Originally published 2009-01-08 14:14:40 -1000 - promoted by Roxy

In contrast to the mainstream media, there were many warnings in the progressive blogosphere over the past two years about the dangers of economic imbalances – most particularly the gap in incomes resulting from the 28-year old war Ronald Reagan initiated on the working and middle classes  – leading to a financial crisis. There is one primary and very important reason for this blindness of the mainstream media and prescience of the progressive blogosphere – the mainstream media is infested with the reigning economic paradigm of monetarism and financial economics which places emphasis on financial and monetary capital, while the progressive blogosphere throbs with populist economics focused on how well the least in society are uplifted and supported - the hoary old idea of developing human capital.

Let’s start with Vice-President Dick Cheney, who last week gave an interview in which he attempted to rewrite history by asserting that the financial, banking, and economic crises had only begun in the middle of 2008.   In his latest article, Henry C K Liu demolishes Cheney's spin, discussing in detail the onset of the crises in the autumn of 2006, and erupting full force in July 2007. But the actual thrust of Liu's article is to devastatingly critique Federal Reserve Chairman Ben Bernanke's handling of the crises. (Stirling Newberry began referring to Bernanke as "Captain Carnage" just about a year ago.)  Using some extensive quotes of Bernanke speaking before various august forums, Liu shows that Bernanke was completely blind to the onrushing train wreck just mere days before the collision. In July 2007, Liu writes, the commercial paper market collapsed.

Only after the commercial paper seizure hit LIBOR did the Federal Reserve belatedly realize that the credit market was not clearing efficiently. Half of the world's outstanding finance of $150 trillion, which includes financing for derivative trades, is routinely tied to LIBOR rates. The risk of global recession from widespread toxic infection of the entire credit market caused by rising defaults of US subprime loans was creating panic in the market. The Fed and the Treasury, official guardians of a stable financial market, were the last parties to know that a systemic crisis was about to implode and had only hours to act from their offices in New York when government officials were told by the management of major US financial institutions that they would be unable to meet their global obligations when markets opened in Asia. . . .

Warnings had been publicly aired months before the credit crisis imploded in July 2007 by a few lonely voices that the subprime mortgage bubble would burst and its effect would spread globally, granted that such warnings had been summarily dismissed by the establishment media. (See Why the sub-prime mortgage bust will spread, Asia Times Online, March 17, 2007.)

Liu explains how Bernanke's misplaced faith in Milton Freidman's monetarism led Bernanke - and the rest of us - into catastrophe. Liu includes one extended quote from Bernanke's presentation to the Federal Reserve Bank of Kansas City's Annual Economic Symposium at Jackson Hole, Wyoming on August 31, 2007, six weeks after the credit crisis broke out in mid July, which includes this outrageous Bernanke pronouncement:

Economic theory suggests that the greater liquidity of home equity should allow households to better smooth consumption over time. This smoothing in turn should reduce the dependence of their spending on current income, which, by limiting the power of conventional multiplier effects, should tend to increase macroeconomic stability and reduce the effects of a given change in the short-term interest rate. These inferences are supported by some empirical evidence.

A near mystical faith in economic theory is one of the most glaring faults of most economists today. Unfortunately for us, it appears that only cataclysms in the real world can shake that faith.

Even worse, Liu notes, Bernanke and the Friedmanites have placed us in a position where even a properly applied Keynsian stimulus will no longer work:

Bernanke, by his blind faith in the power of misguided monetarist measures to deal with a global credit crisis created by decades of runaway monetary indulgence, has unwittingly neutralized even the antibiotic power of Keynesian fiscal countermeasures against demand deficiency in a monetary bust from excessive debt. Deficit financing in a recession does not work without a reservoir of fiscal surplus from a previous boom. . . .

Unfortunately, the rescue approach by the George W Bush administration led by Treasury Secretary Henry Paulson and the Bernanke Fed has been focused on saving distressed financial institutions by providing taxpayers' money to restructuring bad debts and de-leveraging overblown balance sheets. This approach inevitably pushes already stagnant wage income further down, with more layoffs and ruthless renegotiation of already draconian labor contracts, to cut operating cost. All this does is to reinforce the downward market spiral by transferring financial pain to innocent workers while not helping the economy with a needed revival of consumer demand.

Trillions of dollars of good taxpayer money are being thrown after bad debts concocted by unprincipled financiers into a crisis black hole. This money will have to be repaid in coming years by taxpayers while supply-siders are clamoring for tax cuts for corporations, on capital gains and for high-income earners. This means the future tax bill to pay for the Greenspan put will be borne by low- and middle-income wage earners. Thus far in this financial crisis, the Bernanke Fed has sown the seeds not for a quick recovery but for a decade or more of stagflation for the US and the global economy.

Liu’s warnings are echoed in an unusual full page guest op-ed in the New York Times on January 4, 2009, jointly written by hedge fund manager David Einhorn, and author Michael Lewis, who chronicled the greed on Wall Street in the 1980s in Liar's Poker, his comic memoir of his short career as a bond trader at Solomon Brothers:

If we are going to spend trillions of dollars of taxpayer money, it makes more sense to focus less on the failed institutions at the top of the financial system and more on the individuals at the bottom. Instead of buying dodgy assets and guaranteeing deals that should never have been made in the first place, we should use our money to A) repair the social safety net, now badly rent in ways that cause perfectly rational people to be terrified; and B) transform the bailout of the banks into a rescue of homeowners.

What people overlook is that in having to confront these financial, banking, monetary, and economic crises, Obama has a world historic opportunity to remake the American economy, and polity. But it's not clear that Obama grasps this. Newberry reminds us what is really at stake, by quoting Martin Wolf:

Welcome to 2009. This is a year in which the fate of the world economy will be determined, maybe for generations. Some entertain hopes that we can restore the globally unbalanced economic growth of the middle years of this decade. They are wrong. Our choice is only over what will replace it. It is between a better balanced world economy and disintegration. That choice cannot be postponed. It must be made this year.

Now, here’s the scary thing: The people who correctly foresaw financial catastrophe have looked at the details of Obama’s stimulus plan – and to say that they are not impressed, is an understatement. There are three major criticisms: the stimulus is not large enough, it does not do enough to push the economy into the future, and the tax cut component is a waste. But even worse, faced with the Congressional Budget Office projecting a $1.2 trillion budget deficit for the fiscal year, Obama has apparently taken social security out of its protective lock box.

“We expect that discussion around entitlements will be a part, a central part” of efforts to curb federal spending, Mr. Obama said at a news conference. By February, he said, “we will have more to say about how we’re going to approach entitlement spending.”

Dean Baker has an interesting take on what Obama said about “entitlements”: Obama Suggests Defaulting on the National Debt. In fact, there are some retroactive tax cuts hidden in Obama’s program, as Stirling Newberry notes in Obama Puts New Bank Bailout in Stimulus Bill, allowing financial companies to use losses in this crisis to “recover” taxes paid on profits going back five years! As Newberry notes, “The Wall Street Journal calls it a bonanza.”

Newberry notes in a different article, this one on The Agonist:

An economic package facing a significant downturn has three parts: relief, restructuring, and recovery. Relief is to ameliorate the pain in the immediate context - this is done primarily by "counter-cyclical" policies like Unemployment insurance and other forms of direct aid. Restructuring is designed to move resources from wasteful activities to more productive ones, and recovery is designed to create a long term stream of sustainable demand and supply that will attract private investment. Obama's plan can best be described as "Better Bush"; a tax cut and war spending driven plan which at least includes the no brainer steps of infrastructure and counter-cyclicals. . . .

The design of Obama's cuts is not that much better. 100 billion is slated for corporate tax breaks. This can more or less be called "pork for the fat cats," in terms of how little it will do for the economy. Of the remaining 200 billion, most is using the "deduction reduction" method. This has been tried at various times in the past, and almost invariably, it doesn't do very much. The reason is that the amount of money given is so small, that it never encourages the household to spend it, and, in the current environment of lack of pricing power for consumers, it is likely to simply be reflected in higher prices, or in lower wages.

Newberry’s takedown of the Obama stimulus plan is trenchant and merciless, and very much worth taking the time to pop over and read. Ian Walsh also had a good critique of the Obama stimulus plan three days ago: A Stimulus Bill with 40% in Tax Cuts Won’t Do the Job

. . . the only economic policy that Obama really really believes in is tax cuts. During the election, even when no one really cared, he would keep repeating, over and over and over again, that he was going to cut taxes.

The problem is that giving money to people without pricing power (most middle and working class people) is pointless. People with pricing power, like health care providers, credit card companies (who can and will raise rates) and employers (who will take into account that their workers are now taking home more money and thus don't need as much from them) will simply take the money away. And at this time workers and ordinary consumers just don't have pricing power.

Likewise corporations are not going to create real new jobs if there's no demand. Who wants to invest into this economy? This isn't an economy where you hire new people, it's an economy where you take any money you've got and you use it to buy up distressed competitors and properties at generational lows. Then you rationalize your new acquisition with your own company by laying people off. We've just spent the past few months watching this play out in the banking industry, heavily subsidized by the government, now we're going to have to watch the government subsidize buyouts of non-financial companies. If at first giving money to corporations (banks) doesn't work, why not try it with even more companies?

In stark contrast to the disappointing neo-Chicago pablum coming from Obama is the article by David Cay Johnston, former New York Times correspondent, and author of Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You With the Bill), on Mother Jones' website a few days ago. Johnston  provides a point by point guide to dismantling some of the most glaring abuses of the corporatist state which has developed since the Reagan revolution. It is a very powerful article, full of great zingers, and you should take to time to read it in full. As Johnston notes, all Obama has offered so far are “some interesting ideas to make the tax code more fair” that amount to “tinkering around the edges, not the kind of serious restructuring previous presidents, most notably Reagan, undertook.”  

Here's some of Johnston's  specific policy proposals: 

1. Stop allowing companies to use one set of accounting rules to report to investors, and a second set of accounting rules to report to the IRS.

2. Make the super-rich pay their share.

Back in 1990, people making more than $1 million in today's dollars earned less than 0.8 percent of all the wages paid in America. Last year these multimillionaires sucked up more than 5 percent, squeezing everyone else. Also during this period, the number of people getting million-dollar-plus salaries grew 12 times faster than the number of workers overall, tax data show—this in an economy where, in 2007, one in three workers earned less than $15,000, more than three-fourths made less than $50,000, and 99 percent earned less than $200,000. 

3. End tax deferrals of executive compensation.

While most of us must pay each time we get a paycheck, executives and corporations can defer their taxes for years, even decades. When the treasury finally gets the money, inflation has eroded its value; in the meantime, government must borrow more, pay more interest, and collect more from everyone else.

4. Shut down overseas tax havens

In 1983 just 10 percent of America's corporate profits were funneled through places that charge little or no corporate income tax; today more than 25 percent of profits go through tax havens. The Obama administration could tell the Caymans—now fifth in the world in bank deposits—to repeal its bank secrecy laws or be invaded; since the island nation's total armed forces consists of about 300 police officers, it shouldn't be hard for technicians and auditors, accompanied by a few Marines, to fly in and seize all the records. Bermuda, which relies on the Royal Navy for its military, could be next, and so on. Long before we get to Switzerland and Luxembourg, their governments should have gotten the message.

Barring gunboat diplomacy (tempting as it is), there is no reason we cannot pass laws to block financial transactions with tax havens or even, Cuba-style, make it a crime for Americans to visit or do business with them without special permission. Congress could declare the hiding of funds a threat to national security and require that anyone with offshore assets disclose them to the irs within 30 days and pay taxes, interest, and penalties within 180 days. For the holdouts, temporary special teams in the irs and Justice Department could speedily pursue civil or criminal charges.

5. Force utilities to pay all the taxes they collect.

I did not know this, but Johnston reports that many utility companies collect hundreds of millions in use taxes that they never actually pass on to government. The numbers Johnston reports are eye-popping and enraging.

6. Eliminate subsidies for big box chains and professional sports

Similar to the point above, many large retailers collect hundreds of millions in retail taxes that they never actually pass on to government. And check this out: the big four commercial sports, the MLB, the NFL, NBA, and NHL reported operating profits of $1.6 billion – but received $2 billion in local government subsidies. That’s right – professional sports would be bleeding as badly as General Motors if it weren’t for lots of extra juice from us taxpayers.

7. Ground the Private Jet Exemption

The numbers are amazing. Really, you have to go read the entire article.

8. Demolish the Mansion Deduction

This is sort of like social security – it’s a deadly third rail for politicians to even touch. But, did you know that Canada has almost exactly the same level of home ownership as the United States, and does not allow mortgage interest to be deducted?

9. Stop Indenturing Students

This is one area where I just don’t understand why people tolerate it. We are seriously, seriously, screwing up our future here.

Over the past 40 years, the cost of public colleges has doubled, and financing tuition is an $85 billion a year business for credit companies. Sallie Mae, the biggest of the private student loan companies, earns an average 48 percent annual return, three times the return of commercial banks. Students who sign up for loans with what appear to be low fixed rates may discover upon graduating that they face an 18 percent rate; if they make a single late payment, late fees will be tacked on every month until the debt is paid off. And the law makes no allowance for students who can't find a job in a bad economy, or can't work because of illness, or choose to serve their communities by, say, joining Teach for America. Albert Lord, Sallie Mae's chief executive, has become so rich from student lending that he built his own private golf course just outside the nation's capital.

10. Bring back usury laws

Again, the numbers Johnston reports are mind-numbing. In the past three decades, credit card and other revolving debt has risen from $128 billion to $968 billion (adjusted for inflation), a 7.5-fold increase. Interest on this debt, at an average rate of about 18 percent. And Johnston reminds us that one of the most damaging acts of the Bush administration, was the preemptory invalidating of state predatory lending law, despite the protests of all 50 state attorneys general.

11. Protect Pensions

Did you know that, thanks to a little-known provision inserted by lobbyists in 2006, when a new buyer takes over a company, the new owners can wipe out up to 85 percent of the company’s pension obligation? Dude, we are so screwed.

Johnston headlines his article with the claim that a $2 trillion recovery program can be entirely financed with these measures, without having to extract a dime in higher taxes from the middle and working classes. I’m not sure Johnston is entirely correct on this point, but I would sure rather try what Johnston is proposing, rather than even discussing “what to do about entitlements."

In fact, I believe there is an easy way to avoid a long and painful decade of economic stagnation and declining living standards. Begin by accepting the fact that the financial system of the United States has been pretty much nationalized. Now add a new rule, entirely unpalatable to the financial and economic elites: All uses of credit for anything other than investments in real economic activity must be ended. No more financial derivatives, no more credit default swaps, no more foreign exchange trading, no more floating interest rates, no more futures based in the Standard and Poors 500, or any other market index. Credit must be strictly and ruthlessly directed into a massively mind-boggling program of dragging the United States into the future.

For example, if we are truly to terminate our dependence on imported energy, we must end the dominance of the internal combustion engine as a prime mover in transportation. That means getting Americans out of their cars. That in turn means some alternative means of transportation must be provided. But to build urban rail transit systems to the service density needed in the 39 largest urban areas (where nearly half of all Americans reside) requires $3.4 trillion just for construction of the railways and stations. Then we need to procure the rolling stock.

Or, to get the U.S. to 20% of electricity provided by wind power by 2030 requires building 100,000 2.5-5.0 megawatt wind turbines at a cost of over $1.0 trillion. That should be scaled up to 50% wind power by 2020, for another program of over $3.0 trillion. Probably another $1.0 trillion is required to revitalize and reroute the national transmission grid to accommodate the emergence of wind as the primary source of electricity.

The employment impact of these programs is measured by the tens of millions. Unemployment will not be a problem. Quite the opposite: we need to develop a lot of human capital to get the job done.

These types of massive infrastructure programs are what credit should be used for. Nothing else.  That's the only long-term solution to our financial, banking, and economic crises.