the two key sponsors of the commission, Senators Judd Gregg (R-NH) and Kent Conrad (D-ND). Last week, it looked as if they were close to a deal to have the White House appoint a more moderate version of such a commission, but after signaling support for the deal Gregg went out of his way to disparage that idea. Mercifully, it now appears that the deficit hawks in the Senate don't have the votes, since it would require some tax hikes as well as spending cuts, and most Senate Republicans won't touch anything that raises taxes. But on Friday, Obama himself said that he'd support a legislated commission, reversing his earlier position. The only hopeful sign is that he doesn't seem prepared to spend much political capital on it.
The politics of the deficit commission are all tangled up with the politics of how much to spend on a new jobs bill. In December, the House, with no assistance from Obama, narrowly passed a $154 billion jobs will, which also provides fiscal relief to the states and extends unemployment and health benefits for jobless workers. But the word from the White House is that Obama will not support that high a number, and will give more prominence to deficit reduction. So despite the rhetoric about Obama getting past the health-bill morass and emphasizing jobs, jobs, jobs, he hasn't yet put his money (ours, actually) where his mouth is.
Then there is the matter of the carcass of health reform, and the related question of whether Obama is willing to get tough with Republicans as well as bankers. The early signs are not encouraging. In a Wednesday interview with ABC's George Stephanopoulos, Obama said that he'd look for areas of common ground, and by week's end, it appeared that the White House would be trying to get some kind of face saver that stopped far short of even the weak Senate bill.
With 59 votes in the Senate, the Democrats have more senators than the Republicans have had at any time since the 1920s. If Obama has discovered the virtues of leadership and occasional anger, he should be pummeling the Republicans for their sheer obstructionism, and asking the Senate leadership to enact key legislation with a simple majority of 51 votes through the budget reconciliation process. But on this front, Obama's conciliatory side still seems to be winning.
A little populism here and a little conciliation there is no game-changer. The worst strategy of all would be for Obama to be a populist on Mondays and Wednesdays, and a conciliator on Tuesdays and Thursdays. That would signal pure mush.
Democrats, unfortunately, default to this habit, because of an excessive reliance on a shallow reading of polls. You could see this tacking back and forth in the losing Gore campaign of 2000 and Kerry's failed run in 2004, where the candidate and his handlers oscillated between a progressive stance and a New Democrat one.
If Lincoln had based his decisions on polls, we'd still have slavery. Polls show that Americans resent corporate excesses, but value corporations as sources of jobs; that they are worried about the deficit but also frightened about unemployment; and that they are fearful of losing their health coverage but also anxious about the Obama version of health reform.
These, of course, are somewhat contradictory positions. It's normal for citizens to hold views that are not totally consistent. The job of a president is to fashion a coherent narrative and strategy of reform, even if some of it is momentarily unpopular, and to persuade the people to embrace it. A president who bases his posture mainly on a tactical reading of the polls is the opposite of a leader, and will be rejected for his weakness -- even if every one of his positions tracks majority support in the polls.
The administration's response to the twin loss of the 60th senate seat and a justifiably unpopular health bill could be a turning point in the redemption of Obama's presidency. So far, we've only seen a bare beginning.
Friday, January 29, 2010
Michael Hudson on the State of the Union - Part II
State of the Union Rhetoric, 2010: Part II Euphemisms, oxymorons and internal contradictions
By Michael Hudson
Economic Perspectives from Kansas City
January 25, 2009
The State of the Union address is in danger of purveying the usual euphemisms. I expect Mr. Obama to brag that he has overseen a recovery. But can there be any such thing as a jobless recovery? What has recovered are stock market averages and Wall Street bonuses, not disposable personal income or discretionary spending after paying debt service.
There is a dream that what can be “recovered” is something so idyllic as to be mythical: a Bubble Economy enabling people to make money without actually working, by borrowing and riding the tide of asset-price inflation to make capital gains. Corporate Democrat Harold Ford Jr. writes nostalgically that Bill Clinton’s eight years in office created 22 million jobs, “balanced the budget and left his successor with a surplus. This can be done again,” if only Mr. Obama moves further to the right (which Mr. Ford calls the center, meaning the Bayhs and Republicans).
Well, no it can’t be done again. Pres. Clinton’s administration balanced the budget by “welfare reform” to cut back public spending. This would be lethal today. Meanwhile, his explosion of bank credit and the dot.com boom (rising stock prices and bonuses without any earnings) fueled the early stages of the Greenspan bubble. It was a debt-leveraged illusion. Instead of the government running budget deficits to expand domestic demand, Mr. Clinton left it to banks to extend interest-bearing credit – debt pollution that we are still struggling to clean up.
The danger is that when Mr. Obama speaks of “stabilizing the economy,” he means trying to sustain the rise in compound interest and debt. This mathematical financial dynamic is autonomous from the “real” industrial economy, overwhelming it economically. That is what makes the present economic road to debt peonage so self-defeating.
Debts that can’t be paid, won’t be. So defaults are rising. The question that Mr. Obama should be addressing is how to deal with the excess of debt above the ability to pay – and of negative equity for the one-quarter of U.S. real estate that has a higher mortgage debt than the market price is worth. If the hope is still to “borrow our way out of debt” by getting the banks to start lending again, then listeners on Wednesday will know that Mr. Obama’s second year in office will be worse for the economy than his first.
How realistic is it to expect the speech to make clear that “we can’t go home again”? Mr. Obama promised change. “We simply cannot return to business as usual,” he said on Jan. 21, introducing the “Volcker plan.” But how can there be meaningful structural change if the plan is to return to an idealized dynamic that enriched Wall Street but not the rest of the economy?
The word “recession” implies that economic trends will return to normal almost naturally
Any dream of “recovery” in today’s debt-leveraged economy is a false hope. Yet high financial circles expect Mr. Obama to insist that the economy cannot recover without first reimbursing and enriching Wall Street. To re-inflate asset prices, Mr. Obama’s team looks to Japan’s post-1990 model. A compliant Federal Reserve is to flood the credit markets to lower interest rates to revive bank lending –interest-bearing debt borrowed to buy real estate already in place (and stocks and bonds already issued), enabling banks to work out of their negative equity position by inflating asset prices relative to wages.
The promise is that re-inflating prices will help the “real” economy. But what will “recover” is the rising trend of consumer and homeowner debt responsible for stifling the economy with debt deflation in the first place. This end-result of the Clinton-Bush bubble economy is still being applauded as a model for recovery.
We are not really emerging from a “recession.” The word means literally a falling below a trend line. The economy cannot “recover” its past exponential growth, because it was not really normal. GDP is rising mainly for the FIRE sector – finance, insurance and real estate – not the “real economy.” Financial and corporate managers are paying themselves more for their success in paying their employees less.
This is the antithesis of recovery for Main Street. That is what makes the FIRE sector so self-destructive, and what has ended America’s great post-1945 upswing.
There are two economies – and the extractive FIRE sector dominates the “real” economy
When listening to the State of the Union speech, one should ask just which economy Mr. Obama means when he talks about recovery. Most wage earners and taxpayers will think of the “real” economy of production and consumption. But Mr. Obama believes that this “Economy #1” is dependent on that of Wall Street. His major campaign contributors and “wealth creators” in the FIRE sector – Economy #2, wrapped around the “real” Economy #1.
Economy #2 is the “balance sheet” economy of property and debt. The wealthiest 10% lend out their savings to become debts owed by the bottom 90%. A rising share of gains are made in extractive ways, by charging rent and interest, by financial speculation (“capital gains”), and by shifting taxes off itself onto the “real” Economy #1.
John Edwards talked about “the two economies,” but never explained what he meant operationally. Back in the 1960s when Michael Harrington wrote The Other America, the term meant affluent vs. poor America. For 19th-century novelists such as Charles Dickens and Benjamin Disraeli, it referred to property owners vs. renters. Today, it is finance vs. debtors. Any discussion of economic polarization betweens rich and poor must focus on the deepening indebtedness of most families, companies, real estate, cities and states to an emerging financial oligarchy.
Financial oligarchy is antithetical to democracy. That is what the political fight in Washington is all about today. The Corporate Democrats are trying to get democratically elected to bring about oligarchy. I hope that this is a political oxymoron, but I worry about how many people but into the idea that “wealth creation” requires debt creation. While wealth gushes upward through the Wall Street financial siphon, trickle-down economic ideology to fuel a Bubble Economy via debt-leveraged asset-price inflation.
The role of public spending – and hence budget deficits – no longer means taxing citizens to spend on improving their well-being within Economy #1. Since the 2008 financial meltdown the enormous rise in national debt has resulted from reimbursing Wall Street for its bad gambles on derivatives, collateralized debt obligations and credit default swaps that had little to do with the “real” economy. They could have been wiped out without bringing down the economy. That was an idle threat. A.I.G.’s swap insurance department could have collapsed (it was largely in London anyway) while keeping its normal insurance activities unscathed. But the government paid off the financial sector’s bad speculative debts by taking them onto the public balance sheet.
The economy is best viewed as the FIRE sector wrapped around the production and consumption core, extracting financial and rent charges that are not technologically or economically necessary costs.
Say’s Law of markets, taught to every economics student, states that workers and their employers use their wages and profits to buy what they produce (consumer goods and capital goods). Profits are earned by employing labor to produce goods and services to sell at a markup. (M – C – M’ to the initiated.)
The financial and property sector is wrapped around this core, siphoning off revenue from this circular flow. This FIRE sector is extractive. Its revenue takes the form of what classical economists called “economic rent,” a broad category that includes interest, monopoly super-profits (price gouging) and land rent, as well as “capital” gains. (These are mainly land-price gains and stock-market gains, not gains from industrial capital as such.) Economic rent and capital gains are income without a corresponding necessary cost of production (M – M’ to the initiated). “Banks have lent increasingly to buy up these rentier rights to extract interest, and less and less to promote industrial capital formation. Wealth creation” FIRE-style consists most easily of privatizing the public domain and erecting tollbooths to charge access fees for basic necessities such as health insurance, land sites, home ownership, the communication spectrum (cable and phone rights), patent medicine, water and electricity, and other public utilities, including the use of convenient money (credit cards), or the credit needed to get by. This kind of wealth is not what Adam Smith described in The Wealth of Nations. It is a form of overhead, not a means of production. The revenue it extracts is a zero-sum economic activity, meaning that one party’s gain (that of Wall Street usually) is another’s loss.
Debt deflation resulting from a distorted “financialized” economy
The problem that Mr. Obama faces is one that he cannot voice politically without offending his political constituency. The Bubble Economy has left families, companies, real estate and government so heavily indebted that they must use current income to pay banks and bondholders. The U.S. economy is in a debt deflation. The debt service they pay is not available for spending on goods and services. This is why sales are falling, shops are closing down and employment continues to be cut back.
Banks evidently do not believe that the debt problem can be solved. That is why they have taken the $13 trillion in bailout money and run – by it out in bonuses, or buying other banks and foreign affiliates. They see the domestic economy as being all loaned up. The game is over. Why would they make yet more loans against real estate already in negative equity, with mortgage debt in excess of the market price that can be recovered? Banks are not writing more “equity lines of credit” against homes or making second mortgages in today’s market, so consumers cannot use rising mortgage debt to fuel their spending.
Banks also are cutting back their credit card limits. They are “earning their way out of debt,” making up for the bad gambles they have taken with depositor funds, by raising interest rates, penalties and fees, by borrowing low-interest credit from the Federal Reserve and investing it abroad – preferably in currencies rising against the dollar. This is what Japan did in the “carry trade.” It kept the yen’s exchange rate down, and it is lowering the dollar’s exchange rate today. This threatens to raise prices for imports, on which domestic consumer prices are based. So easy credit for Wall Street means a cost squeeze for consumers.
The President needs a better set of advisors. But Wall Street has obtained veto power over just who they should be. Control over the President’s ear time has been part of the financial sector’s takeover of government. Wall Street has threatened that the stock market will plunge if oligarch-friendly Fed Chairman Bernanke is not reappointed. Mr. Obama insists on keeping him on board, in the belief that what’s good for Wall Street is good for the economy at large.
But what’s good for the banks is a larger market for their credit – more debt for the families and companies that are their customers, higher fees and penalties, no truth-in-lending laws, harsher bankruptcy terms, and further deregulation and bailouts.
This is the program that Mr. Bernanke has advised Washington to follow. Wall Street hopes that he will be kept on board. Mr. Bernanke’s advice has helped bolster that of Tim Geithner at Treasury and Larry Summers as chief advisor to convince Pres. Obama that “recovery” requires more credit.
Going down this road will make the debt overhead heavier, raising the cost of living and doing business. So we must beware of the President using the term “recovery” in his State of the Union speech to mean a recovery of debt and giving more money to Wall Street Jobs cannot revive without consumers having more to spend. And consumer demand (I don’t like this jargon word, because only Wall Street and the Pentagon’s military-industrial complex really make demands) cannot be revived without reducing the debt burden. Bankers are refusing to write down mortgages and other debts to reflect the ability to pay. That act of economic realism would mean taking a loss on their bad debts. So they have asked the government to lend new buyers enough credit to re-inflate housing prices. This is the aim of the housing subsidy to new homebuyers. It leaves more revenue to be capitalized into higher mortgage loans to support prices for real estate fallen into negative equity.
The pretense is that this is subsidizing the middle class, but homebuyers are only the intermediaries for government credit (debt to be paid off by taxpayers) to mortgage bankers. Nearly 90 percent of new home mortgages are being funded or guaranteed by the FHA, Fannie Mae and Freddie Mac – all providing a concealed subsidy to Wall Street.
Mr. Obama’s most dangerous belief is the myth that the economy needs the financial sector to lead its recovery by providing credit. Every economy needs a means of payment, which is why Wall Street has been able to threaten to wreck the economy if the government does not give in to its demands. But the monetary function should not be confused with predatory lending and casino gambling, not to mention Wall Street’s use of bailout funds on lobbying efforts to spread its gospel.
Deficit reduction
It seems absurd for politicians to worry that running a deficit from health care or Social Security can cause serious economic problems, after having given away $13 trillion to Wall Street and a blank check to the Pentagon. The “stimulus package” was only about 5 percent of this amount. But Mr. Obama has announced that he intends on Tuesday to close the barn door by proposing a bipartisan Senate Budget Commission to recommend how to limit future deficits – now that Congress is unwilling to give away any more money to Wall Street.
Republican approval would set the stage for Wednesday’s State of the Union message promising to press for “fiscal responsibility,” as if a lower deficit will help recovery. I suspect that Republicans will have little interest in joining. They see the aim as being to co-opt their criticism of Democratic spending plans. But in view of the rising and well-subsidized efforts of Harold Ford and his fellow Corporate Democrats, the actual “bipartisan” aim seems to be to provide political cover for cutting spending on labor and on social services. Mr. Obama already has sent up trial balloons about needing to address the Social Security and Medicare deficits, as if they should not be financed out of the general budget by taxpayers including the higher brackets (presently exempted from FICA paycheck withholding).
Traditionally, running deficits is supposed to help pull economies out of recession. But today, spending money on public services is deemed “bad,” because it may be “inflationary” – that is, threatening to raise wages. Talk of cutting deficits thus is class-war talk – on behalf of the FIRE sector.
The economy needs deficit spending to avoid unemployment and poverty, to increase social spending to deal with the present economic shrinkage, and to maintain their capital infrastructure. The federal government also needs to increase revenue sharing with states forced to slash their budgets in response to falling tax revenue and rising unemployment insurance.
But the deficits that the Bush-Obama administration have run are nothing like the familiar old Keynesian-style deficits to help the economy recover. Running up public debt to pay Wall Street in the hope that much of this credit will be lent out to inflate asset prices is deemed good. This belief will form the context for Wednesday’s State of the Union speech. So we are brought back to the idea of economic recovery and just what is to be recovered.
Financial lobbyists are hoping to get the government to fill the gap in domestic demand below full-employment levels by providing bank credit. When governments spend money to help increase economic activity, this does not help the banks sell more interest bearing debt. Wall Street’s golden age occurred under Bill Clinton, whose budget surplus was more than offset by an explosion of commercial bank lending.
The pro-financial mass media reiterate that deficits are inflationary and bankrupt economies. The reality is that Keynesian-style deficits raise wage levels relative to the price of property (the cost of obtaining housing, and of buying stocks and bonds to yield a retirement income). The aim of running a “Wall Street deficit” is just the reverse: It is to re-inflate property prices relative to wages.
A generation of financial “ideological engineering” has told people to welcome asset-price inflation (the Bubble Economy). People became accustomed to imagine that they were getting richer when the price of their homes rose. The problem is that real estate is worth what banks will lend – and mortgage loans are a form of debt, which needs to be repaid.
I worry that Wednesday’s address will celebrate this failed era.
By Michael Hudson
Economic Perspectives from Kansas City
January 25, 2009
The State of the Union address is in danger of purveying the usual euphemisms. I expect Mr. Obama to brag that he has overseen a recovery. But can there be any such thing as a jobless recovery? What has recovered are stock market averages and Wall Street bonuses, not disposable personal income or discretionary spending after paying debt service.
There is a dream that what can be “recovered” is something so idyllic as to be mythical: a Bubble Economy enabling people to make money without actually working, by borrowing and riding the tide of asset-price inflation to make capital gains. Corporate Democrat Harold Ford Jr. writes nostalgically that Bill Clinton’s eight years in office created 22 million jobs, “balanced the budget and left his successor with a surplus. This can be done again,” if only Mr. Obama moves further to the right (which Mr. Ford calls the center, meaning the Bayhs and Republicans).
Well, no it can’t be done again. Pres. Clinton’s administration balanced the budget by “welfare reform” to cut back public spending. This would be lethal today. Meanwhile, his explosion of bank credit and the dot.com boom (rising stock prices and bonuses without any earnings) fueled the early stages of the Greenspan bubble. It was a debt-leveraged illusion. Instead of the government running budget deficits to expand domestic demand, Mr. Clinton left it to banks to extend interest-bearing credit – debt pollution that we are still struggling to clean up.
The danger is that when Mr. Obama speaks of “stabilizing the economy,” he means trying to sustain the rise in compound interest and debt. This mathematical financial dynamic is autonomous from the “real” industrial economy, overwhelming it economically. That is what makes the present economic road to debt peonage so self-defeating.
Debts that can’t be paid, won’t be. So defaults are rising. The question that Mr. Obama should be addressing is how to deal with the excess of debt above the ability to pay – and of negative equity for the one-quarter of U.S. real estate that has a higher mortgage debt than the market price is worth. If the hope is still to “borrow our way out of debt” by getting the banks to start lending again, then listeners on Wednesday will know that Mr. Obama’s second year in office will be worse for the economy than his first.
How realistic is it to expect the speech to make clear that “we can’t go home again”? Mr. Obama promised change. “We simply cannot return to business as usual,” he said on Jan. 21, introducing the “Volcker plan.” But how can there be meaningful structural change if the plan is to return to an idealized dynamic that enriched Wall Street but not the rest of the economy?
The word “recession” implies that economic trends will return to normal almost naturally
Any dream of “recovery” in today’s debt-leveraged economy is a false hope. Yet high financial circles expect Mr. Obama to insist that the economy cannot recover without first reimbursing and enriching Wall Street. To re-inflate asset prices, Mr. Obama’s team looks to Japan’s post-1990 model. A compliant Federal Reserve is to flood the credit markets to lower interest rates to revive bank lending –interest-bearing debt borrowed to buy real estate already in place (and stocks and bonds already issued), enabling banks to work out of their negative equity position by inflating asset prices relative to wages.
The promise is that re-inflating prices will help the “real” economy. But what will “recover” is the rising trend of consumer and homeowner debt responsible for stifling the economy with debt deflation in the first place. This end-result of the Clinton-Bush bubble economy is still being applauded as a model for recovery.
We are not really emerging from a “recession.” The word means literally a falling below a trend line. The economy cannot “recover” its past exponential growth, because it was not really normal. GDP is rising mainly for the FIRE sector – finance, insurance and real estate – not the “real economy.” Financial and corporate managers are paying themselves more for their success in paying their employees less.
This is the antithesis of recovery for Main Street. That is what makes the FIRE sector so self-destructive, and what has ended America’s great post-1945 upswing.
There are two economies – and the extractive FIRE sector dominates the “real” economy
When listening to the State of the Union speech, one should ask just which economy Mr. Obama means when he talks about recovery. Most wage earners and taxpayers will think of the “real” economy of production and consumption. But Mr. Obama believes that this “Economy #1” is dependent on that of Wall Street. His major campaign contributors and “wealth creators” in the FIRE sector – Economy #2, wrapped around the “real” Economy #1.
Economy #2 is the “balance sheet” economy of property and debt. The wealthiest 10% lend out their savings to become debts owed by the bottom 90%. A rising share of gains are made in extractive ways, by charging rent and interest, by financial speculation (“capital gains”), and by shifting taxes off itself onto the “real” Economy #1.
John Edwards talked about “the two economies,” but never explained what he meant operationally. Back in the 1960s when Michael Harrington wrote The Other America, the term meant affluent vs. poor America. For 19th-century novelists such as Charles Dickens and Benjamin Disraeli, it referred to property owners vs. renters. Today, it is finance vs. debtors. Any discussion of economic polarization betweens rich and poor must focus on the deepening indebtedness of most families, companies, real estate, cities and states to an emerging financial oligarchy.
Financial oligarchy is antithetical to democracy. That is what the political fight in Washington is all about today. The Corporate Democrats are trying to get democratically elected to bring about oligarchy. I hope that this is a political oxymoron, but I worry about how many people but into the idea that “wealth creation” requires debt creation. While wealth gushes upward through the Wall Street financial siphon, trickle-down economic ideology to fuel a Bubble Economy via debt-leveraged asset-price inflation.
The role of public spending – and hence budget deficits – no longer means taxing citizens to spend on improving their well-being within Economy #1. Since the 2008 financial meltdown the enormous rise in national debt has resulted from reimbursing Wall Street for its bad gambles on derivatives, collateralized debt obligations and credit default swaps that had little to do with the “real” economy. They could have been wiped out without bringing down the economy. That was an idle threat. A.I.G.’s swap insurance department could have collapsed (it was largely in London anyway) while keeping its normal insurance activities unscathed. But the government paid off the financial sector’s bad speculative debts by taking them onto the public balance sheet.
The economy is best viewed as the FIRE sector wrapped around the production and consumption core, extracting financial and rent charges that are not technologically or economically necessary costs.
Say’s Law of markets, taught to every economics student, states that workers and their employers use their wages and profits to buy what they produce (consumer goods and capital goods). Profits are earned by employing labor to produce goods and services to sell at a markup. (M – C – M’ to the initiated.)
The financial and property sector is wrapped around this core, siphoning off revenue from this circular flow. This FIRE sector is extractive. Its revenue takes the form of what classical economists called “economic rent,” a broad category that includes interest, monopoly super-profits (price gouging) and land rent, as well as “capital” gains. (These are mainly land-price gains and stock-market gains, not gains from industrial capital as such.) Economic rent and capital gains are income without a corresponding necessary cost of production (M – M’ to the initiated). “Banks have lent increasingly to buy up these rentier rights to extract interest, and less and less to promote industrial capital formation. Wealth creation” FIRE-style consists most easily of privatizing the public domain and erecting tollbooths to charge access fees for basic necessities such as health insurance, land sites, home ownership, the communication spectrum (cable and phone rights), patent medicine, water and electricity, and other public utilities, including the use of convenient money (credit cards), or the credit needed to get by. This kind of wealth is not what Adam Smith described in The Wealth of Nations. It is a form of overhead, not a means of production. The revenue it extracts is a zero-sum economic activity, meaning that one party’s gain (that of Wall Street usually) is another’s loss.
Debt deflation resulting from a distorted “financialized” economy
The problem that Mr. Obama faces is one that he cannot voice politically without offending his political constituency. The Bubble Economy has left families, companies, real estate and government so heavily indebted that they must use current income to pay banks and bondholders. The U.S. economy is in a debt deflation. The debt service they pay is not available for spending on goods and services. This is why sales are falling, shops are closing down and employment continues to be cut back.
Banks evidently do not believe that the debt problem can be solved. That is why they have taken the $13 trillion in bailout money and run – by it out in bonuses, or buying other banks and foreign affiliates. They see the domestic economy as being all loaned up. The game is over. Why would they make yet more loans against real estate already in negative equity, with mortgage debt in excess of the market price that can be recovered? Banks are not writing more “equity lines of credit” against homes or making second mortgages in today’s market, so consumers cannot use rising mortgage debt to fuel their spending.
Banks also are cutting back their credit card limits. They are “earning their way out of debt,” making up for the bad gambles they have taken with depositor funds, by raising interest rates, penalties and fees, by borrowing low-interest credit from the Federal Reserve and investing it abroad – preferably in currencies rising against the dollar. This is what Japan did in the “carry trade.” It kept the yen’s exchange rate down, and it is lowering the dollar’s exchange rate today. This threatens to raise prices for imports, on which domestic consumer prices are based. So easy credit for Wall Street means a cost squeeze for consumers.
The President needs a better set of advisors. But Wall Street has obtained veto power over just who they should be. Control over the President’s ear time has been part of the financial sector’s takeover of government. Wall Street has threatened that the stock market will plunge if oligarch-friendly Fed Chairman Bernanke is not reappointed. Mr. Obama insists on keeping him on board, in the belief that what’s good for Wall Street is good for the economy at large.
But what’s good for the banks is a larger market for their credit – more debt for the families and companies that are their customers, higher fees and penalties, no truth-in-lending laws, harsher bankruptcy terms, and further deregulation and bailouts.
This is the program that Mr. Bernanke has advised Washington to follow. Wall Street hopes that he will be kept on board. Mr. Bernanke’s advice has helped bolster that of Tim Geithner at Treasury and Larry Summers as chief advisor to convince Pres. Obama that “recovery” requires more credit.
Going down this road will make the debt overhead heavier, raising the cost of living and doing business. So we must beware of the President using the term “recovery” in his State of the Union speech to mean a recovery of debt and giving more money to Wall Street Jobs cannot revive without consumers having more to spend. And consumer demand (I don’t like this jargon word, because only Wall Street and the Pentagon’s military-industrial complex really make demands) cannot be revived without reducing the debt burden. Bankers are refusing to write down mortgages and other debts to reflect the ability to pay. That act of economic realism would mean taking a loss on their bad debts. So they have asked the government to lend new buyers enough credit to re-inflate housing prices. This is the aim of the housing subsidy to new homebuyers. It leaves more revenue to be capitalized into higher mortgage loans to support prices for real estate fallen into negative equity.
The pretense is that this is subsidizing the middle class, but homebuyers are only the intermediaries for government credit (debt to be paid off by taxpayers) to mortgage bankers. Nearly 90 percent of new home mortgages are being funded or guaranteed by the FHA, Fannie Mae and Freddie Mac – all providing a concealed subsidy to Wall Street.
Mr. Obama’s most dangerous belief is the myth that the economy needs the financial sector to lead its recovery by providing credit. Every economy needs a means of payment, which is why Wall Street has been able to threaten to wreck the economy if the government does not give in to its demands. But the monetary function should not be confused with predatory lending and casino gambling, not to mention Wall Street’s use of bailout funds on lobbying efforts to spread its gospel.
Deficit reduction
It seems absurd for politicians to worry that running a deficit from health care or Social Security can cause serious economic problems, after having given away $13 trillion to Wall Street and a blank check to the Pentagon. The “stimulus package” was only about 5 percent of this amount. But Mr. Obama has announced that he intends on Tuesday to close the barn door by proposing a bipartisan Senate Budget Commission to recommend how to limit future deficits – now that Congress is unwilling to give away any more money to Wall Street.
Republican approval would set the stage for Wednesday’s State of the Union message promising to press for “fiscal responsibility,” as if a lower deficit will help recovery. I suspect that Republicans will have little interest in joining. They see the aim as being to co-opt their criticism of Democratic spending plans. But in view of the rising and well-subsidized efforts of Harold Ford and his fellow Corporate Democrats, the actual “bipartisan” aim seems to be to provide political cover for cutting spending on labor and on social services. Mr. Obama already has sent up trial balloons about needing to address the Social Security and Medicare deficits, as if they should not be financed out of the general budget by taxpayers including the higher brackets (presently exempted from FICA paycheck withholding).
Traditionally, running deficits is supposed to help pull economies out of recession. But today, spending money on public services is deemed “bad,” because it may be “inflationary” – that is, threatening to raise wages. Talk of cutting deficits thus is class-war talk – on behalf of the FIRE sector.
The economy needs deficit spending to avoid unemployment and poverty, to increase social spending to deal with the present economic shrinkage, and to maintain their capital infrastructure. The federal government also needs to increase revenue sharing with states forced to slash their budgets in response to falling tax revenue and rising unemployment insurance.
But the deficits that the Bush-Obama administration have run are nothing like the familiar old Keynesian-style deficits to help the economy recover. Running up public debt to pay Wall Street in the hope that much of this credit will be lent out to inflate asset prices is deemed good. This belief will form the context for Wednesday’s State of the Union speech. So we are brought back to the idea of economic recovery and just what is to be recovered.
Financial lobbyists are hoping to get the government to fill the gap in domestic demand below full-employment levels by providing bank credit. When governments spend money to help increase economic activity, this does not help the banks sell more interest bearing debt. Wall Street’s golden age occurred under Bill Clinton, whose budget surplus was more than offset by an explosion of commercial bank lending.
The pro-financial mass media reiterate that deficits are inflationary and bankrupt economies. The reality is that Keynesian-style deficits raise wage levels relative to the price of property (the cost of obtaining housing, and of buying stocks and bonds to yield a retirement income). The aim of running a “Wall Street deficit” is just the reverse: It is to re-inflate property prices relative to wages.
A generation of financial “ideological engineering” has told people to welcome asset-price inflation (the Bubble Economy). People became accustomed to imagine that they were getting richer when the price of their homes rose. The problem is that real estate is worth what banks will lend – and mortgage loans are a form of debt, which needs to be repaid.
I worry that Wednesday’s address will celebrate this failed era.
Transcript: 351 Friday Forecast, er, Market Predictions
Listen to this episode
Coming in here on the day of the release of GDP numbers, likely to be four plus... We do it to emphasize our extreme outlier position that the economy is still in recession. Then our market forecasts, yes, straying from the economy into the market mob or at least the casino run by the market mob.
Demand Side is, as we've made clear for the past six months, not calling the current so-called growth even a "technical recovery" quote unquote. This is going to sound pretty strange, because perhaps before you hear it even, the GDP number will be out with a 4 plus number. This reflects the stimulus that was supposed to jump start the recovery. Not the recovery. So, strange-sounding or not, we continue with still in recession.
We have warned for months about the danger of another crisis, possibly centered on commercial real estate and the wholesale failure of the not too big to fail banks or on the incredible and incredibly stupid 60 billion in credit default swaps traded in dark markets with no legitimate regulation.
We may be stubborn, but we still do not see that we have been proven wrong. The most credible evidence to the contrary, in our opinion, is the blue bar on Calculated Risk's graphs is ended in late summer. The decision will ultimately be made by NBER, the National Bureau of Economic Research, and it will be made long after all the evidence is in. In our view, that means it will be decided by the performance of the economy in the next six months.
But we are SO stubborn, we won't even take their word for it. Unless, of course, they agree with us. Why?
Because there is no investment, there is no credit growth, there is no end to the housing price decrease, there is no end to the loss of jobs. What we have done is found the bottom, and now we are bouncing along it, and we are soon to find that it is sloped downward. All the talk in 2009 among forecasters of second derivatives was not an indication of an eventual turnaround. It was an indication that we were getting close to this bottom.
Three things about that:
The bottom is sloped downward. It is not flat.
Automatic and discretionary stabilizers can reduce the slope, but not make it positive.
An eventual turnaround depends on policy choices that are not even on the table.
Now, realizing that outliers like ourselves are not taken seriously, even if proven right, and are considered more annoyances than voices to be listened to, we turn to the arena where we will be taken seriously, even if we have much less confidence in our own views. The arena we are leaving is economic forecasting. The one we are entering is market prediction.
You will remember we, unlike other bears, have correctly predicted market booms in the current recession. Most accurate was our contemporaneous call of the oil and commodity boom beginning in the fall of 2007 and ending in July 2008. We called the bull on time and came out with the bear on the very day. Elsewhere, unlike for example, Nouriel Roubini who called the strength in stocks in early 2009 a "dead cat bounce" and a "sucker's rally," Demand Side allowed that there were plenty of chips for the casino and a rebound from the lows was likely.
Our errors were made early on when we suspected that Treasury prices would fall, yields rising, as a result of deteriorating fundamentals. In fact, prices have remained above our early calls, though we can see and have seen for some time the flight to quality, aka, safety and the real returns benefiting from deflation. So in spite of immense supply, we suppose bond prices will continue stable and high. There is, of course, the built-in demand from those institutions able to borrow at zero from the Fed and carry their money over to the Treasury for three and a quarter.
Stocks we predict here will fall over the next six months, as the bubble from the same zero percent financed positions deflates in response to flagging demand from anybody else. Nor retail individuals, nor institutional investors, nor hedge funds, nor foreigners are buying the stocks. They can float on an unlimited supply of chips to the professional players, but sooner or later some gotta win and some gotta lose. The first one's to take their chips off the table will be the winners. Which means everybody has their hands poised over their stacks.
That fall may have already begun. But more about that later. And of course, a crisis such as we imagined above in the financial sector would transform that fall into a crash. At the same time, bubbles in places like Australia and China, borne up by the carry trade, could collapse and create spikes in U.S. markets.
We think the stronger economies, particularly Brazil's, are saturated in real terms, but may benefit for being the only healthy fields left. We encourage Brazil to continue and increase its restrictions on capital flows. Talk about a turnaround! We are talking about Brazil as if it were Germany. Speaking of Germany, the place that looks like it could create political instability such as visited interwar Germany is China, where a huge bubble is in progress. Rather than create stability by expanding its social insurance programs, that country has created instability by funding big new infrastructure and fomenting a housing boom. The fever for housing is not unlike that in the U.S. in the early aughts, when people bought as an investment and as a sure source of retirement security.
Markets in commodities, particularly oil and metals, benefit from bubble financing as well. The current price of oil is not really out of line with historical trends, but those trends were set in the context of much stronger real economies. If supply and demand were truly the rule for oil, the price would have trouble getting to $50. On the other hand, oil goes up when the dollar goes down, indicating to some a trade relationship and to others a role for oil as a store of value like gold.
We're not commenting on gold, other than to say it is more a currency than a commodity and is subject to fevered and religious ecstasies.
In terms of specific sectors. All consumer discretionaries, including most durables, will be under immense pressure. Financial sector stocks suffer from the fact that they are not providing any service, many are insolvent, torches and pitchforks are at the moat, and the casino games they are playing are fundamentally nonproductive. The companies in Health Care, Big Oil, Big Coal, Pharmaceuticals, FIRE -- finance, insurance and real estate -- whose interests are protected by the Joe Lieberman's of the world, probably have another couple of years of up and down before they are wiped out.
As absurd as not seeing the housing bubble is not seeing the profits of corporations as being conjured up out of downsizing, accounting gimicks and foregoing productive investment. It is more a function of money needing a place to be with returns labeled above 3 percent. The labels come off.
So, to summarize. Market Predictions:
The end of the bear market rally is in sight, and may have begun.
There is a better than fifty percent chance of a major new crisis in 2010.
The crisis will again be in the financial sector, from CRE and not too big to fail banks, or from the collapse of unregulated derivatives
Treasury bond markets will be stable in the sense of having prices and yields that don't vary.
Commodity markets and oil will deteriorate over the next two years.
Brazil is the only healthy economy, but it is overbought in spite of its defenses.
Chinese and Australian markets will crash within two years.
Politically muscular sectors will hold on for longer than real economy sectors like consumer durables
The housing market has much further to fall.
Now, for context, with an assist from David Rosenberg, Glusken Scheff, whose free e-mailed daily newsletter ought to be your guide for investing.
Asian stocks hit their lowest level in a month on Wednesday with a 1.1% loss and are down now in each of the past eight sessions. And the MSCI emerging markets index slid 0.6% and is down 8% over the past six-day losing streak. In the FX market, the Yen has firmed to nine-month high against the euro in a classic sign of heightened risk aversion.
Corporate bond risks in Europe are rising too – underscored by the widening in CDS spreads – CDS (Credit Default Swaps) are also widening on sovereign debt in response to intractable fiscal deficits everywhere – with Portugal, Spain and Greece the primary suspects. The commodity complex is trading softly as well, with copper needing to play some catch-up – but the gold price is hanging tight at its 100-day moving average and it was encouraging yesterday to see it rebound even with the DXY edging higher at the same time. Bonds are on an even keel with the 10-year note yield still flirting with one-month lows and Tuesday’s 2-year auction going quite well (bid-cover ratio of 3.13x and indirect bidding – a proxy for foreign central bank activity – taking up a not-too-shabby 43% of the auction).
CPI data in Germany are showing a deep plunge for January (-0.7% MoM in Bavaria) and the U.K. retail sales figures (the CBI survey) also posted a surprising decline to kick off the year (the diffusion index swung from +13% in December to -8% in January). Mmortgage applications in the U.S. fell an immense 11% last week and there was no sign of upturn in the ABC News weekly consumer confidence index either which came in at a recessionary -48 level last week and has averaged -46 so far in January versus -44 in December, not exactly ratifying the results from the Conference Board yesterday (see more below).
The Fed released its statement indicating continuation of the wholly ineffective and dangerous zero percent rates policy for an extended period of time.
Rosenberg offers the following commentary:
quote:
On December 16, the press statement read “economic activity is likely to remain weak for a time”, and now, it reads “the pace of economic recovery is likely to be moderate for a time.” So, it would seem as though the Fed has actually upgraded its forecast! No mention was made about the downturn in the housing data (and in the December statement, we were told that “the housing sector has shown some signs of improvement over recent months”). Then again, the Fed knows that we are going to see a ripping GDP report for Q4 this Friday so why bother talking the economy down — though in my view it is on the cusp of rolling over.
unquote
Ben Bernanke was seen as likely to be confirmed by the Senate later today.
The U.S., Canada and the EU or reducing fiscal stimulus.
The President has announced his intention to freeze about 20% of government program spending. There has been no talk of the Fed backtracking on its plan to cease it its home-loan interventions or for the U.S. government extending the expiry date of its housing tax credits, again.
The Case-Shiller home price index came in a tad below expected in November at +0.24%, which is a discernible slowing from the +0.6% average from June to October. With over 9 million housing units either vacant for sale, in foreclosed inventory or occupied and listed actively, together with a competing record 11% nationwide rental vacancy rate, it’s only a matter of time before home prices succumb,
says David Rosenberg.
Treasury one-month bill rates turned negative for the first time in 10 months, as issuance declines while investors seek the most easily-traded securities amid a renewal of risk aversion.
The rate on the four-week security dropped to negative 0.0101 percent, the lowest since it reached negative 0.015 percent on March 26. The Treasury sold $10 billion of four-week bills on Jan. 26 at a rate of zero percent ...
The Ten Year yield is back down to 3.61%.
It’s going to be very interesting to see how the global economy performs without the government lifeline that has pumped over $2 trillion of government stimulus into the world economy since 2008. A disrobed emperor is not likely going to be a very pleasant sight.
And completing today's edition of the podcast, we take note of a video our daughter sent us, which most have already seen. A rap featuring Keynes and Hayek.
I wrote her back,
somehow Hayek comes out looking somewhat similar in intelligence and perspicacity to Keynes.
AND it's produced at the cost of a million dollars!!!
Therefore? It is produced to get Hayek's nonsense on a level in the popular mind as Keynes' insights.
Knowing you are probably not interested in the logical proofs, I offer only this empirical (historical fact) proof. It was the Keynesians who were crying out against the superbubble that has now burst, who were pointing to the immense credit explosion, and the Hayekians who were saying "let the market work."
Ta-da
Coming in here on the day of the release of GDP numbers, likely to be four plus... We do it to emphasize our extreme outlier position that the economy is still in recession. Then our market forecasts, yes, straying from the economy into the market mob or at least the casino run by the market mob.
Demand Side is, as we've made clear for the past six months, not calling the current so-called growth even a "technical recovery" quote unquote. This is going to sound pretty strange, because perhaps before you hear it even, the GDP number will be out with a 4 plus number. This reflects the stimulus that was supposed to jump start the recovery. Not the recovery. So, strange-sounding or not, we continue with still in recession.
We have warned for months about the danger of another crisis, possibly centered on commercial real estate and the wholesale failure of the not too big to fail banks or on the incredible and incredibly stupid 60 billion in credit default swaps traded in dark markets with no legitimate regulation.
We may be stubborn, but we still do not see that we have been proven wrong. The most credible evidence to the contrary, in our opinion, is the blue bar on Calculated Risk's graphs is ended in late summer. The decision will ultimately be made by NBER, the National Bureau of Economic Research, and it will be made long after all the evidence is in. In our view, that means it will be decided by the performance of the economy in the next six months.
But we are SO stubborn, we won't even take their word for it. Unless, of course, they agree with us. Why?
Because there is no investment, there is no credit growth, there is no end to the housing price decrease, there is no end to the loss of jobs. What we have done is found the bottom, and now we are bouncing along it, and we are soon to find that it is sloped downward. All the talk in 2009 among forecasters of second derivatives was not an indication of an eventual turnaround. It was an indication that we were getting close to this bottom.
Three things about that:
The bottom is sloped downward. It is not flat.
Automatic and discretionary stabilizers can reduce the slope, but not make it positive.
An eventual turnaround depends on policy choices that are not even on the table.
Now, realizing that outliers like ourselves are not taken seriously, even if proven right, and are considered more annoyances than voices to be listened to, we turn to the arena where we will be taken seriously, even if we have much less confidence in our own views. The arena we are leaving is economic forecasting. The one we are entering is market prediction.
You will remember we, unlike other bears, have correctly predicted market booms in the current recession. Most accurate was our contemporaneous call of the oil and commodity boom beginning in the fall of 2007 and ending in July 2008. We called the bull on time and came out with the bear on the very day. Elsewhere, unlike for example, Nouriel Roubini who called the strength in stocks in early 2009 a "dead cat bounce" and a "sucker's rally," Demand Side allowed that there were plenty of chips for the casino and a rebound from the lows was likely.
Our errors were made early on when we suspected that Treasury prices would fall, yields rising, as a result of deteriorating fundamentals. In fact, prices have remained above our early calls, though we can see and have seen for some time the flight to quality, aka, safety and the real returns benefiting from deflation. So in spite of immense supply, we suppose bond prices will continue stable and high. There is, of course, the built-in demand from those institutions able to borrow at zero from the Fed and carry their money over to the Treasury for three and a quarter.
Stocks we predict here will fall over the next six months, as the bubble from the same zero percent financed positions deflates in response to flagging demand from anybody else. Nor retail individuals, nor institutional investors, nor hedge funds, nor foreigners are buying the stocks. They can float on an unlimited supply of chips to the professional players, but sooner or later some gotta win and some gotta lose. The first one's to take their chips off the table will be the winners. Which means everybody has their hands poised over their stacks.
That fall may have already begun. But more about that later. And of course, a crisis such as we imagined above in the financial sector would transform that fall into a crash. At the same time, bubbles in places like Australia and China, borne up by the carry trade, could collapse and create spikes in U.S. markets.
We think the stronger economies, particularly Brazil's, are saturated in real terms, but may benefit for being the only healthy fields left. We encourage Brazil to continue and increase its restrictions on capital flows. Talk about a turnaround! We are talking about Brazil as if it were Germany. Speaking of Germany, the place that looks like it could create political instability such as visited interwar Germany is China, where a huge bubble is in progress. Rather than create stability by expanding its social insurance programs, that country has created instability by funding big new infrastructure and fomenting a housing boom. The fever for housing is not unlike that in the U.S. in the early aughts, when people bought as an investment and as a sure source of retirement security.
Markets in commodities, particularly oil and metals, benefit from bubble financing as well. The current price of oil is not really out of line with historical trends, but those trends were set in the context of much stronger real economies. If supply and demand were truly the rule for oil, the price would have trouble getting to $50. On the other hand, oil goes up when the dollar goes down, indicating to some a trade relationship and to others a role for oil as a store of value like gold.
We're not commenting on gold, other than to say it is more a currency than a commodity and is subject to fevered and religious ecstasies.
In terms of specific sectors. All consumer discretionaries, including most durables, will be under immense pressure. Financial sector stocks suffer from the fact that they are not providing any service, many are insolvent, torches and pitchforks are at the moat, and the casino games they are playing are fundamentally nonproductive. The companies in Health Care, Big Oil, Big Coal, Pharmaceuticals, FIRE -- finance, insurance and real estate -- whose interests are protected by the Joe Lieberman's of the world, probably have another couple of years of up and down before they are wiped out.
As absurd as not seeing the housing bubble is not seeing the profits of corporations as being conjured up out of downsizing, accounting gimicks and foregoing productive investment. It is more a function of money needing a place to be with returns labeled above 3 percent. The labels come off.
So, to summarize. Market Predictions:
The end of the bear market rally is in sight, and may have begun.
There is a better than fifty percent chance of a major new crisis in 2010.
The crisis will again be in the financial sector, from CRE and not too big to fail banks, or from the collapse of unregulated derivatives
Treasury bond markets will be stable in the sense of having prices and yields that don't vary.
Commodity markets and oil will deteriorate over the next two years.
Brazil is the only healthy economy, but it is overbought in spite of its defenses.
Chinese and Australian markets will crash within two years.
Politically muscular sectors will hold on for longer than real economy sectors like consumer durables
The housing market has much further to fall.
Now, for context, with an assist from David Rosenberg, Glusken Scheff, whose free e-mailed daily newsletter ought to be your guide for investing.
Asian stocks hit their lowest level in a month on Wednesday with a 1.1% loss and are down now in each of the past eight sessions. And the MSCI emerging markets index slid 0.6% and is down 8% over the past six-day losing streak. In the FX market, the Yen has firmed to nine-month high against the euro in a classic sign of heightened risk aversion.
Corporate bond risks in Europe are rising too – underscored by the widening in CDS spreads – CDS (Credit Default Swaps) are also widening on sovereign debt in response to intractable fiscal deficits everywhere – with Portugal, Spain and Greece the primary suspects. The commodity complex is trading softly as well, with copper needing to play some catch-up – but the gold price is hanging tight at its 100-day moving average and it was encouraging yesterday to see it rebound even with the DXY edging higher at the same time. Bonds are on an even keel with the 10-year note yield still flirting with one-month lows and Tuesday’s 2-year auction going quite well (bid-cover ratio of 3.13x and indirect bidding – a proxy for foreign central bank activity – taking up a not-too-shabby 43% of the auction).
CPI data in Germany are showing a deep plunge for January (-0.7% MoM in Bavaria) and the U.K. retail sales figures (the CBI survey) also posted a surprising decline to kick off the year (the diffusion index swung from +13% in December to -8% in January). Mmortgage applications in the U.S. fell an immense 11% last week and there was no sign of upturn in the ABC News weekly consumer confidence index either which came in at a recessionary -48 level last week and has averaged -46 so far in January versus -44 in December, not exactly ratifying the results from the Conference Board yesterday (see more below).
The Fed released its statement indicating continuation of the wholly ineffective and dangerous zero percent rates policy for an extended period of time.
Rosenberg offers the following commentary:
quote:
On December 16, the press statement read “economic activity is likely to remain weak for a time”, and now, it reads “the pace of economic recovery is likely to be moderate for a time.” So, it would seem as though the Fed has actually upgraded its forecast! No mention was made about the downturn in the housing data (and in the December statement, we were told that “the housing sector has shown some signs of improvement over recent months”). Then again, the Fed knows that we are going to see a ripping GDP report for Q4 this Friday so why bother talking the economy down — though in my view it is on the cusp of rolling over.
unquote
Ben Bernanke was seen as likely to be confirmed by the Senate later today.
The U.S., Canada and the EU or reducing fiscal stimulus.
The President has announced his intention to freeze about 20% of government program spending. There has been no talk of the Fed backtracking on its plan to cease it its home-loan interventions or for the U.S. government extending the expiry date of its housing tax credits, again.
The Case-Shiller home price index came in a tad below expected in November at +0.24%, which is a discernible slowing from the +0.6% average from June to October. With over 9 million housing units either vacant for sale, in foreclosed inventory or occupied and listed actively, together with a competing record 11% nationwide rental vacancy rate, it’s only a matter of time before home prices succumb,
says David Rosenberg.
Treasury one-month bill rates turned negative for the first time in 10 months, as issuance declines while investors seek the most easily-traded securities amid a renewal of risk aversion.
The rate on the four-week security dropped to negative 0.0101 percent, the lowest since it reached negative 0.015 percent on March 26. The Treasury sold $10 billion of four-week bills on Jan. 26 at a rate of zero percent ...
The Ten Year yield is back down to 3.61%.
It’s going to be very interesting to see how the global economy performs without the government lifeline that has pumped over $2 trillion of government stimulus into the world economy since 2008. A disrobed emperor is not likely going to be a very pleasant sight.
And completing today's edition of the podcast, we take note of a video our daughter sent us, which most have already seen. A rap featuring Keynes and Hayek.
I wrote her back,
somehow Hayek comes out looking somewhat similar in intelligence and perspicacity to Keynes.
AND it's produced at the cost of a million dollars!!!
Therefore? It is produced to get Hayek's nonsense on a level in the popular mind as Keynes' insights.
Knowing you are probably not interested in the logical proofs, I offer only this empirical (historical fact) proof. It was the Keynesians who were crying out against the superbubble that has now burst, who were pointing to the immense credit explosion, and the Hayekians who were saying "let the market work."
Ta-da
Thursday, January 28, 2010
Paul Krugman steps up to the plate for Bernanke, swings ... and misses
Demand Side has had its bone to pick with Paul Krugman many times. We are happy at least one economist was willing to call himself a liberal during the Bush years. Unfortunately, it is not so clear to us that it was the right economist.
Supporting Bernanke with these words is evidence that the two are fellow Princetonians, not that these arguments are valid.
Bernanke's view of the Depression is deeply flawed. (See Steve Keen's recent work at Debtwatch.) His so-called "aggressive, unorthodox tactics" were old-fashioned lender of last resort to whatever bizarre innovation the banking sector came up with. It is the great danger that this backstopping will continue and extend to the gamut of derivatives traded in dark markets when they -- as they will -- also come a cropper.
Supporting Bernanke with these words is evidence that the two are fellow Princetonians, not that these arguments are valid.
Bernanke's view of the Depression is deeply flawed. (See Steve Keen's recent work at Debtwatch.) His so-called "aggressive, unorthodox tactics" were old-fashioned lender of last resort to whatever bizarre innovation the banking sector came up with. It is the great danger that this backstopping will continue and extend to the gamut of derivatives traded in dark markets when they -- as they will -- also come a cropper.
Paul Krugman: The Bernanke ConundrumEnough!
by Mark Thoma
Paul Krugman's view on Ben Bernanke's reconfirmation as Fed Chair:
The Bernanke Conundrum, by Paul Krugman, Commentary, NY Times: A Republican won in Massachusetts — and suddenly it’s not clear whether the Senate will confirm Ben Bernanke for a second term as Federal Reserve chairman. That’s not as strange as it sounds: Washington has suddenly noticed public rage over economic policies that bailed out big banks but failed to create jobs. And Mr. Bernanke has become a symbol of those policies.
Where do I stand? I deeply admire Mr. Bernanke, both as an economist and for his response to the financial crisis. ... Yet his critics have a strong case. In the end, I favor his reappointment, but only because rejecting him could make the Fed’s policies worse...
Mr. Bernanke is a superb research economist..., his academic expertise and his policy role meshed perfectly, as he used aggressive, unorthodox tactics to head off a second Great Depression.
..."
Michael Hudson on the State of the Union - Part I
The state of the union was yesterday. Michael Hudson wrote these pieces prior to the speech. We put them up here to offer a measure not tainted with the post-speech spin. Tomorrow is part 2 and on Saturday, we'll do Robert Kuttner's pre-speech perspective.
State of the Union Junk Economics, 2010: How Much More “Debt Recovery” can the Economy Take?
By Michael Hudson
Economic Perspectives from Kansas City
January 24, 2010
It’s make or break time for Democrats since last Tuesday’s defeat in Massachusetts. At stake is Mr. Obama’s credibility as an agent for change. Exit polls show that voters see his main change to be favoritism to Wall Street, to a degree that the “old Democrats” would not have let a Republican administration get away with. Rivalry over just what party is more Wall Street friendly prompted Jay Leno to joke that Mr. Obama has done the impossible: resurrected the seemingly dying Republican Party and given it the coveted label of the “Party of Change” running against Wall Street.
Some politicians are hoping that the effect of Massachusetts has been an oxymoron, a “fortuitous calamity” in the form of a wake-up call to Washington. The question is, will the party be able to drag Mr. Obama away from the Corporate Democrats? This is the setting for what must certainly be a hastily rewritten State of the Union message. Instead of celebrating a Republican- and Lieberman-approved health care bill, Mr. Obama finds himself obliged to respond to voters who celebrated his first anniversary in office by choosing a Republican as their designated voice for change. That was supposed to be his line.
My reading of last week’s election is that voters who felt duped by Mr. Obama’s promise as a reform candidate did not really turn Republican, but at least they could throw out the Democrats for failing to make a credible start fixing the debt-strapped economy. The President has begged the banks to start lending again. But this means loading the economy down with yet more debt. The $13 trillion bailout was supposed to help them do this, but they have simply taken the money and run, paying it out in bonuses and salaries, stepping up their lobbying efforts to buy Congress, and buying out other banks to grow larger and increase their monopoly power.
The contrast between Wall Street’s recovery and the failure of the “real” economy to recover its employment and consumption levels has enabled Republicans to depict Mr. Obama and his party as stalling against financial reform. Instead of fulfilling his election promise to become an agent of change, the past year has seen a continuity with the widely rejected Bush policies. Even the personnel remain the same. Over the weekend, Mr. Obama reiterated his endorsement for reappointing Helicopter Ben Bernanke as Federal Reserve Chairman.
As ex officio lobbyist for high finance, Mr. Bernanke’s money drop seemed to land only on Wall Street. Now that it has emptied out the government’s credit in an unparalleled deficit, Mr. Obama is saying, “No more. I’m drawing the line. No further deficit.” There goes any hope for stimulating the “real” economy. Treasury apparatchik Tim Geithner, backed with his armada of administrators on loan from Goldman Sachs, is unlikely to support indebted labor, consumers or their companies in any way that does not benefit Wall Street first.
Even worse has been Mr. Obama’s rehabilitation of Clinton Rubinomics deregulator Larry Summers as chief advisor, sidelining Paul Volcker until he was hurriedly flown back from political Siberia, as if to soften the leak by the Wall Street Journal on January 15 that Mr. Obama and the Democrats were not unhappy to see Elizabeth Warren’s Consumer Financial Products Agency die stillborn, despite Mr. Obama promise that the agency was “non-negotiable.”
Democrats insist that politics had nothing to do with the timing of Mr. Obama’s 180-degree turn and sudden infusion of passion for the “Volcker rule” to re-separate commercial banking from its casino capitalist outgrowth. The photo-op with Mr. Volcker was intended to provide at least a semblance of regulation of the sort that was normal before Mr. Summers and other Clinton-Gore era “Democratic Leadership Committee” operatives had backed Republicans to repeal Glass-Steagall. They are now back in the White House, and the Democrats have failed every litmus test involving finance, insurance and real estate – the FIRE sector, which remains the major campaign contributor and lobbyist for both parties.
Democrats up for re-election this November are jumping ship. On Friday, within just 72 hours of the Massachusetts vote, Barbara Boxer and other Democrats on the Senate Finance Committee came out against reappointing Mr. Bernanke. Republican leaders already had taken a head start on opposing him. Still, many Democrats have found enough born-again populism to sacrifice Mr. Bernanke, and perhaps Messrs. Summers and Geithner as well.
It is bad enough that Mr. Obama has not joined in the criticism of Mr. Bernanke for having refused to regulate mortgage fraud or slow the bubble economy even when the law required him to do so. And it is bad enough that Mr. Bernanke has been so willfully blind as to deny that the Fed was fueling the Bubble with low interest rates and a refusal to regulate fraud. What he calls the “free market” is what many consider to be consumer fraud.
The widening public perception of Mr. Obama’s first year as being a Great Continuity with the Bush Administration has enabled Republicans to position themselves for this year’s mid-term elections – and 2012 – by reminding voters how they opposed the bank bailout back in September 2008, when Mr. Obama supported it. Now that support for Wall Street has become the third rail in American politics, they may appoint a standard bearer who voted against the bailout.
This is ironic. George W. Bush ran for president saying: “I’m a uniter, not a divider,” and proceeded to divide the country (needing only 50 Senate votes plus the Vice Presidential tie-breaker to do it). Mr. Obama promised change, but then decided that he wants to be bipartisan (and insisting that he needs 60 votes; many are asking whether, if he had them, he then would say that he needed 90 votes to get the Baucuses and Bayhs, Liebermans and Boehners on board for his promised change). On Tuesday he is scheduled to invite Republicans to participate in a joint committee on the budget deficit – to get Republicans on board for tax increases to finance future giveaways to their mutual Wall Street constituency. They probably will say “no.” This should enable him to make a clean break. But then he would not be who he is.
For opportunists in both parties, the trick is how to wrap pro-Wall Street policies in enough populist rhetoric to win re-election, given that the FIRE sector remains the key source of funding for most political campaigns. The contrast between rhetoric and policy reality is the basic set of forces pulling Wednesday’s State of the Union address this Wednesday – and for the next two years. The real question is thus whether Mr. Obama’s promise to make an about-face and back financial reform will remain merely rhetorical, or actually be substantive?
Putting Mr. Obama’s speech in perspective
Spending a year hoping to get Republicans to sign onto health care almost seems to have been a tactic to give Mr. Obama a plausible excuse for stalling rather than to address what most voters are mainly concerned about: the economy. Subsidizing the debt overhead and the debt deflation that is shrinking markets and causing unemployment, home foreclosures and a capital flight out of the dollar has cost $13 trillion in just over a year – more than ten times the anticipated shortfall of any public health insurance reform or an entire decade of the anticipated Social Security shortfall.
Not only are voters angry, so are the community organizers and Mr. Obama's former Harvard Law School colleagues with whom I have spoken. Instead of providing help in slowing the foreclosure process or pressuring banks to renegotiate, his solution is for the Fed to flood the banking system with enough money at low enough interest rates to re-inflate housing prices. What Mr. Obama seems to mean by “recovery” is that consumers once again will be extended Bubble-era levels of debt to afford housing at prices that will rescue bank balance sheets.
It is an impossible dream. American workers now pay about 40% of their take-home pay on housing, and another 15% on debt service – even before buying goods and services. No wonder our economy has lost its export markets! Debts that can’t be paid, won’t be.
The moral is that the solution to any given problem – in this case, how to make Wall Street richer by debt leveraging – creates a new problem, in this case bankruptcy for high-priced American industry. The cost of living and doing business is inflated by high financial charges, HMO and insurance charges, and debt-inflated real estate prices. This has made Mr. Obama’s Wall Street constituency richer, but as the Chinese proverb expresses the problem: “He who tries to go two roads at once will get a broken hip joint.”
Banks have not paid much attention to Mr. Obama’s urging them to renegotiate bad mortgages. Their profits lie in driving homeowners out of their homes if they do not stay and fight. What is needed is to help debtors fight against junk mortgages issued irresponsibly beyond their reasonable means to pay.
When homeowners do fight, they win. In Cambridge, Massachusetts, I spoke to community leaders who organized neighborhood protests blocking evictions from being carried out. I spoke to lawyers advising that victims of predatory mortgages insist that the foreclosing parties produce the physical mortgages in court. (They rarely are able to do this.) These people feel they are getting little help from Washington.
And last Friday, Nomi Prins, Bob Johnson and other financial insiders voiced fears that the “Volcker Rule” separating commercial banking from casino derivatives gambling will end up being gutted by so many loopholes (such as letting banks to write their contracts out of their London branches) that it will end up merely rhetorical, not substantive. Financial lobbyists have the upper hand in detoothing and disabling attempts to reduce their power or even to enact simple truth-in-lending laws.
Two opposing lines of advice to Mr. Obama
Over the weekend Sen. John McCain suggested that Mr. Obama should reach out to Republicans in his State of the Union address. Bush advisor Karl Rove advised him to move to “the center” – what most people used to call the right wing of the spectrum. The Republicans blame Mr. Obama’s deepening unpopularity on his alleged move to the left.
It is more realistic to say that he has been perceived as being too little for change, too centrist while the economy is polarizing. It certainly seems unlikely that he will now turn on his FIRE-sector backers. His plan is that real estate prices can be re-inflated on enough credit – that is, enough more mortgage debt – to enable the banks to work out of the negative equity position into which their loan portfolios and investments have fallen.
The inherent impossibility of this plan succeeding is the main problem that we may expect from this Wednesday’s State of the Union address. Mr. Obama will promise to cut taxes further for working Americans, but his financial policy aims to raise the cost of their housing, their debt service and the cost of buying pensions. Some trade-off!
America’s debt overhead exceeds the means to pay. Rhetoric alone cannot solve this problem, even when delivered with Mr. Obama’s rhetorical élan. Its solution requires a policy alternative more radical than his current advisors are willing to accept, because the inevitable solution must be to write down debts to reflect the capacity to pay under today’s market conditions. This means that some banks and creditors must take a loss.
In the 2008 election campaign, Rep. Dennis Kucinich kept spelling out precisely what law he had introduced to Congress to effect each change he proposed. Mr. Obama never descended to this concrete level. But after spending a year treading water, he now must be asked to do so.
For starters, the litmus test for commitment to change should be to rapidly push through the Consumer Finance Protection Agency while the Democrats still have their political Viagra fillip from last Tuesday – and before Wall Street lobbyists wield their bankrolls.
There is talk in the press about the Democrats not even pressing forward with the Consumer Financial Protection Agency. The argument is that if they can’t get their health care plan by the Senate in the face of HMO and drug company lobbyists, what chance do they have when it comes on to taking on predatory Wall Street lenders?
It is a false worry – or even worse, an excuse to continue doing nothing. Republicans were able to mobilize populist opposition to the health-care bill by representing it as adding to the cost of relatively healthy young adults forced into the arms of the HMO monopolies. But it is much harder for the Republicans to buck financial reform and still strike their pose as opposing Wall Street. Proposing strong legislation against Wall Street will force politicians of both parties to show their true colors. If they don’t jump on board the best and most popular law the Democrats can draw up, they will lose their ability to pose. And what is populist politics these days without such a pose?
If the Democrats do not force the debt reform issue, we must conclude that they don’t really want financial restructuring. This is what Celinda Lake, pollster for the losing Democratic senate candidate last Tuesday, found that most voters believed to be the case: “When six times more people think that the banks benefited from the stimulus than working families, you've got a problem. And it’s not just a problem with what Martha Coakley did in her campaign” she wrote in her day-after report. “Voters are still voting for the change they voted for in 2008, but they want to see it. And right now they think they've got economic policies for Washington that are delivering more for banks than Main Street.”
Mr. Obama needs to signal a change of heart by replacing his failed deregulatory-era trio of Summers, Bernanke and Geithner with advisors who will focus more on the “real” economy than on Wall Street’s shadow economy.
I don’t see him doing this. I will discuss how to pierce what I expect to be Wednesday evening’s rhetorical fog in Part II of this article tomorrow.
Wednesday, January 27, 2010
Darcy Burner says public option can be a winner IF...
The debacle in Massachusetts will lead to an even weaker health care bill, right? Not if you listen to our favorite never-an-office-holder progressive politician, Darcy Burner. We're beginning a four-day political week on state of the union Wednesday. Tomorrow and Friday, we'll put up Michael Hudson's two part preview of the state of the union, to measure the actual speech against. On Saturday, we'll do Robert Kuttner's "What a Week!" post to see whether history is shaping up to his vision.
How we can get the healthcare bill across the line
Ironically, it appears the most likely way to get healthcare reform is to pass GOOD healthcare reform.
The Democrats in Washington DC are likely to spend most of this week consumed by the question of how they can pass healthcare reform now. Fortunately, there's a fairly clear path.
Here are the constraints:
The Senate won't have 60 votes for diddly-squat. No Republican is going to vote for cloture on anything. Whatever the Senate is going to do needs to be done with 50 votes (plus Biden), which means budget reconciliation will have to be used.
The House doesn't trust the Senate. House members believing the Senate will fix something later is about as likely as pigs flying. Over and over in the last year, the Senate has completely screwed the House. No faith remains. That means the Senate is going to have to go first.
The House can't get 218 votes for the Senate bill. Every single House member is up for re-election in ten months. They've seen the polling, they've seen what happened in Massachusetts. They don't have political death wishes, and the profoundly flawed insurance giveaway that is the Senate bill isn't going to inspire them to take one for the team. The team they'd be asked to take one for is Aetna and United Healthcare and Joe Lieberman, friends - not their constituents. No way.
Ok, so is it hopeless?
Not at all.
Use sidecare reconciliation, with the Senate going first
All you need to do is figure out what fixes can be passed through reconciliation that would make the bill palatable to 218 House members. Speaker Pelosi and Majority Leader Reid are discussing that now. Then you have the Senate pass that reconciliation bill and send it over to the House. The House passes the reconciliation fixes and the underlying Senate bill. The President signs them (in the correct order), and viola! You're done.
So the key question is this: what needs to be in the package of fixes that can qualify for reconciliation, get 50+ votes in the Senate, and get 218 votes in the House?
Counting the votes
How do we get 218 votes in the House? Well, starting from the 220 who voted for the House bill; you're clearly not going to pick up any Republican votes on the House side, but the some of the Democrats who voted no the first time around are probably in play.
Abortion language = Nelson
It appears unlikely that reconciliation can be used to change the abortion language, so the Nelson language will prevail. For some House members who supported Stupak, that's a dealbreaker. You will lose some votes, likely between 10 and 20.
The freshmen and sophomores
Vulnerable freshmen and sophomores look at the Massachusetts race and the polling and conclude that to vote for the Senate bill as is against the wishes of their constituents is to guarantee they won't be re-elected. (It's really hard to argue for a mandate with no real choice or competition. Add that to pissing off the unions with the excise tax, and the giveaways to Nelson and Landreiu, and you have one gigantic PR problem.) So you lose between 10 and 20 votes there.
Progressives and the pro-choice caucus
Now let's be clear about something. The House progressives and pro-choice caucus members who voted yes for the House bill (which is pretty much all of them) are fundamentally team players. They were team players the first time around, they're likely to be team players again the second time around. So they can likely all - or nearly all - be brought home by leadership again.
But looking at the numbers and the members it's possible to please with a fix in reconciliation, it would appear that it's probable that all of the remaining votes you need to win back are from vunerable freshmen and sophomores.
How do you convince Betsy Markey and Tom Perriello and Steve Driehaus and Frank Kratovil and Mary Jo Kilroy et al to vote for the bill? Show them that it'll help their re-election chances.
The public option is (ironically) the key
So far, the only thing polling has shown works is public buy-in to a government healthcare program - either the public option or a Medicare buy-in. Polling done in September by Lake Research showed that a mandate with no public option was acceptable to only 34% of the public; add in a public option, and support nearly doubles to 60%. In December when CBS News/New York Times asked, "Would you favor or oppose the government offering some people who are uninsured the choice of a government-administered health insurance plan - also known as a 'public option' - that would compete with private health insurance plans?" 59% of voters were in favor.
If you want to win back the voters, give them the one thing they clearly understand is a win for them over the insurance companies: the option to choose a public plan.
Oh - and it appears that a significant portion of the problem in Massachusetts was that the Democratic base wasn't excited. They were downright frustrated, in fact. Want to give the Democratic base some change they can believe in? Then give them the public option they've been clamoring for.
Either a public option or a Medicare buy-in can be done through reconciliation. Sen. Harkin claimed 52 Senate votes for the public option over the summer, and it appears it was only Lieberman who killed the Medicare buy-in at the 60-vote threshold.
Look, I know the DC conventional wisdom has been that the public option is dead, and that the Medicare buy-in is a non-starter. The excuse was always, "We can't get 60 votes for it." Guess what? Now that it's clear they're going to have to use reconciliation, they don't have to get 60 votes.
(If you're feeling inspired to contact your Senators and Congressperson, we've made it easy at http://www.congressionalplan.com .)
Tuesday, January 26, 2010
Transcript: 350 Joseph Stiglitz and Nell Minow on Financial Industry compensation distorts the economy
Listen to this episode
Today we have Marc Faber and Steven Roach courtesy of Geoff Cutmore and CNBC's Squawk Box, but also testimony from Joseph Stiglitz and Nell Minow on compensation in the financial industry courtesy of Chairman Barney Frank and the House Financial Services Committee. We also take a couple of exceptions to Steve Keen and Hyman Minsky.
First a note on some of the newest housing data.
The Atlanta Fed says the agency MBS purchase program nears its goal of $1.25 trillion. Thirteen months after its inception, the Fed has purchased over $1.1 trillion in mortgage backed securities. The wind-down of these purchases causes concern in the housing market that it will put upward pressure on interest rates and stall out whatever housing recovery was in prospect.
Most importantly for the economy, we think at Demand Side, some homeowners were able to refinance and lower monthly payments. The housing collapse is still in progress, and the effort by the Fed was a fool's errand in that regard. Now it looks forward to $1.25 trillion in securities in a market where it was the only buyer. What is the exit strategy for the nation's central bank?
Existing home sales collapsed by nearly 17 percent in December. The false alarm on the expiration of the first-time homebuyers tax credit encouraged a boom in existing sales in November and put more debt into the economy. The extension of the credit did not extend the boom.
And the New York Times and Wall Street Journal report that Tishman Speyer Properties and BlackRock Realty have turned the immense Stuyvesant Town and Peter Cooper Village over to their creditors. A strategic default, if you will, of a property encompassing 56 buildings and 11,000 units which was acquired for $5.4 billioin in 2006. Some accounts put the current value at $1.6 billion. Equity investors like the California Public Employees' Retirement System, a Florida pension fund and the Church of England, as well as many debtholders, including the government of Singapore Investment Corporation and Hartford Financial Services Group are seeing their investments wiped out.
Now directly to the House Financial Services Committee and its hearing on financial sector compensation practices with the opening statements of witnesses Joseph Stiglitz, the eminent economist, here with Nell Minow, founder and editor of the Corporate Library.
HOUSE FINANCIAL SERVICES COMMITTEE
Joseph Stiglitz and Nell Minow
And to end, from Squawk Box, an exchange between Marc Faber, Geoff Cutmore and Steven Roach, head of Morgan Stanley Asia.
SQUAWK BOX
Steven Roach with the notorious investor Marc Faber.
Now, reluctantly supplying some of our own content.
Over the past several months we've exposed our listeners to Hyman Minsky and one of his most able students Steve Keen. Now we would like to expose what we believe to be two aspects not fully appreciated by these two.
The models of both Minsky and Keen and others have not yet incorporated the dynamic contribution of public goods. Nor have they addressed sufficiently the role of energy prices, particularly oil.
Government is seen by almost every economist as a consumer, employer, regulator and source of uncertainty, but rarely except anecdotally as a contributor to growth. Yet education, infrastruture, pbulic safety, legal structures and more are the products of govenrment without which private business, workers and consumers cannot function efficiently, or in some cases at all. These are the public goods, financed ultimately by taxation. Taxes are the way we purchase public goods. it is not from an absence of value that these are ignored, but the fact that they have no market value. By their nature, being not excludable and not depletable -- to a greater or lesser degree -- public goods are not effectively produced by private businesses nor effectively valued by economists.
It is precisely because the U.S. has skimped on public goods that it finds its economy in stagnation and decline. Rather than buy the productive assets of roads and education, a "taxes are theft" mentality shifted investment to nonproductive residential housing, speculative activity in financial markets and military adventures. This at the expense of true public goods.
Take the example of a road. A public good. Except in relatively few toll roads, it is not excludable. Anyone can use it. Freight is delivered, workers transported, all manner of activities happen with a road that do not happen without it and freely. It is not depletable. My using a road -- and realizing there are limits to everything -- does not preclude your using it.
Immense private financial benefit accompanies the construction of a road or bridge. To perperty owners in newly accessible areas to transport activities that broaden markets or convenience to individuals. These are real private gains that could be computed.
The same is true of education, where individuals, communities, employers and society at large all benefit from the successful education of citizens.
Taxes are viewed as theft. In fact they simply finance the progress of the society. If this were not true Somalia would be Sweden. But in a very real measure, the higher the tax level, the more prosperous the citizenry. This is not an observation that is refuted by anti-tax voices. It is simply ignored.
Incorporating the value of public goods into one's way of thinking, whether that way is mathematical or narrative, is required to fill out one's understanding. This has yet to be done.
Also not well acknowledged is the role of energy and anergy prices.
From the new and wonderful book by Joe Stiglitz, Freefall, we read,
"The burden on monetary policy was increased when oil prices started to soar after the invasion of Iraq in 2003. The United States spent hundreds of billions of dollars importing oil -- money that otherwise would have gone to support the U.S. economy. Oil prices rose from $32 a barrel in March 2003 when th Iraq war began to $137 per barrel in July 2008. This meant that Americans were spending $1.4 billion per day to import oil (up from $292 million per day before the war started), instead of spending hte money at home. Greenspan felt he could keep interest rates low because there was little inflationary pressure, and without hte housing bubble that the low interest rates csustained and the consumption boom that the housing bubble supported, the American economy wold have been weak."Stiglitz main point is valid. Though we correct the highest price from $137 to $147, and cite a oil and commodities bubble that began in the fall of 2007. Stiglitz cites the Iraq war, but it was speculation turning from stocks and housing to commodities, assets believed to be inflation proof. Ironically the oil and commodities bubble produced the inflation of the first part of 2008.
But the purchase of energy is correctly seen as a subtraction of support from the real U.S. economy.
Andrew Oswald of Warwick University observed that everything is composed of labor and energy. When energy prices go up, the wage rate goes down. Inflation has not been driven by wages for decades, but by the exogenous price of energy, particularly oil. This is a commodity with an inelastic demand curve. The Clinton years benefited as much from low oil prices as from policy choices. Again oil induced inflation reduces real incomes and subtracts from demand.
It is no accident that the oil price shock of the first part of 2008 was followed by the severe economic contraction of the second part. We do not dispute the primacy of the financial sector's incompetence, but we insist that oil prices have led all recessions in the past half century and absent inclusion of this phenomenon, ones view is incomplete.
Enough for today.
Monday, January 25, 2010
Steve Keen describes the why's of what we all know, Bernanke must go
We at Demand Side were perplexed when Obama put Ben Bernanke back up for Fed Chair.
In December we wrote:
In December we wrote:
Baffled Ben Bernanke and the entire Fed are marching to the wrong tune in the wrong direction. They mimick nothing so much as blind men in a cluttered alley, crashing into obvious obstacles and lashing out against nonexistent enemies. Here are some questions for the esteemed Fed Chair.In August we put on the podcast:
"More Bernanke? ..... NO. Bernanke back at the Fed? The question of the day, or one of the questions, is whether to re-up Baffled Ben Bernanke in January for another term as head of the Federal Reserve.And right at the time, we were confounded as was nobody else:
You know our response: Bernanke failed to understand the crisis approaching, allowed the systemic collapse to unfold until at the last moment he rushed in with trillions in central bank funds for the big banks, and now clings to the tatters of his legitimacy with the plaint, "At least we avoided the Great Depression."
It's a defense that is far less justified but far more accepted than the similar one from the Obama Administration. In spite of the clear positive effects of the Recovery Act (see ChristinaRomer's defense to the National Press Club posted on the blog), Obama is not getting much traction with "It could have been worse."...
What a disaster. Ben Bernanke to be reappointed Fed Chairman: This reveals very deep problems in the Obama program.Here is Keen, complete and clear.
Bernanke was chief economist to George W. Bush, from which position he rose to Fed chairman. It is often remarked that we are so lucky to have an expert on the Great Depression in charge when the second Great Depression came knocking.
Bernanke was put in charge not because he is an expert on the Great Depression, but because he values the big banks above all else. He is deep in the pockets of Wall Street. His theory of the Depression is that it could have been avoided if we'd just saved the institutions that caused it. Witness the hundreds of billions of dollars in transfer from the taxpayer to the big banks, the free too-big-to-fail insurance, the many missed calls and predictions, the absence to this day of real help for mortgage holders when their main asset goes down.
Wow".....
The economic case against Bernankeand there's much more at Keen's Debtwatch site.
Steve Keen
Debtwatch No. 42
January 24, 2010
The US Senate should not reappoint Ben Bernanke. As Obama’s reaction to the loss of Ted Kennedy’s seat showed, real change in policy only occurs after political scalps have been taken. An economic scalp of this scale might finally shake America from the unsustainable path that reckless and feckless Federal Reserve behavior set it on over 20 years ago.
Some may think this would be an unfair outcome for Bernanke. It is not. There are solid economic reasons why Bernanke should pay the ultimate political price.
Haste is necessary, since Senator Reid’s proposal to hold a cloture vote could result in a decision as early as this Wednesday, and with only 51 votes being needed for his reappointment rather than 60 as at present. This document will therefore consider only the most fundamental reason not to reappoint him, and leave additional reasons for a later update.
Misunderstanding the Great Depression
Bernanke is popularly portrayed as an expert on the Great Depression—the person whose intimate knowledge of what went wrong in the 1930s saved us from a similar fate in 2009.
In fact, his ignorance of the factors that really caused the Great Depression is a major reason why the Global Financial Crisis occurred in the first place.
The best contemporary explanation of the Great Depression was given by the US economist Irving Fisher in his 1933 paper “The Debt-Deflation Theory of Great Depressions”. Fisher had previously been a cheerleader for the Stock Market bubble of the 1930s, and he is unfortunately famous for the prediction, right in the middle of the 1929 Crash, that it was merely a blip that would soon pass:
“ Stock prices have reached what looks like a permanently high plateau. I do not feel that there will soon, if ever, be a fifty or sixty point break below present levels, such as Mr. Babson has predicted. I expect to see the stock market a good deal higher than it is today within a few months.” (Irving Fisher, New York Times, October 15 1929)
When events proved this prediction to be spectacularly wrong, Fisher to his credit tried to find an explanaton. The analysis he developed completely inverted the economic model on which he had previously relied.
His pre-Great Depression model treated finance as just like any other market, with supply and demand setting an equilibrium price. In building his models, he made two assumptions to handle the fact that, unlike the market for, say, apples, transactions in finance markets involved receiving something now (a loan) in return for payments made in the future. Fisher assumed
(A) The market must be cleared—and cleared with respect to every interval of time.
(B) The debts must be paid.” (Fisher 1930, The Theory of Interest, p. 495)[1]
I don’t need to point out how absurd those assumptions are, and how wrong they proved to be when the Great Depression hit—Fisher himself was one of the many whose fortunes were wiped out by margin calls they were unable to meet. After this experience, he realized that his equilibrium assumption blinded him to the forces that led to the Great Depression.
Thursday, January 21, 2010
Oil and economic outcomes
The following is from Prof. James Hamilton in November. It reflects our interest here at Demand Side in an aspect of the economy that is often ignored in forecasting and theory. That is the price of energy. Minsky and others are completely absorbed with the wage rate, but as Andrew Oswald pointed out a decade ago, everything is made of labor and energy.
Oswald's formulation of a predictive function was based on oil prices and interest rates. Following him, we correctly predicted the recession of 2000. While the dot.com boom and bust was, and is, the theme of that time, too little attention has been paid to the extremely low oil prices during the Clinton years and their positive effect on incomes.
Oswald's formulation of a predictive function was based on oil prices and interest rates. Following him, we correctly predicted the recession of 2000. While the dot.com boom and bust was, and is, the theme of that time, too little attention has been paid to the extremely low oil prices during the Clinton years and their positive effect on incomes.
Will rising oil prices derail the recovery?
James Hamilton
Econobrowser
November 10, 2009
Last April I described new research on the role of oil prices in the recent recession. Here's an update on what's happened since then.
In a paper presented at the Brookings Institution last spring, I examined the post-sample forecasting performance of an equation originally published in 2003, which relates real GDP to past values of GDP and oil prices. I noted in April that if you had known in October 2007 the values of GDP through 2007:Q3 and what was about to happen to oil prices through 2008:Q2, you could have used that historical relation to predict the value of U.S. real GDP for 2008:Q3 with an accuracy better than 99.5%.
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In the figure above I extend the earlier-reported forecast an additional four quarters and compare the projection with what actually happened to GDP through 2009:Q3. The dotted green line is a forecast formed in October 2007 of what would happen to U.S. GDP if you used nothing more than the values of GDP observed through 2007:Q3. Basically that forecast simply extrapolates the recent prior trend. The dashed red line is the forecast that uses GDP values only through 2007:Q3 but also uses knowledge of what was going to happen to oil prices between 2007:Q4 and 2009:Q3. If you treated oil prices as the only thing that matters for the economy, you would have predicted the bottom would be reached in 2009:Q1, flat growth between 2009:Q1 and 2009:Q2, and normal growth resuming in 2009:Q3. That's exactly the trajectory that GDP has taken so far, although the bottom in 2009:Q2 was 2-1/2 percent lower than would be predicted on the basis of oil prices alone.
I have no doubt that the problems with financial markets were a bigger factor than oil prices in the striking collapse in output in 2008:Q4 and 2009:Q1. The other approaches to measuring the contribution of oil to the downturn surveyed in my Brookings paper would estimate a smaller contribution of oil to the downturn than suggested by the figure above. On the other hand, all of the approaches surveyed in that paper suggest that oil made a material contribution to the initial downturn, and it seems hard to deny that that the severity of the financial crisis was exacerbated by the fact that the U.S. had spent three quarters in recession prior to the failure of Lehman in September 2008.
What do these estimates imply looking forward, with oil prices now back up to $80 a barrel? The relation used to produce the figure above assumes that there is a threshold effect before the next oil price shock would begin to do its damage. According to that relation, oil has to get back above $130 before it would matter again for GDP growth. On the other hand, the original research on which that relation is based acknowledged that there's really not a very compelling basis in the data for choosing among various plausible nonlinear possibilities. The other approaches surveyed in my Brookings study assume a simple linear relation, according to which the recent resurgence in oil prices would already begin to exert a drag on spending.
Another magnitude that I think is important to watch is the share of the budget of an average U.S. consumer that is devoted to energy purchases. This had fallen considerably in the 1990s, making it easier for many consumers to largely ignore modest energy price fluctuations. When this share rises above 6%, it seems to become a more significant factor. The consumer energy expenditure share peaked last summer at 6.8%, but collapsing energy prices subsequently brought it back down to 4.7%. The resurgence in oil prices this summer had pushed that share back up to 5.4% in September.
Wednesday, January 20, 2010
Nouriel Roubini is still Doctor Doom
The Risky Rich
Nouriel Roubini
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
January 20, 2010
The Risky Rich
Nouriel Roubini
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
January 20, 2010
NEW YORK – Today’s swollen fiscal deficits and public debt are fueling concerns about sovereign risk in many advanced economies. Traditionally, sovereign risk has been concentrated in emerging-market economies. After all, in the last decade or so, Russia, Argentina, and Ecuador defaulted on their public debts, while Pakistan, Ukraine, and Uruguay coercively restructured their public debt under the threat of default.
But, in large part – and with a few exceptions in Central and Eastern Europe – emerging-market economies improved their fiscal performance by reducing overall deficits, running large primary surpluses, lowering their stock of public debt-to-GDP ratios, and reducing the currency and maturity mismatches in their public debt. As a result, sovereign risk today is a greater problem in advanced economies than in most emerging-market economies.
Indeed, rating-agency downgrades, a widening of sovereign spreads, and failed public-debt auctions in countries like the United Kingdom, Greece, Ireland, and Spain provided a stark reminder last year that unless advanced economies begin to put their fiscal houses in order, investors, bond-market vigilantes, and rating agencies may turn from friend to foe. The severe recession, combined with the financial crisis during 2008-2009, worsened developed countries’ fiscal positions, owing to stimulus spending, lower tax revenues, and backstopping and ring-fencing of their financial sectors.
The impact was greater in countries that had a history of structural fiscal problems, maintained loose fiscal policies, and ignored fiscal reforms during the boom years. In the future, a weak economic recovery and an aging population are likely to increase the debt burden of many advanced economies, including the United States, the UK, Japan, and several euro-zone countries.
More ominously, monetization of these fiscal deficits is becoming a pattern in many advanced economies, as central banks have started to swell the monetary base via massive purchases of short- and long-term government paper. Eventually, large monetized fiscal deficits will lead to a fiscal train wreck and/or a rise in inflation expectations that could sharply increase long-term government bond yields and crowd out a tentative and so far fragile economic recovery.
Fiscal stimulus is a tricky business. Policymakers are damned if they do and damned if they don’t. If they remove the stimulus too soon by raising taxes, cutting spending, and mopping up the excess liquidity, the economy may fall back into recession and deflation. But if monetized fiscal deficits are allowed to run, the increase in long-term yields will put a chokehold on growth.
Countries with weaker initial fiscal positions – such as Greece, the UK, Ireland, Spain, and Iceland – have been forced by the market to implement early fiscal consolidation. While that could be contractionary, the gain in fiscal-policy credibility might prevent a damaging spike in long-term government-bond yields. So early fiscal consolidation can be expansionary on balance.
For the Club Med members of the euro zone – Italy, Spain, Greece, and Portugal – public-debt problems come on top of a loss of international competitiveness. These countries had already lost export-market shares to China and other low value-added and labor-intensive Asian economies. Then a decade of nominal-wage growth that out-paced productivity gains led to a rise in unit labor costs, real exchange-rate appreciation, and large current-account deficits.
The euro’s recent sharp rise has made this competitiveness problem even more severe, reducing growth further and making fiscal imbalances even larger. So the question is whether these euro-zone members will be willing to undergo painful fiscal consolidation and internal real depreciation through deflation and structural reforms in order to increase productivity growth and prevent an Argentine-style outcome: exit from the monetary union, devaluation, and default. Countries like Latvia and Hungary have shown a willingness to do so. Whether Greece, Spain, and other euro-zone members will accept such wrenching adjustments remains to be seen.
The US and Japan might be among the last to face the wrath of the bond-market vigilantes: the dollar is the main global reserve currency, and foreign-reserve accumulation – mostly US government bills and bonds – continues at a rapid pace. Japan is a net creditor and largely finances its debt domestically.
But investors will become increasingly cautious even about these countries if the necessary fiscal consolidation is delayed. The US is a net debtor with an aging population, unfunded entitlement spending on social security and health care, an anemic economic recovery, and risks of continued monetization of the fiscal deficit. Japan is aging even faster, and economic stagnation is reducing domestic savings, while the public debt is approaching 200% of GDP.
The US also faces political constraints to fiscal consolidation: Americans are deluding themselves that they can enjoy European-style social spending while maintaining low tax rates, as under President Ronald Reagan. At least European voters are willing to pay higher taxes for their public services.
If America’s Democrats lose in the mid-term elections this November, there is a risk of persistent fiscal deficits as Republicans veto tax increases while Democrats veto spending cuts. Monetizing the fiscal deficits would then become the path of least resistance: running the printing presses is much easier than politically painful deficit reduction.
But if the US does use the inflation tax as a way to reduce the real value of its public debt, the risk of a disorderly collapse of the US dollar would rise significantly. America’s foreign creditors would not accept a sharp reduction in their dollar assets’ real value that debasement of the dollar via inflation and devaluation would entail. A disorderly rush to the exit could lead to a dollar collapse, a spike in long-term interest rates, and a severe double dip recession.
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