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Tuesday, February 1, 2011

Transcript: Forecast Part 2: GDP and Net GDP

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We don't understand the difference between the price of things, the value of things and the cost of things. For instance, coal. Coal is a dirty fossil fuel that is changing the atmosphere, and yet everybody says we have to use a lot of coal because it is so cheap compared to other fuels. Well, it is cheap because there is a lot of it, and because the economic system simply prices what you get in the trade.

You buy a ton of coal, you get a ton of coal, and that's what you pay for. But the cost of the coal is dumped out onto the commos and the future of humanity. The cost includes changing the heat balance of the whole planet, turning the oceans acid, which is dissolving shellfish and dissolving coral reefs. It puts the mercury in our seafood. That's where the mercury comes from.

These are all the true costs of coal, but they are nowhere in the price. If the economy really caught up to reality and our understnading of science from the last century and a half, the price of coal would not be cheap, it would be prohibitive, because the costs are enormous.

Today on the podcast, Forecast Part 2, GDP and Net GDP. We opened with audio from a recent interview of conservationist-philosopher Carl Safina by Tom Ashbrook as a caution.

What we have been discussing over the past few months is the workings of a system in crisis, in a crisis of internal contradiction. Last week we talked about prices and inflation and investment. This week it is growth. Our crisis is made deeper, much deeper, by the fact that those in positions of power, with access to the policy levers, do not understand the causes and conditions of the crisis, nor even the elements of the economy they are trying to control. The Fed does not understand credit-money, for example. And few seem to see that the enormous weight of debt as the salient condition to be removed. They continue to look to corporations and business for jobs, when jobs can only come from the demand side.

That said, and even if magically the clouds parted and effective policies were put in place, it is still a fix to a dilapidated machine. In the domination of the economy by the market, which is essentially the moment of purchase and sale, Both our society and our economic understanding misunderstand costs and value. Value and costs are largely outside price in our economy, which means they are outside any real coherent connection to market capitalism. This in face of the contention of the orthodoxy that markets assign true values.

So we can fix market capitalism with the right policies. If and when that were to happen, however, we would be only halfway there.

But we're here to do the forecast. Will the machine break down again before it carries us over the cliff?

We now return to GDP and Net GDP.

"Net Real GDP" is our exclusive demand side measure which gauges what the economy would do in terms of GDP without federal deficits.

As you can see from the chart up on the website, our expectations for the economy and the actual performance of the economy have tracked fairly well. One caveat is that the new forecast we are unveiling this week, last week and the next few weeks, benefits from the fact that we are predicting the present to some degree, so the bend upward in the forecast is not what we predicted fourteen months ago, but reflects experience. You can see the break in the forecast lines.

We would like to suggest that the gaps between our predictions and the data are due to some extent ... well, largely to the fact that the government's deficits have not been ladled out so evenly as we projected ... but also to the inefficiency of the government's stimulus measures. We expected six percent of GDP to be borrowed, but to be spent on something more than candy for the rich and comfort food for corporations.

Our call is for the economy to weaken and fall into negative growth territory in terms of Real GDP by the end of Q3. Of course, the economy has never gotten out of negative territory in terms of Net Real GDP, which peaked in Q4 2009 at minus two percent growth.

The observant among you may note that our definition of the federal deficit is different from that you see in the media and talked up by the deficit reduction commission.

This is because we treat borrowing from the Social Insurance trust funds the same way we treat borrowing from private pension funds, or from any other entity. Our treatment is not the norm. Under the practice of the so-called Unified Budget, the former surpluses of the trust funds were used to mask the deficits in the federal operating budget. Now that the trust funds are no longer in surplus, they are redeeming some of their U.S. bonds to pay benefits. So the practice of the Unified Budget is creating apparently much deeper deficits than had an honest accounting framework been used all along.

So our forecast of fairly consistent deficits amounting to 6.5 percent of GDP translates to a growing deficit of three to five points higher under the Unified Budget treatment. Not happy times.

You will see we have predicted a sharp recovery beginning in Q2 of 2012. This is based on nothing other than our hope that fundamental policy will change for the better. There is no reason to expect the current weak economy to recover under the current regime of ineffective monetary policy and reactionary fiscal policy.

So, it is a bold position. We expect to be derided in the short term for being so far out of the mainstream. If our call proves out, however, we look forward to being ignored amidst the clatter of blaming unforeseeable events.

Unforeseeable events:

At one time Argentina was the IMF's poster child, its darling. That was, of course, before the ill-conceived strategies promoted by the International Monetary Fund led to a run on the banks and a reversal of policy. Then Tunisia and its willingness to go whole hog on the Structural Adjustment Policies, which have the so-apt acronym SAP. Well, Tunisia filled up with educated, unemployed young people. Then the Jasmine rebellion. In the middle of 2004, Egypt appointed a new cadre of officials who had drunk the Washington Consensus Kool-Aid and who methodically instituted the privatization, the reduction of government subsidies and the rest of the market fundamentalism that has so many advocates and so few success stories. Any success stories.

That is our observation on the current uprising in Egypt.

Also in the past week was the release of the Financial Crisis Inquiry Commission, the Angeledes Commission. The majority report came out scourging the banks and the regulators. It met with general approval among the informed, but the impact on public opinion was diluted by conservative spin control, led by the rerlease of two dissenting reports from the Republicans on the commission. The media stopped short of responsible journalism and did not really analyze what the dissenters had to say. What they had to say was that deregulation was not a factor.

"Why are we suffering recurrent, intensifying crises? To answer this question we must find not only the causes of the crises, but also (and even more importantly) why we fail to learn the correct lessons from the crises and keep making even worse policy mistakes. The answer to the second part is dogma. The definition of dogma is that it cannot be examined or changed – except to become even purer."

Friday, January 28, 2011
How can the Architects of the Crisis Investigate it?

By William K. Black

The Financial Crisis Inquiry Commission (FCIC) issued its report today on the causes of the crisis. The Commissioners were chosen along partisan lines and the Republicans, one-upping the Republicans’ dual responses to President Obama’s State of the Union address, have issued three rebuttals. The rebuttals follow a failed preemptive effort by the Republicans to censor the report – they insisted on banning the use of the terms “shadow banking system” (the virtually unregulated financial sector that conducts most financial transactions), “Wall Street,” and “deregulation.” The Republicans then issued their first rebuttal last month, their “primer.” The primer, following the lead of the censorship effort, ignored the contributions that the shadow banking system, Wall Street, and deregulation made to the crisis. The combination of the demand that the report be censored and the primer’s crude apologia critical role that the unmentionable Wall Street, particularly its back alleys (the unmentionable “shadow banking system”), and the unmentionable deregulators played in causing the crisis was derided by neutrals. The failure of their preemptive primer has now led the Republican commissioners to release two additional rebuttals to the Commission report. Again, they issued their rebuttals before the Commission issued its report in an attempt to discredit it.

The primary Republican rebuttal was issued by Bill Thomas, a former congressman from California and the vice chairman of the commission; Keith Hennessey, who was President George W. Bush’s senior economic advisor, and Douglas Holtz-Eakin, who was an economic advisor to President Bush on the regulation of Fannie and Freddie and principal policy advisor to the Republican nominee for the President, Senator McCain.

Republican Commissioner Peter Wallison felt his Republican colleagues’ dissent was insufficient, so he drafted a separate, far longer dissent. Wallison is an attorney who was one of the leaders of the Reagan administration’s efforts to deregulate financial institutions and later became the leader of the American Enterprise Institute’s (AEI) deregulation initiatives. His bio emphasizes his passion for financial deregulation.

From June 1981 to January 1985, he was general counsel of the United States Treasury Department, where he had a significant role in the development of the Reagan administration’s proposals for deregulation in the financial services industry….

[He] is co-director of American Enterprise Institute's ("AEI") program on financial market deregulation.
Each of the Republicans commissioners was a proponent of financial deregulation and was appointed to the Commission by the Republican Congressional leadership to champion that view. Three of the Republican commissioners were architects of financial deregulation. For example, the Republican congressional leadership appointed Wallison to the commission because they knew that he was the originator and leading proponent of the claim that Fannie and Freddie were the Great Satans that had caused the current crisis. The fourth member, Representative Thomas, voted for the key deregulatory legislation when he was in Congress and was a strong proponent of deregulation.

The Republican commissioners’ desire to ban the use of the word “deregulation” in the Commission’s report is understandable. There was no chance that they would support a report that explained the decisive role that deregulation and desupervison played in making the crisis possible. Wallison was a major architect of three successful anti-regulatory pogroms (primarily, but not exclusively, led by Republicans) that created the criminogenic environments that led to our three most recent fraud epidemics and financial crises (the S&L debacle, the Enron era frauds, and the current crisis). The Republican congressional leadership appointed Wallison to the Commission in order to place the nation’s leading apologist for deregulation in a position where he could defend it. President Bush appointed Harvey Pitt to be SEC Chairman because he was the leading opponent in America of the SEC Chairman Levitt’s efforts to make the SEC a more effective regulator. In each case, “mission accomplished.”

Each of the Republican commissioners was in the impossible position of having to investigate and judge their own culpability for the crisis. The Republican politicians who selected them for appointment to the Commission knew that they were placing them in an impossible position and ensuring that the Commission would either give deregulation a pass or split along partisan lines and lose some of its credibility. The proverbial bottom line is that the Commission would fail to identify the real causes of the crisis and the control frauds that drove it would continue to be able to loot with impunity.

In contrast, only one of the six Democratic commissioners was involved in financial institution regulation or deregulation. None of the Democrats was known as a strong proponent of any particular view about the causes of the crisis prior to their appointment. Brooksley Born was head of the Commodities Futures Trading Commission (CFTC) under President Clinton. She famously warned of the systemic risks that credit default swaps (CDS) posed. Her efforts to protect the nation were squashed by the Commodities Futures Modernization Act of 2000, which deliberately created regulatory “black holes” by removing the CFTC’s authority to regulate many trades in financial derivatives. Enron exploited one of these black holes to create the California energy crisis of 2001. The largest banks and AIG exploited the black hole to trade CDS. While the squashing of Brooksley Born was a bipartisan effort (Senator Gramm and Alan Greenspan were the most prominent Republicans in the effort), it was led by the Clinton administration – Messrs. Rubin and Summers at their arrogant, anti-regulatory worst.

By appointing Born to the Commission, the Democrats were admitting their error and ensuring that one of the Democratic Party’s great embarrassments – passage of the Commodities Futures Modernization Act – would be exposed. The Democrats were fostering rather than seeking to forbid discussion of their dirty laundry by appointing someone with a proven track record of taking on her own party.

In 1999, Born resigned as CFTC Chair. She retired from her law firm in 2002. She did not influence or seek to influence regulatory policy role during the crisis. She was not active in making comments about the causes of this crisis prior to her appointment to the Commission.

The next, nastier stage in the Republican apologia for Wall Street and the anti-regulators has already begun. Bloomberg reports that House Oversight Committee Chairman Issa claims to be:

“looking into allegations of partisanship, mismanagement and conflict of interest at the commission. The California Republican and two other lawmakers sent a letter yesterday renewing a demand for documents on the panel’s spending, its use of media consultants and its staff turnover.”
Issa is a deeply committed anti-regulator. He will not be investigating the allegations of partisanship and conflicts of interest by the Republican commissioners who have exemplified partisanship and who are in the impossible position of having to examine their own culpability for the crisis. He will seek to discredit any report and any expert who explains why financial deregulation and desupervision are criminogenic.

The most important question we must answer about our financial crises is actually a two-part question: why are we suffering recurrent, intensifying crises? To answer it we must find not only the causes of the crises, but also (and even more importantly) why we fail to learn the correct lessons from the crises and keep making even worse policy mistakes. The answer to the second question is dogma. The definition of dogma is that it cannot be examined or changed – except to become even purer. The ever purer anti-regulatory dogma creates the ever more intensely criminogenic environments that produce intensifying crises. The Commission’s report makes that clear. For example, Alan Greenspan claimed that markets automatically exclude fraud. He did so after the most notorious “accounting control fraud” of the S&L debacle (Charles Keating) used him to praise his fraudulent S&L, leading to the most expensive failure in the entire debacle. Greenspan learned nothing useful from the S&L debacle. He concluded that there was no reason for the Fed to use its unique authority under HOEPA to stop the pervasively fraudulent “liar’s” loans that were hyper-inflating the real estate bubble and leading us to a crisis. Greenspan ignored the FBI’s September 2004 warning that mortgage fraud was becoming “epidemic” and would cause an “economic crisis.” This anti-regulatory dogma that Greenspan exemplified spread through much of the Western world, and the resultant crises have done the same.

We are witnessing in the multiple Republican apologias for their anti-regulatory policies an example of why we fail to learn the correct lessons from the crises. The groups most in the thrall of the dogma appoint true believers in theoclassical economics to the body that is supposed to find the truth. These anti-regulatory architects of the crisis then purport to be impartial judges of the causes of the crisis that they helped create. The Republican House leadership now openly threatens to use aggressively its subpoena authority to bash anyone who dares to oppose the dogma and the Republican effort to censor the decisive role the anti-regulators play in causing our recurrent, intensifying crises.

The Commission is correct. Absent the crisis was avoidable. The scandal of the Republican commissioners’ apologia for their failed anti-regulatory policies was also avoidable. The Republican Congressional leadership should have ensured that it did not appoint individuals who would be in the impossible position of judging themselves. Even if the leadership failed to do so and proposed such appointments, the appointees to the Commission should have recognized the inherent conflict of interest and displayed the integrity to decline appointment. There were many Republicans available with expertise in, for example, investigating elite white-collar criminals regardless of party affiliation. That was the most relevant expertise needed on the Commission. Few commissioners had any investigative expertise and none appears to have had any experience in investigating elite white-collar crimes. These Republicans, former Assistant U.S. Attorneys (AUSAs) and FBI agents would have played no role in the financial regulation or deregulation policies in the lead up to the crisis. They would not have had to judge their own policies and they would have brought the most useful expertise and experience to the Commission – knowledge of financial fraud schemes and experience in leading complex investigative and analytical skills.

1 comment:

  1. Unfortunately for the US tax payer they will have to pay for another crisis very soon. This time they might not like the cost. Without serious reform this crisis will have been wasted and the politicians will have walked away from their responsibility yet again. With US unemployment serious understated the US Misery index would be closer to Tunisia and Egypt than it is officially. Without decent statistics the country is sleepwalking into social disorder.