Michael Hudson - Article Archive

The Revelations of Sheila Bair
Wall Street's Power Grab
By MICHAEL HUDSON
January 19, 2010

You almost could hear the bankers heave a sigh of relief when Haiti’s earthquake knocked the Financial Crisis Inquiry Commission hearings off the front pages and evening news broadcasts last week. At stake is Wall Street’s power grab seeking to centralize policy control firmly in its own hands by neutralizing the government’s regulatory agencies.

The first day – Wednesday, January 15 – went innocuously enough. Four emperors of finance were called on to voice ceremonial platitudes and pro forma apologies without explaining what they might be apologizing for. Typical was the statement by Goldman Sachs chairman Lloyd C. Blankfein: “Whatever we did, it didn’t work out well. We regret the consequence that people have lost money.”

Their strategy certainly made money for themselves – and they made it off those for whom the financial crisis “didn’t work out well,” whose bad bets ended up paying Wall Street’s bonuses. So when Paul Krugman poked fun at the four leading “Bankers without a clue” in his New York Times kcolumn, he was lending credence to their pretense at innocent gullibility.

Recipients of such enormous bonuses cannot be deemed all that clueless. They blamed the problem on natural cycles – what Mr. Blankfein called a “100-year storm.” Jamie Dimon of JPMorgan Chase trivialized the crisis as a normal and even unsurprising event that “happens every five to seven years,” as if the crash is just another business cycle downturn, not aggravated by any systemic financial flaws. If anything, Wall Street accuses liberal government planners of being too nice to poor people, by providing cheap mortgage credit to the uninitiated who could not quite handle the responsibility.

But the Wall Street executives were careful not to blame the government. This was not just an attempt to avoid antagonizing the Congressional panel. The last thing Wall Street wants is for the government to change its behavior.

The Wall Street boys are playing possum. Why should we expect them to explain their strategy to us?

To understand their game plan, the Commissioners had to wait for the second day of the hearings, when Sheila Bair of the Federal Deposit Insurance Corp. (FDIC) spelled it out. Their first order of business is to make sure that the Federal Reserve Board is designated the sole financial regulator, knocking out any more activist regulators – above all the proposed Consumer Financial Products Agency that Harvard Professor Elizabeth Warren has helped design. Wall Street also is seeking to avert any thought of restoring the Glass-Steagall Act in an attempt to protect the economy from having merged retail commercial banking with wholesale investment banking, insurance, real estate brokerage and kindred arms of high finance.

Perception – and exposure – of this strategy is what made the second day’s hearing (on Thursday) so important. From Ms. Bair down to state officials, these administrators explained that the problem was structural. They blamed government and the financial sector’s short-run time frame. And they complained that neither the Federal Reserve nor the rest of the current Washington administration seemed very interested in cleaning up the problem.

The past few years have demonstrated how thoroughly the commercial and investment-banking sector already has taken control of government. Having disabled the Securities and Exchange Commission (SEC) to such an extent that it refused to act even when warned about Bernie Madoff, deregulators did not raise a protest against the junk accounting that was burying the financial system in junk mortgages and kindred accounting fraud. The Comptroller of the Currency blocked local prosecutors from moving against financial fraud, citing a small-print rule from the Civil War era National Bank Act giving federal agencies the right to override state agencies. Passed in the era of wildcat banking, the rule aimed to prevent elites from using crooked local courts to protect them. But in the early 2000s it was Washington that was protecting national banking elites from state prosecutors such as New York Attorney General Eliot Spitzer and his counterparts in Massachusetts, Illinois and other states. This prompted Illinois Attorney General Lisa Madigan to remind the Angelides Commission that the Office of the Comptroller of the Currency and the Office of Thrift Supervision were “actively engaged in a campaign to thwart state efforts to avert the coming crisis.”

Ms. Madigan’s testimony is scathing with regard not only to the obstruction of federal agencies protecting the fraudsters, but the fact that the Obama administration has done little to improve matters: “even in the face of mounting public evidence that the mortgage lending industry was abandoning common-sense underwriting standards, the federal regulators made no move to strengthen underwriting controls for the lenders under their direct supervision.… In fact, in response to aggressive actions at the state level, federal regulators took unprecedented steps to shield national lenders and their subsidiaries from state enforcement and from the growing number of state anti-predatory lending laws on the books.” Unless state agencies retain leeway to prosecute financial crime, she concluded, financial criminals will continue to rely on Washington to protect them. And the “them” to whom she refers are the largest banks, those which the Obama administration has given most of the bailout money and deemed too big to fail, thereby giving them a marketing (and tax) advantage over smaller rivals.

By far the major enabler has been the Federal Reserve Board (FRB). Acting as the banking system’s lobbying organization, its tandem of Alan Greenspan and Ben Bernanke fought as a free-market Taliban against attempts to introduce financial regulation. Working with the Goldman Sachs managers on loan to the Treasury, the Fed managed to block attempts to rein in debt pyramiding.

Mr. Bernanke ignored the very first lesson taught in business schools. This was the lesson taught by William Petty in the 17th century and used by economists ever since: The market price of land, a government bond or other security is calculated by dividing its expected income stream by the going rate of interest – that is, “capitalizing” its rent (or any other flow of income) into what a bank would lend. The lower the rate of interest, the higher a loan can be capitalized. At an interest rate of 10 per cent , a $10,000 annual income is worth $100,000. At 5 per cent , this income stream is worth $200,000; at 4 per cent, $250,000. Mr. Bernanke thus rejected over three hundred years of economic orthodoxy in testifying recently that the Fed was blameless in fueling the real estate bubble by slashing interest rates after 2001. Financial fraud also was not to blame. Anointed with the reputation for being a “student of the Great Depression,” he showed himself to be clueless.

He is not really all that clueless, of course. His role is to play the "useful idiot" whom financial elites can blame to distract attention from how they have gamed the system. Wall Street’s first aim is to make sure that the Fed remains in control as the government’s central regulator – or in the present case, deregulator, able to disable any serious attempt to check Wall Street’s drive to load down the economy with yet more debt so as to “borrow its way out of the bubble.” Public relations “think tanks” (spin centers adept in crafting blame-the-victim rhetoric) use simple Doublethink 101 tactics to call this “free market” policy. Financial self-regulation is to be left to bankers, shifting economic planning out of the hands of elected representatives to those of planners drawn from the ranks of Wall Street. This centralization of authority in a public agency “independent” from control by elected representatives is dubbed “market efficiency,” with an “independent central bank” deemed to be the hallmark of democracy. The words “democracy,” “progress” and “reform,” are thus given meanings opposite from what they meant back in the Progressive Era a century ago. The pretense is that constraints on finance are anti-democratic, not public protection against today’s emerging financial oligarchy. And to distract attention from the road to debt peonage, financial lobbyists accuse governments strong enough to check the financial interest” of threatening to lead society down “the road to serfdom.”

Avoiding regulation by having the Fed “regulate,” with neoliberal deregulators in charge

All that is needed is to reduce the number of regulators to one – and to appoint a deregulator to that key position. The most dependable deregulator is the commercial banking system’s in-house lobbyist, the Federal Reserve. This requires knocking out potential rivals. But at the Federal Deposit Insurance Corporation (FDIC), Sheila Bair is not willing to relinquish this authority. Her testimony last Thursday was buried on the back pages of the press, and her most trenchant written arguments lost in the hubbub h media, her testimony should have been welcomed as intellectual dynamite.

For Ms. Bair the task requires blocking three key battles that the financial sector is waging in its war to control and extract tribute from the “real” economy of production and consumption. Her first policy to get the economy back on track is to ward off any plans that politicians might harbor to keep Wall Street unregulated. “Over the past two decades, there was a world view that markets were, by their very nature, self-regulating and self-correcting – resulting in a period that was referred to as the ‘Great Moderation’ [Mr. Bernanke’s notorious euphemism]. However, we now know that this period was one of great excess.”

Banks are using the ploy familiar to readers of the Uncle Remus stories about B’rer Rabbit. When the fox finally catches him, the rabbit begs, “Please don’t throw me in the briar batch.” The fox does just that, wanting to harm the rabbit – who gets up and laughs, “Born and bred in the briar patch!” and hops happily away, free. This is essentially what the financial scenario would be under Federal Reserve aegis. “Not only did market discipline fail to prevent the excesses of the last few years, but the regulatory system also failed in its responsibilities. There were critical shortcomings in our approach that permitted excessive risks to build in the system. Existing authorities were not always used, regulatory gaps within the financial system provided an environment in which regulatory arbitrage became rampant …”

No more damning reason could be given for Congress to reject Mr. Bernanke out of hand, if not indeed to set about restructuring the Fed to bring it back into the Treasury, from which it emerged in 1914 in one of the most unfortunate Caesarian births of the 20th century. In detail, she explained how the Fed had acted as an agent of the commercial banks perpetrating fraud, protecting their sale of toxic mortgage products against consumer interests and indeed, the solvency of the economy itself. Nobody can read her explanation without seeing what utter folly it would be to put Creditor Fox in charge of the Debtor Henhouse.

Blocking creation of a Consumer Protection Agency

Ms. Bair’s second aim was to counter Wall Street’s attempt to block enactment of the Consumer Protection Agency. Its lobbyists have had a year to disable any real reform, and Washington obviously believes that it can be safely jettisoned. But Ms. Bair spelled out just how willful and egregious the Fed’s refusal to use its regulatory powers – and indeed, its designated responsibilities – has been. “Federal consumer protections from predatory and abusive mortgage-lending practices are established principally under the Home Ownership and Equity Protection Act (HOEPA), which is part of the Truth in Lending Act (TILA). TILA and HOEPA regulations are the responsibility of the Board of Governors of the Federal Reserve System (FRB) and apply to both bank and non-bank lenders,” she explained. “Many of the toxic mortgage products that were originated to fund the housing boom … could have been regulated and restricted under another provision of HOEPA that requires the FRB to prohibit acts or practices in connection with any mortgage loan that it finds to be unfair or deceptive, or acts and practices associated with refinancing of mortgage loans that it finds abusive or not otherwise in the interest of the borrower.”

This was not done. It was actively thwarted by the Fed

“Problems in the subprime mortgage market were identified well before many of the abusive mortgage loans were made. A joint report issued in 2000 by HUD and the Department of the Treasury entitled Curbing Predatory Home Mortgage Lending … found that certain terms of subprime loans appear to be harmful or abusive in practically all cases. To address these issues, the report made a number of recommendations, including that the FRB use its HOEPA authority to prohibit certain unfair, deceptive and abusive practices by lenders and third parties. During hearings held in 2000, consumer groups urged the FRB to use its HOEPA rulemaking authority to address concerns about predatory lending. Both the House and Senate held hearings on predatory abuses in the subprime market in May 2000 and July 2001, respectively. In December 2001 the FRB issued a HOEPA rule that addressed a narrow range of predatory lending issues.

“It was not until 2008 that the FRB issued a more extensive regulation using its broader HOEPA authority to restrict unfair, deceptive, or abusive practices in the mortgage market.”

This was closing the barn door after the horses had fled, of course. “The rule imposes an ‘ability to repay’ standard in connection with higher-priced mortgage loans. For these loans, the rule underscores a fundamental rule of underwriting: that all lenders, banks and nonbanks, should only make loans where they have documented a reasonable ability on the part of the borrower to repay. The rule also restricts abusive prepayment penalties.”

Warning that “the consequences we have seen during this crisis will recur,” Ms. Bair reiterated a recommendation she had earlier made to the effect that “an ability to repay standard should be required for all mortgages, including interest-only and negative-amortization mortgages and home equity lines of credit (HELOCs). Interest-only and negative-amortization mortgages must be underwritten to qualify the borrower to pay a fully amortizing payment.” The Fed blocked this common-sense regulatory policy. And by doing so, it became an enabler of fraud.

“As the private-label MBS [Mortgage-Backed Securities] market grew, issuances became increasingly driven by interest-only, hybrid adjustable-rate, second-lien, pay-option and Alt-A mortgage products. Many of these products had debt-service burdens that exceeded the homeowner's payment capacity. For example, Alt-A mortgages typically included loans with high loan-to-value ratios or loans where borrowers provided little or no documentation regarding the magnitude or source of their income or assets. Unfortunately, this class of mortgage products was particularly susceptible to fraud, both from borrowers who intentionally overstated their financial resources and from the mortgage brokers who misrepresented borrower resources without the borrower’s knowledge.”

As Paul Volcker recently suggested, financial “innovation” did not contribute much to production. Packaging junk mortgages and organizing CDO swaps made real estate more debt-leveraged, while adding higher debt balances to the economy’s homes and office properties. But “the regulatory capital requirements for holding these rated instruments were far lower than for directly holding these toxic loans,” Ms. Bair explained. “Many of the current problems affecting the safety and soundness of the financial system were caused by a lack of strong, comprehensive rules against abusive lending practices applying to both banks and non-banks.”

“Improved consumer protections are in everyone's best interest. It is important to understand that many of the current problems affecting the safety and soundness of the financial system were caused by a lack of strong, comprehensive rules against abusive practices in mortgage lending. If HOEPA regulations had been amended in 2001, instead of in 2008, a large number of the toxic mortgage loans could not have been originated and much of the crisis may have been prevented. The FDIC strongly supported the FRB’s promulgation of an ‘ability to repay’ standard for high priced loans in 2008, and continues to urge the FRB to apply common sense, ‘ability to repay’ requirements to all mortgages, including interest-only and option-ARM loans."

Illinois Attorney General Madigan made the same point: “The Federal Reserve had the unquestionable authority to tighten underwriting standards for all lenders under HOEPA,” but did nothing. Although “Last year, the Fed finalized rules that require all lenders to evaluate a borrowers’ repayment capacity in transactions involving home loans with certain features known to be high-risk,” its strategy seems to be merely to give the appearance of moving against credit fraud without really stopping Wall Street.

“Unfortunately, these common-sense underwriting standards apply only to what the Fed has defined as ‘higher cost’ loans. In light of the financial services industry’s demonstrated talent for developing new products that evade regulatory reach, the Fed’s definitional limitations are an invitation for trouble. It is not even clear whether the Fed’s rules would apply to many of the toxic pay-option ARM products that are helping to drive the current wave of foreclosures. I join with other consumer advocates in calling for strong underwriting standards that apply to all home loans.”

Ms. Bair (as well as Ms. Madigan) emphasize that the absence of proper consumer protection was a major contributing factor to the present financial meltdown, for “it has now become clear that abrogating sound state laws, particularly regarding consumer protection, created opportunity for regulatory arbitrage that resulted in a regulatory ‘race-to-the-bottom.’” Mortgage fraud became rife as bank regulators failed to protect consumers or the economy at large. This is why an independent agency is needed rather than hoping that the Federal Reserve somehow can change its spots. “If the bank regulators are not performing this role properly, the consumer regulator should retain backup examination and enforcement authority to address any situation where it determines that a banking agency is providing insufficient supervision.”

Orally summarizing her 54-page written testimony, Ms. Bair commented: “looking back, I think if we had had some good strong constraints at that time, just simple standards like … you've got to document income and make sure they can repay the loan ... we could have avoided a lot of this.” But alas, matters have not changed all that much. “Even now,” Ms. Madigan complained,

“there appears to be a lack of will in Washington to fill the regulatory void that led to this crisis. Congress and the federal regulators have yet to put into place strict underwriting standards that apply to all home loans, even though the record shows that such standards are essential to preventing another crisis. Additionally, as seen in the ongoing battle over President Obama’s proposed Consumer Financial Protection Agency, the big banks continue to lobby for the ability to operate within state borders without regard to state laws. … Ultimately, my efforts and those of other state attorneys general were unable to fill the void created by what I view as an abdication of consumer protection and meaningful oversight at the federal level.”

And indeed, on the same day on which Ms. Bair’s and Ms. Madigan’s testimony was shriveled to a few short news bites, the Wall Street Journal leaked the story that “Senate Banking Committee Chairman Christopher Dodd is considering scrapping the idea of creating a Consumer Financial Protection Agency … as a way to secure a bipartisan deal on the legislation,” that is, a deal with “Richard Shelby of Alabama, who has referred to the Consumer Financial Protection Agency as a ‘nanny state.’ … The banking industry has spent months lobbying aggressively to defeat the creation of the CFPA. ‘One of our principal objections all along is that you would have a terrible conflict on an ongoing basis between a separate consumer regulator and the safety and soundness regulator, with the bank constantly caught in the middle,’ said Ed Yingling, chief executive of the American Bankers Association trade group.” The idea is that a “conflict” between an institution seeking to protect consumers – and indeed, the economy – from an in-house banking lobbying institution (the Fed), backed by the Treasury safely in the hands of Goldman-Sachs caretakers on loan is “inefficient” rather than a necessary democratic safeguard! But the paper gave more space crowing over the likely defeat of the Consumer Financial Protection Agency than it did to Ms. Bair’s eloquent written testimony.

Avert any thought of re-enacting Glass-Steagall

On the institutional level, Wall Street’s managers want to ward off any threat that the Glass-Steagall legislation might be revived to separate consumer deposit banking and money management from today’s casino capitalism. This is what Paul Volcker has urged, but it is now obvious that Pres. Obama appointed him only for window dressing, much like that of Pres. Johnson said of J. Edgar Hoover: he would rather have him inside his tent pissing out than outside pissing in. Appointing Mr. Volcker as a nominal advisor effectively prevents the former Fed Chairman from making hostile criticisms. Pres. Obama simply ignores his advice to re-instate Glass-Steagall, having appointed as his senior advisor the major advocate of the repeal in the first place – Larry Summers, along with the rest of the old Rubinomics gang taken over from the Clinton administration.

Ms. Bair explained why Wall Street’s preferred “reforms” along the current line – maintaining the “too big to fail” financial oligopoly intact, along with the Bush-Obama deregulatory “free market” ideology – threatens to return the financial system to its bad old ways of crashing. To Wall Street, naturally, this is the “good old way.” Wall Street is consolidating the finance, insurance and real estate (FIRE) sector across the board into oligopolistic conglomerates “too big to fail.”

But being realistic under the circumstances, Ms. Bair avoided taking on more of a battle than likely can be won at this time. “One way to address large interconnected institutions,” she proposed, “is to make it expensive to be one. Industry assessments could be risk-based. Firms engaging in higher risk activities, such as proprietary trading, complex structured finance, and other high-risk activities would pay more” for their deposit insurance, to reflect the higher systemic risks they are taking. This suggestion is along the lines of proposals (made for over half a century now) to set different reserve requirements or capital adequacy requirements for different categories of bank loans.

Alas, she acknowledged, the Basel agreements regarding capital adequacy standards are being loosened rather than tightened. “In 2004, the Basel Committee published a new international capital standard, the Basel II advanced internal ratings-based approach (as implemented in the United States, the Advanced Approaches), that allows banks to use their own internal risk assessments to compute their risk-based capital requirements. The overwhelming preponderance of evidence is that the Advanced Approaches will lower capital requirements significantly, to levels well below current requirements that are widely regarded as too low.” She criticized the new, euphemistically termed “Advanced Approach” as producing “capital requirements that are both too low and too subjective.” The result is to increase rather than mitigate financial risk.

The need for tax reform to accompany financial reform

Beyond the scope of the FDIC or other financial regulatory agencies is the symbiosis between financial and fiscal reform.

“For example, federal tax policy has long favored investment in owner-occupied housing and the consumption of housing services. The government-sponsored housing enterprises have also used the implicit backing of the government to lower the cost of mortgage credit and stimulate demand for housing and housing-linked debt. In political terms, these policies have proven to be highly popular. Who will stand up to say they are against homeownership? Yet, we have failed to recognize that there are both opportunity costs and downside risks associated with these policies. Policies that channel capital towards housing necessarily divert capital from other investments, such as plant and equipment, technology, and education—investments that are also necessary for long-term economic growth and improved standards of living.”

The problem is that U.S. financial and fiscal policy has institutionalized the financial sector’s short-term outlook, “distorting of decision-making away from long-term profitability and stability and toward short-term gains with insufficient regard for risk.” For example, money managers are graded every three months on their performance against the norm. Ms. Bair focused on how employee compensation in the form of stock options tended to promote short-termism. “Formula-driven compensation allows high short-term profits to be translated into generous bonus payments, without regard to any longer-term risks. Many derivative products are long-dated, while employees’ compensation was weighted toward near-term results. These short-term incentives magnified risk-taking.” In sum, “performance bonuses and equity-based compensation should have aligned the financial interests of shareholders and managers. Instead, we now see – especially in the financial sector – that they frequently had the effect of promoting short-term thinking and excessive risk-taking that bred instability in our financial system. Meaningful reform of these practices will be essential to promote better long-term decision-making in the U.S. corporate sector.”

Pushing the economy even deeper into debt beyond the ability to pay

The banking system’s marketing departments have set their eyes on the economy’s largest asset, real estate, as its prime customer. The major component of real estate is land. For years, banks lent against the cost of building, using land (tending to rise in value) as the borrower’s equity investment in case of downturn. This was the basic plan in lending 70 per cent , then 80 per cent and finally 100 per cent or even more of the real estate price to mortgage borrowers. The effect is to make housing even more expensive.

Suppose that Wall Street succeeds in its strategy to re-inflate the Bubble Economy. Will this create even larger problems to come, by making the costs of living even higher as labor and industry become even more highly debt leveraged? That is the banking sector’s business plan, after all. The aim of bank marketing departments – backed by the Obama administration – is to steer credit to re-inflate the bubble and thus save financial balance sheets from their current negative equity position.

This policy cannot work. One constraint is the balance of payments. The competitive power of U.S. exports of the products of American labor is undercut by the fact that housing costs absorb some 40 per cent of labor’s family budgets today, other debt 15 per cent , FICA wage withholding 12 per cent , and various taxes another 20 per cent . U.S. labor is priced out of world markets by the economy’s FIRE sector overhead even before food and essential needs of life are bought. The “solution” to the financial sector’s negative equity squeeze thus threatens to create even larger problems for the “real” economy. Ms. Bair appropriately concluded her written testimony by commenting that the context for the present discussion of financial reform should be the fact that “our financial sector has grown disproportionately in relation to the rest of our economy,” from “less than 15 percent of total U.S. corporate profits in the 1950s and 1960s … to 25 percent in the 1990s and 34 percent in the most recent decade through 2008.” While financial services “are essential to our modern economy, the excesses of the last decade” represent “a costly diversion of resources from other sectors of the economy.”

This is the same criticism that John Maynard Keynes levied in his General Theory, citing all the money, effort and genius that went into making money from money in the stock market, without actually contributing to the production process or even to tangible capital formation. In effect, we are seeing finance capitalism autonomous from industrial capitalism. The problem is how to restore a more balanced economy and rescue society from the financial sector’s self-destructive short-term practices.]

On-line transcripts of the hearings are available at
http://www.fcic.gov/hearings/pdfs/2010

Michael Hudson is a former Wall Street economist.
http://www.counterpunch.org/hudson01192010.html

Will Obama Put Muscle Into the White House's New Populist Play?

By MICHAEL HUDSON
January 25, 2010

t stake now is President Obama’s credibility as an agent for change. Voters see his main “change” thus far to have been favoritism to Wall Street. Jay Leno jokes that 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.

This is the political 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, 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.

Those voters in Massachusetts last week who felt duped by Obama’s promise as a reform candidate did not really turn Republican, but obviously felt that 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 the banks 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 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, Obama reiterated his endorsement for reappointing Helicopter Ben Bernanke as Federal Reserve Chairman.

As the lobbyist for high finance, Bernanke’s money drop seemed to land only on Wall Street. Now it has emptied out the government’s credit in an unparalleled deficit. So now, 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 Obama’s rehabilitation of Clinton Rubinomics deregulator Larry Summers as chief advisor, sidelining Paul Volcker until he was hurriedly flown back from political Siberia, in reaction to the Massachusetts debacle and to soften the leak by the Wall Street Journal on January 15 that Obama and the Democrats were not unhappy to see Elizabeth Warren’s Consumer Financial Products Agency die stillborn, despite the president’s promise that the agency was “non-negotiable.”

Hence the sudden passion of the Obama administration for the “Volcker rule” to re-separate commercial banking from its casino capitalist outgrowth. The photo-op with Volcker was intended to provide at least a semblance of regulation of the sort that was normal before Summers and other Clinton-Gore era Democratic Leadership Committee operatives had formed common cause with Republicans to repeal Glass-Steagall. Across the last year 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 Bernanke. Republican leaders already had taken a head start on opposing him. Many Democrats are mustering enough born-again populism to sacrifice Bernanke, and perhaps Messrs. Summers and Geithner as well.

It is bad enough that Obama has not joined in the criticism of 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 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 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 the House Republicans opposed the bank bailout back in September 2008, when 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.

Obama promised change, but then decided that he wanted to be bipartisan and insisting that he needs 60 votes. If he had them, would he then 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.

The trick for politicians in both parties is how to wrap pro-Wall Street policies in enough populist rhetoric to prevail in November, 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 Obama’s promise to make an about-face and back financial reform will remain merely rhetorical, or actually be substantive?

Spending a year hoping to get Republicans to sign onto health care almost seems to have been a tactic to give 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.

Instead of providing help in slowing the foreclosure process or pressuring banks to renegotiate, Obama’s solution is for the Fed to flood the banking system with enough money at low enough interest rates to re-inflate housing prices. What 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 per cent of their take-home pay on housing, and another 15 per cent 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 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 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 help for debtors to 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 fatally riddled by Wall Street’s lobbyists with loopholes such as letting banks write their contracts out of their London branches. These lobbyists have the upper hand in detoothing and disabling attempts to reduce their power or even to enact simple truth-in-lending laws.

It certainly seems unlikely that Obama 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. 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 cannot solve this problem. Its solution requires a policy alternative more radical than Obama’s 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. Obama never gets down to this practical 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 are still panic-stricken by Massachusetts – 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 populist pose. Strong legislation against Wall Street will force politicians of both parties to show their true colors.

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 Martha Coakley, the losing Democratic senate candidate, found last Tuesday: “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 from Washington that are delivering more for banks than Main Street.”

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. But who sees him doing this?

More tomorrow from Michael Hudson on what Obama’s State of the Union will really have to offer.

Michael Hudson is a former Wall Street economist.
http://www.counterpunch.org/hudson01252010.html

Democrats Say "Bye" to Populist Option Obama's Junk Economics
By MICHAEL HUDSON
February 1, 2010

In a dress rehearsal for this November’s mid-term election, Democrats and Republicans vied last week for who could denounce the banks and blame the other party the most for the giveaways to Wall Street that have swollen the public debt since September 2008, pushing the federal budget into deficit and the economy into a slump.

The Republicans are winning the populist war. On the weekend before his State of the Union address on Wednesday, Obama strong-armed Democratic senators to re-appoint Ben Bernanke as Federal Reserve Chairman. His Wednesday speech did not mention this act (happily applauded by Wall Street). The President sought to defuse voter opposition by acknowledging that nobody likes the banks. But he claimed that unemployment would be much higher if they hadn’t been bailed out. So the giveaway of public funds was all for the workers. The $13 trillion that has created a new power elite was just an incidental byproduct. Unpleasant, perhaps, as American democracy slips into oligarchy. But the least bad option. People might not like it, but Main Street simply cannot prosper without creating hundreds of Wall Street billionaires – without enabling them to increase their bonuses and capital gains as bank stock prices quadruple. It’s all to get credit flowing again (at 30 per cent for credit card users, to be sure.)

So the rest of us must wait for wealth to trickle down. The cover story is that, like it or not, this is how the world works. At least this is the argument of the lobbyists who are drafting and censoring laws and signing off on just who is acceptable to run the Federal Reserve, Treasury and other public-subsidy agencies. The working assumption is that the economy cannot recover without enriching Wall Street.

In fact what the economy needs is to recover from the Bush-Obama supposed cure, i.e., from the mushrooming debt overhead. It needs to recover from the enrichment of Wall Street. It doesn’t need more credit, but a write-down for the unpayably high debts that the banks have imposed on American families, businesses, states and localities, real estate, and the federal government itself.

Instead of helping debtors, Obama has moved to heal the creditors, at public expense. If debtors cannot pay, the Treasury and Fed will take their IOUs and bad casino gambles onto the public sector’s balance sheet. The financial winners must come first – and it seems second and third, too. The rationale is that unless the government gives the large financial institutions what they want and saves them from taking a loss, their “incentive” to protect the economy from devastation will be gone.

Knuckling under to this protection racket is not the change that most people voted for in November 2008. So on Thursday afternoon, most Republican senators opposed a second four-year term for Bernanke. By leading the effort to re-confirm him, the Corporate Democrats (but not most of their colleagues who had to face voters this autumn) removed this albatross from the Republican neck and put it around their own.

For starters, Chairman Bernanke has convinced the President that the Fed should be the single regulator of Wall Street – ideologically kindred, and drawn from its ranks, or with its assent. There was no place in Obama’s Act Now list last Wednesday for the Consumer Financial Products Agency he promised a year ago as the centerpiece of financial reform. Its main sponsor, Elizabeth Warren, has been warning that hopes for reform are being overwhelmed by financial lobbyists arguing that truth-in-lending laws and anti-usury regulations threaten to reduce bank profits, forcing lenders to raise costs to consumers. In Bernanke’s world, regulations to protect consumers simply will oblige the banks to pass on the cost increase caused by this “government interference.” The more regulation there is, the more consumers will have to pay.

This is the inside-out picture drawn by bank lobbyists and purveyed by Obama’s economic team. Could George Bush have gotten away with it? Democrats have a friendlier and more compassionate face, but the substance remains the same.

Most economists believe that Obama is whistling in the dark when he says the economy will recover this year under Chairman Bernanke’s guidance.
The financial screws are being tightened, yet the Fed refuses to abide by its charter and regulate credit card rates going through the roof. Instead of countercyclical federal spending to rescue the economy from debt deflation, Obama says that since we have given so much to Wall Street in the past year and a half, little is left to spend on the “real” economy.

Sounding like a Republican in Democratic clothing not unlike his Senate mentor Joe Lieberman, his State of the Union speech urged creation of a bipartisan (that is, Republican-friendly) working group to agree on how to lower the deficit. The President proposes that starting next year Congress should freeze spending not already committed under entitlement programs.

Testifying Wednesday morning as a run-up to Pres. Obama’s evening speech, Messrs. Geithner and Paulson at least avoided the Washington ploy of emulating Alzheimer’s patients and saying that they couldn’t recall anything about their giveaways. Sophisticated enough to outplay their questioners in verbal tennis, the past and present Treasury Secretaries brazened it out. Using the Plausible Deniability defense, they claimed that they weren’t even in the loop when it came to paying AIG enough to turn around and pay Goldman Sachs and other arbitrageurs 100 cents on the dollar for securities worth about a fifth as much. Their underlings did it.

“This was a Federal Reserve loan,” Paulson explained. “They had the authority. They had the technical expertise … and I was working on many other things which were in my bailiwick.” And in any case an AIG bankruptcy “would have buckled our financial system and wrought economic havoc.” Unemployment, he warned, “could have risen to 25 per cent.” The Fed had to protect people.

When there was no way to dodge, they frankly admitted what had happened, providing helpful pieties to the effect that it is the job of Congress to change the law to make sure nothing like this happens again. Yes, there was a big giveaway, but we saved the economy. Wall Street’s loss would have been the peoples’ loss. Certainly we need new rules to protect the taxpaye …. We’re all in the same boat. If the banks took a loss, they would have to raise the price of financial services and we would all have had to pay more. Thank heavens that everything is getting back to normal now.

“A lot of people think the president of the New York Fed works for the government,” Democrat Marcy Kaptur of Ohio concluded, “but in fact he works for the banks on the board that elected you.” Not so, testified New York Federal Reserve general counsel Thomas Baxter. “A.I.G. wanted to keep the information confidential, for fear that it would lose business if customers were named.” And if it lost business, “This would have had the effect of harming the taxpayers’ investment in A.I.G.” So it was all to save the taxpayers money that the Fed spent $185 billion of their money.

But was it really necessary not to let A.I.G. go bankrupt in September of 2008? The Wall Street Journal’seditorial page blew the whistle on how the government’s wheeler-dealer insiders have been changing their story again and again – not usually a sign of truthfulness. “Secretary of the Treasury Timothy Geithner and predecessor Hank Paulson said they didn’t bail out AIG to save its derivatives counterparties” from bad credit default swap contracts because if it would have asked these counterparties to “take a haircut,” credit-ratings agencies would have downgraded AIG. A lower rating would have obliged it to post even more collateral on its other swap contracts, presumably because of the higher risk.

There are a number of problems with this story, the editorial explained. First of all, Goldman Sachs and other counterparties unilaterally said the prices had declined for securities that had no market price at all, only subjective valuations. A.I.G. would have been reasonable in disputing this. In any event, as the firm’s new 80 per cent stockholder, the U.S. Government said it would stand behind AIG. This should have removed fears of non-payment. But most important of all was the claim by Messrs. Paulson and Geithner that failure to “honor” AIG’s swaps would have threatened its far-flung insurance businesses on which so many American consumers depended. New York Insurance Superintendent Eric Dinallo, who was AIG’s principal insurance regulator at the time, testified before the Senate last year that these operations were not threatened at all! “‘The main reason why the federal government decided to rescue AIG was not because of its insurance companies.’ He was so confident in the health of the AIG subsidiaries that, before the federal bailout, he was working on a plan to transfer $20 billion of their excess reserves to the parent company.”

This directly contradicts Geithner’s claim “that the ‘people responsible’ for overseeing the insurance subsidiaries ‘had no idea’ about the risks facing AIG policyholders. He’s talking about Dinallo here. Instead of being safely segregated, Geithner said the insurance businesses were ‘tightly connected’ to the parent company. Paulson added that the healthy parts of AIG had been ‘infected’ by the ‘toxic assets.’ He added, ‘One part of the company would have contaminated the other.’” Does this mean that New York’s “heavy state insurance regulation was a sham,” the newspaper asked? It would seem that “When push came to shove, policyholders were not protected from a default by the parent company.” It urges that Dinallo be brought back to straighten the matter out.

Geithner closed his own comments by saying, “if you are outraged by what happened with A.I.G., then you should be deeply committed to financial reform.” This is rhetorical judo. The financial system in question is not the economy at large. It was A.I.G.’s carefully segregated bookies’ account for wealthy hedge fund gambles and Wall Street speculations that should have had little to do with the “real” economy at all.

Wall Street – and most business schools – promote the myth that the “real” economy of production and consumption cannot function without making Wall Street’s insiders immensely rich. There seems nothing to be done about banks impoverishing people by extortionate credit card rates, junk securities and a debt burden so heavy that it will require one bailout after another over the next few years. Present policy is based on the assumption that the U.S. economy will crash if we don’t keep the debt overhead growing at past exponential rates. It is credit – that is, debt – that is supposed to pull real estate out of its present negative equity. Credit – that is, debt leveraging – that is supposed to raise stock market prices to enable pension funds to meet their scheduled payments. And it is credit – that is, debt –is supposed to be the key to employment growth.

Credit means giving Wall Street what it wants. Regulating it is supposed to interfere with prosperity. Truth-in-lending, for example, will increase the “cost of production” by “making” banks charge consumers even more for creating credit on their computer keyboards.

This Stockholm syndrome when it comes to Wall Street’s power-grab is junk economics. Wall Street is not “the economy.” It is a superstructure of credit and money management privileges positioned to extract as much as it can, while threatening to close down the economy if it does not get its way. High finance holds the economy hostage not only economically but also intellectually at least to the extent of having captured Obama’s brain – and also the federal budget, as money paid to Wall Street has crowded out spending on economic recovery. It has re-defined “reform” to mean putting Wall Street even more in power by making the Fed the sole regulator of Wall Street. Under these conditions, saving “the system” means saving a mess. It means saving a debt dynamic that must grow exponentially at the economy’s expense, absorbing more and more federal bailout funds and hence crowding out the spending needed to revive the economy.

Paulson’s testimony echoed the idea that the rescue of A.I.G. was necessary to keep the economy from collapsing. “We would have seen a complete collapse of our financial system,” Paulson said, “and unemployment easily could have risen to the 25 per cent level reached in the Great Depression.” So it was all for the working class, for employees and consumers. It was done to save the government – a.k.a. “taxpayers” – from losing money on its investment. It was to save the economy from breaking down – or perhaps to pay off protection-racket money to Wall Street not to wreck the economy. And as we all know, taxpayers today are mainly the lower-income individuals unable to take their revenue in the form of low-taxed “capital gains” like Wall Street traders, in today’s fiscal war between finance and labor.

It seems to be merely an incidental by-product of saving taxpayers and labor that Wall Street ended up with the hundreds of billions of dollars of gains (and losses avoided) – at a $13 trillion expense by government, of about four million jobs in the overall economy whose employment is shrinking, and of about four million home foreclosures in 2009-10. The cover story is that matters would have been worse otherwise. This was the price for “saving the system.” But “the system” turns out to be the Bubble Economy, in which the Obama administration has put as much faith as Bush did. This is why the same managers have been kept in place. This policy has enabled Republicans to strike a posture of denouncing the banks in preparation for this November’s mid-term election.

“Saving the economy” has become a euphemism for the policy of keeping bad debts on the books and saving high finance from writing them down to reflect the realistic ability to pay. Wall Street has used its bailout money to lobby Washington, back its political nominees to hold Congress hostage, and blame the downturn on any regulator or president who does not yield to its demands.

The resulting program is not saving the economy; it is sacrificing it. What has been saved is the debt overhead – the wrong side of the balance sheet.

A bipartisan compact between Corporate Democrats and Republicans is not the change voters expected in November 2008. Confronted with the “Obama surprise” – an absence of change – the only option that many voters believe they have is to change the existing party. Republicans are setting their eyes on Pres. Obama’s former Senate seat in Illinois, Vice Pres. Biden’s seat in Baltimore, and Majority Leader Reid’s seat in Nevada. Losing these and other seats would create a political standoff giving Obama further excuse for not changing course.

This kind of standoff normally would enable a popular president to ask voters to elect a majority large enough to legislate the program he outlines. But instead of a program, Obama has simply appointed the leading Bush-era administrators and brought back the Clinton “Rubinomics” team from Wall Street. His spending freeze in a shrinking economy is a Republican program, his modest “stimulus package” is over, and he has dropped the Consumer Financial Products Agency under Wall Street pressure. So if we are to look at what the administration actually is doing, its program is simply a blank check to the Fed and Treasury (under Bush-era management) to revive Wall Street fortunes – in a nutshell, more Rubinomics.

Convergence between the two parties reflects the privatization of politics by political lobbying and campaign contributions. Paybacks to corporations with fiscal favors, sell-offs and bailouts promises to increase in the wake of the recent Supreme Court decision that corporations are virtual people when it comes to freedom of speech and the purchase of media time.

The only countervailing power is that within the Republican Party a fringe of tea partiers threatens to run against more established candidates safely sold to special interests. The Democratic Party always has been a looser coalition, which may not hold together if the Rubinomics team continues to lock out non-Corporate Democrats. So a political realignment may be in the making. Financial and fiscal restructuring issues span left and right, progressive Democrats and populist Republicans. So far, their sentiments are reactive rather than being spelled out in a policy program. But there is a widening realization that the economy has painted itself into a financial corner.

What is needed is to explain to voters how financial and tax policies are symbiotic. The tax shift off finance, insurance and real estate (FIRE) onto labor and industry since 1980 has polarized the economy between a creditor class at the top of and an indebted “real” economy below. Unless this tax favoritism is reversed, more and more revenue will be diverted away from spending on consumption and investment to pay debt service and “financialize” the economy even more.

It is natural that the world’s most debt-ridden economies – Latvia and its Baltic and post-Soviet neighbors, and Iceland – are the first to perceive the problem. They may be viewed as an object lesson for a dystopian future of debt peonage. New Europe’s debt strains are threatening to break up the core euro-currency area (aggravated from within by the Greek, Spanish and Irish public debt problems). The British economy is likewise financialized, weakening sterling. And Europe lacks the U.S. financial safeguard that enables mortgage debtors here to walk away from properties that have fallen into negative equity. Insolvent homeowners in Europe face a lifetime of literal debt peonage to make the banks (even foreign banks, which dominate Central Europe’s post-Soviet economies) whole on their bad debts as the continent’s real estate prices are plunging even more steeply than those in the United States – some 70 per cent in Iceland and Latvia.

The only silver lining I can see is that perception will spread that the financial sector is an intrusive dynamic subjecting the economy to debt deflation. But at present, lawmakers are acting as if the economy is an albatross around Wall Street’s neck. (“How are we wealthy people to bear the cost of healing the sick and employing the masses?” the financial sector complains. “The cost is eating into our ability to create wealth.”) Libertarians have warned that our economy is going down the Road to Serfdom. What they do not realize is that by fighting against government power to check financial hubris, they are paving the road for centralized financial planning by Wall Street. They have been tricked into leading the parade on behalf of the financial, insurance and real estate sector – down the road to debt peonage in a monopolized and polarized economy.

Michael Hudson is a former Wall Street economist.
http://www.counterpunch.org/hudson02012010.html

The Road to Debt Peonage
The Bernanke Disaster
By MICHAEL HUDSON
February 2, 2010

If the economy deteriorates in the L-shaped “hockey-stick” rut that many economists forecast, what political price will President Obama and the Democrats pay for having returned the financial keys to the Bush Republican appointees who gave away the store in the first place?

Reappointing Federal Reserve Chairman Ben Bernanke may end up injuring not only the economy but also the Democratic Party for years to come. Recognizing this, Republicans made populist points by opposing his reappointment during the Senate confirmation hearings last Thursday, January 27 – the day after Obama’s State of the Union address.

Once the Republicans were certain which way the vote would go, they were able to voice some nice populist sound bites for the mid-term elections this November. Jeff Sessions of Alabama and Sam Brownback of Kansas voted against Bernanke’s confirmation. Jim deMint of South Carolina warned that reappointing him would be “The biggest mistake that we’re going to make for a long time.” He added: “Confirming Bernanke is a continuation of the policies that brought our economy down.”

Among Democrats running for re-election, Barbara Boxer of California pointed out that by spurring the asset-price inflation, the Fed’s pro-Bubble (that is, pro-debt policy) has crashed the economy, shrinking employment. The Fed is supposed to protect consumers, yet Bernanke is a vocal opponent of the Consumer Finance Products Agency, claiming that the deregulatory Fed alone should be the sole financial regulator.

The hearings focused on the Fed’s role as Wall Street’s major lobbyist and deregulator. Despite the fact that its Charter starts off by directing it to promote full employment and stabilize prices, the Fed is anti-labor in practice. Alan Greenspan famously bragged that what has caused quiescence among labor union members when it comes to striking for higher wages – or even for better working conditions – is the fear of being fired and being unable to meet their mortgage and credit card payments. “One paycheck away from homelessness,” or a downgraded credit rating leading to soaring interest charges, has become a formula for labor management.

As for its designated task in promoting price stability, the Fed’s easy-credit bubble has made asset-price inflation the path to wealth, not tangible capital investment. This has brought joy to bank marketing departments as homeowners, consumers, corporate raiders, states and localities run further and further into debt in an attempt to improve their position by debt leveraging. But the economy has all but neglected its industrial base and the employment goes with manufacturing. The Fed’s motto from Bubblemeister Alan Greenspan to Ben Bernanke has been “Asset-price inflation, good; wage and commodity price inflation, bad.”

Obama supports Bernanke and his State of the Union address conspicuously avoided endorsing the Consumer Financial Products Agency that he earlier had claimed would be the centerpiece of financial reform. Wall Street lobbyists have turned him around. Their logic was the same mantra that Connecticut insurance industry’s Sen. Chris Dodd repeated at the confirmation hearings: Bernanke has “saved the economy.”

How can the Fed be said to do this when the volume of debt is growing exponentially beyond the ability to pay? “Saving the debt” by bailing out creditors – by adding bad private-sector debts to the public sector’s balance sheet – is burdening the economy, not saving it. The policy only postpones the crisis while making the ultimate volume of debt that must be written off higher – and therefore more traumatic to write off, annulling a corresponding volume of savings on the other side of the balance sheet (because one party’s savings are another’s debts).

What really is at issue is the economic philosophy that Bernanke will apply during the coming four years. Unfortunately, Bernanke’s questioners failed to ask relevant questions along these policy lines and the economic theory or rationale underlying his basic approach. What needed to be addressed was not just his deregulatory stance in the face of the Bubble Economy and exploding consumer fraud, or even the mistakes he has made. Republican Sen. Jim Bunning elicited only smirks and pained looked as Bernanke rested his chin on his hand, as if to say, “I’m going to be patient and let you rant.” The other Senators were almost apologetic.

One popular (and thoroughly misleading) description of Bernanke that has been cited ad nauseam to promote his reappointment is that he is an expert on the causes of the Great Depression. If you are going to create a new crash, it certainly helps to understand the last one. But economic historians who have compared Bernanke’s writings to actual history have found that it is precisely his misunderstanding of the Depression that is leading him to repeat it.

As a trickle-down apologist for high finance, Prof. Bernanke has drawn systematically wrong conclusions as to the causes of the Great Depression. The ideological prejudice behind his view is of course what got him his job in the first place, for as numerous observers have quipped, a precondition for being hired as Fed Chairman is that one does not understand how the financial system actually works. Instead of recognizing that deepening debt, low wages and the siphoning up of wealth to the top of the economic pyramid were primary causes of the Depression, Prof. Bernanke attributes the main problem simply to a lack of liquidity, causing low prices.

As my Australian colleague Steve Keen recently has written in his Debtwatch No.4, the case against Bernanke should focus on his neoclassical approach that misses the fact that money is debt. He sees the financial problem as being too low a price level for assets to be collateralized for bank loans. And to Bernanke, “wealth” is synonymous with what banks will lend, under existing credit terms.

In 1933, the economist Irving Fischer wrote a classic article, “The Debt-Deflation Theory of the Great Depression,” recanting the neoclassical view that had led him to lose his personal fortune in the 1929 stock market crash. He explained how the inability to pay debts was forcing bankruptcies, wiping out bank credit and spending power, shrinking markets and hence the incentive to invest and employ labor.

Bernanke rejects this idea, or at least the travesty he paraphrases in his Essays on the Great Depression (Princeton, 2000, p. 24), as Prof. Keen quotes:

“Fisher’ s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.”

All that a debt overhead does is transfer purchasing power from debtors to creditors. Bernanke is reminiscent here of Thomas Robert Malthus, whose Principles of Political Economy argued that landlords (Malthus’s own class) were necessary to maintain economic equilibrium in a way akin to trickle-down theorists through the ages. Where would English employment be, Malthus argued, without landlords spending their revenue on coachmen, fine clothes, butlers and servants? It was landlords spending their rental income (protected by England’s agricultural tariffs, the Corn Laws, until 1846) that kept buggy-makers and other suppliers working. And by the same logic, this is what wealthy Wall Street financiers do today with the money they make by lending to enable homeowners and savers to get rich making capital gains off asset-price inflation.

The reality is that wealthy Wall Street financiers who make multi-million dollar salaries and bonuses spend their money on trophies: fine arts, luxury apartments or houses in gated communities, yachts, fancy handbags and high fashion, birthday parties. (“I see the yachts of the stock brokers; but where are those of their clients?”) This is not the kind of spending that reflects the “real” economy’s production profile.

Bernanke sees no problem, unless rich people spend less of their gains on consumer goods and the products of labor than average wage earners. But of course this propensity to consume is precisely the point John Maynard Keynes made in his General Theory (1936). The wealthier people become, the lower a proportion of their income they consume – and the more they save.

This falling propensity to consume is what worried Keynes about the future. He imagined that as economies saved more as their income levels rose, they would spend less on goods and services. So output and employment would not be able to keep pace – unless the government stepped in to make up the gap.

Consumer spending is indeed falling, but not because economies are experiencing a higher net saving rate. The U.S. saving rate has fallen to zero – because despite the fact that gross savings remain high (about 18 percent), most is lent out to become other peoples’ debts. The effect is thus a wash on an economy-wide basis. (18 percent saving less 18 percent debt = zero net saving.)

The problem is that workers and consumers have gone deeper and deeper into debt, saving less and less. This is just the opposite of what Keynes forecast. Only the wealthiest 10 percent or so of the population save more and more – mainly in the form of loans to the “bottom 90 percent.” Saving less, however, goes hand in hand with consuming less, because of the revenue that the financial sector drains out of the “real” economy’s circular flow (wage-earners spending their income to buy the goods they produce) as debt service. The financial sector is wrapped around the production-and-consumption economy. So an inability to consume is part and parcel of the debt problem. The basis of monetary policy throughout the world today therefore should be how to save economies from shrinking as a result of their exponentially growing debt overhead.

Bernanke’s apologetics for finance capital: Economies seem to need more debt, not less

Bernanke finds “declines in aggregate demand” to be the dominant factor in the Great Depression (p. ix, as cited by Steve Keen). This is true in any economic downturn. In his reading, however, debt seems not to have anything to do with falling spending on what labor produces. Taking a banker’s-eye view, he finds the most serious problem to be the demand for stocks and real estate. Bernanke promises not to let falling asset demand (and hence, falling asset prices) happen again. His antidote is to flood the economy with credit as he is now doing, emulating Alan Greenspan’s Bubble policy.

The wealthiest 10 percent of the population do indeed save most of their money. They lend savings – and create new credit – to the bottom 90 per cent, or gamble in derivatives or other zero-sum activities in which their gain (if indeed they make any) finds its counterpart in some other parties’ loss. The system is kept going not by government spending, Keynesian-style, but by new credit creation. That supports consumption, and indeed, lending against real estate, stocks and bonds enables borrowers to bid up their prices, enabling their owners to borrow yet more against these assets. The economy expands – until current revenue no longer covers the debt’s carrying charges.

That’s what brings the Bubble Economy down with a crash. Asset-price inflation gives way to crashing prices and negative equity for real estate and for much financial debt leveraging as well. It is in this sense that Prof. Bernanke’s blames the Depression on lower prices. When prices for real estate or other collateral plunge, it no longer can be pledged for more loans to keep the circular flow of lending and debt repayment in motion.
This circular financial flow is quite different from the circular flow that Keynes (and Say’s Law) discussed – the circulation where workers and their employers spent their wages and profits on consumer goods and investment goods. The financial circular flow is between the banks and their clients. And this circular flow swells as it diverts more and more spending from the “real” economy’s circular flow between income and spending. Finance capital expands relative to industrial capital.

Higher prices in the “real” economy may help maintain the circular financial flow, by giving borrowers more current income to pay their mortgages, student loans and other debts. Bernanke accordingly sees FDR’s devaluation of the dollar as helping reflate prices.

Today, however, a declining dollar would make imports (including raw materials as well as key consumer goods) more costly. This would squeeze the budgets of most families, given America’s rising import dependency as its economy is post-industrialized and financialized. So Bernanke’s favored policy is to get banks lending again – not for the government to spend more on deficit spending on infrastructure, social services or other full employment projects. The government spending that Bernanke has endorsed is pure bailouts to the banks, insurance companies, real estate packagers and other Wall Street institutions so that they can support asset prices and thereby save the economy’s financial balance sheet, not its employment and living standards.

More debt thus is not the problem, in Chairman Bernanke’s view. It is the solution. This is what makes his re-appointment so dangerous.
Devaluation of the dollar FDR-style will make U.S. real estate, corporations and other assets cheaper to global investors. It thus will have the same “positive” effects (if you can call making homes and office buildings more costly to buyers a “positive” effect) as more credit – and without the debt service needing to be raked off from the economy. This policy is akin to the International Monetary Fund’s “stabilization” and austerity programs that have caused such havoc over the past few decades. It is the policy being prepared for imposition on the United States. This too is what makes Bernanke’s re-appointment so dangerous.

The problem is a combination of Bernanke’s dangerous misreading of economic history, and the banker’s-eye perspective that underlies this view – which he now has been empowered to impose from his perch as central planner at the Federal Reserve Board. Pres. Obama’s support for his reappointment suggests that the recent economic rhetoric heard from the White House is a faux populism. The President promises that this time, it will be different. The former Bush appointees – Geithner, Bernanke and the Goldman Sachs managers on loan to the Treasury – will be willing to stand up to Goldman Sachs and the other bankers. And this time the Clinton-era Rubinomics boys will not do to the U.S. economy what they did to the Soviet Union.

With this stance, it is no wonder that the Obama Democrats are relinquishing the populist anti-Wall Street card to the Republicans!

The Bernanke albatross

Bernanke misses the problem that debts need to be repaid – or at least carried. This debt service deflates the non-financial “real” economy. But the Fed’s analysis stops just before the crash. It is a “good news” theory limited to the happy time while the bubble is expanding and homeowners borrow more and more from the banks to buy houses (or more accurately, their land sites) that are rising in price. This was the Greenspan-Bernanke bubble in a nutshell.

We need not look as far back as the Great Depression. Japan since 1990 is a good example. Its land prices declined every quarter for over 15 years after its bubble burst. The Bank of Japan did what the Federal Reserve is doing now: It lowered lending rates to banks below 1 per cent. Banks “earned their way out of debt” by lending to global speculators who used the yen loans to convert into foreign currency and buy higher-yielding assets abroad – capped by Icelandic government bonds paying 15 per cent, and pocketing the arbitrage difference.

This steady conversion of speculative money out of yen into foreign currency held down Japan’s exchange rate, helping its exporters. Likewise today, the Fed’s low-interest policy leads U.S. banks to borrow from it and lend to arbitrageurs buying higher-yielding bonds or other securities denominated in euros, sterling and other currencies.

The foreign-exchange problem develops when these loans are paid back. In Japan’s case, when global financial markets turned down and Japanese interest rates began to rise in 2008, arbitrageurs decided to unwind their positions. To pay back the yen they had borrowed from Japanese banks, they sold euro- and dollar-denominated bonds and bought the Japanese currency. This forced up the yen’s exchange rate – eroding its export competitiveness and throwing its economy into turmoil. The long-ruling Liberal Democratic Party was voted out of power as unemployment spread.

In the U.S. case today, Chairman Bernanke’s low interest-rate regime at the Fed has spurred a dollar-denominated carry trade estimated at $1.5 trillion. Speculators borrow low-interest dollars and buy high-interest foreign-currency bonds. This weakens the dollar’s exchange rate against foreign currencies (whose central banks are administering higher interest rates). The weakening dollar leads U.S. money managers to send more investment funds out of our economy to those promising stock market gains as well as a foreign-currency gain.

The prospect of undoing this credit creation threatens to lock the United States into a low-interest trap. The problem is that if and when the Fed begins to raise interest rates (for instance, to slow the new bubble that Bernanke is trying to inflate), global speculators will repay their dollar debts. As the U.S. carry trade is unwound, the dollar will soar in price. This threatens to make Obama’s promise to double U.S. exports within five years seem an impossible dream.

The prospect is for U.S. consumers to be hit by a triple whammy. They must pay higher prices for the goods they buy as the dollar declines, making imports more expensive. And the government will be spending less on the economy’s circular flow as a result of Pres. Obama’s three-year spending freeze to slow the budget deficits. Meanwhile, states and cities are raising taxes to balance their own budgets as tax receipts fall. Consumers and indeed the entire economy must run more deeply into debt simply to break even (or else see living standards eroded).

To Bernanke, economic recovery requires resuscitating the Goldman Sachs squid, duly protected by the Fed. The banks will lend more to keep the debt pyramid growing to enable consumers, businesses and local government to avoid contraction.

All this will enrich the banks – as long as the debts can be paid. And if they can’t be paid, will the government bail them out all over again? Or will it “be different” this time around?

Will our economy flounder with Bernanke’s reappointment as the rich get richer and the American family comes under increasing financial pressure as incomes drop while debts grow exponentially? Or will Americans get rich off the new bubble as the Fed re-inflates asset prices?

The Road to Debt Peonage

Last week, Senator John Kerry of Massachusetts acknowledged many Americans’ anger about the bailouts of the big banks: “It’s understandable why there is debate, questioning and even anger” about Bernanke’s re-nomination. “Still,” he added, “out of this near calamity, I believe Chairman Bernanke provided leadership that was urgent, nimble, strong and vital in staving off greater disaster.”

Unfortunately, by “disaster” Sen. Kerry seems to mean losses for Wall Street. He shares with Chairman Bernanke the idea that gains in raising asset prices are good for the economy – for instance, by enabling pension funds to pay retirees and “build wealth” for America’s savers.

While the Bush-Obama team hopes to reflate the economy, the $13 trillion bailout money they have spent trying to fuel the destructive bubble takes the form of trickle-down economics. It has not run up public debt in the Keynesian way, by government spending such as in the modest “Stimulus” package to increase employment and income. And it is not providing better public services. It was designed simply to inflate asset prices – or more accurately, to prevent their decline.

This is what re-appointment of the Fed Chairman signifies. It means a policy intended to raise the price of housing on credit, with a corresponding rise in consumer income paid to bankers as mortgage debt service.

Meanwhile, rising stock and bond prices will increase the price of buying a retirement income. A higher stock price means a lower dividend yield. The same is true for bonds. Flooding the capital markets with credit to bid up asset prices thus holds down the yield of the assets of pension funds, pushing them into deficit. This enables corporate managers to threaten bankruptcy of their pension plans or entire companies, General Motors-style, if labor unions do not renegotiate their pension contracts downward. This “frees” yet more money for financial managers to pay creditors at the top of the economic pyramid.

How does one overcome this financial polarization? The seemingly obvious solution is to select Fed and Treasury administrators from outside the ranks of ideologues supported by – indeed, applauded by – Wall Street. Creation of a Consumer Financial Products Agency, for instance, would be largely meaningless if a deregulator such as Bernanke were to run it. But that is precisely what he is asking to do in testifying that his Federal Reserve should be the sole regulatory agency, nullifying the efforts of all others – just in case some state agency, some federal agency or some Congressional committee might move to protect consumers against fraudulent lending, extortionate fees and penalties and usurious interest rates.

Bernanke’s fight against proposals for such regulatory agencies to protect consumers from predatory lending is thus a second reason not to re-appoint him. How can Obama campaign for his reappointment as Chairmanship of the Fed and at the same time endorse the consumer protection agency? Without dumping Bernanke and Geithner, it doesn’t seem to matter what the law says. The Democrats have learned from the Bush and Reagan administrations that all you have to do is appoint deregulators in key positions, and legal teeth are irrelevant.

Independence of the Federal Reserve is a euphemism for financial oligarchy

This brings up the third premise that defenders of Bernanke cite: the much vaunted independence of the Federal Reserve. This is supposed to be safeguarding democracy. But the Fed should be subject to representative democracy, not independent of it! It rightly should be part of the Treasury representing the national interest rather than that of Wall Street.

This has emerged as a major problem within America’s two-party political system. Like the Republican team, the Obama administration also puts financial interests first, on the premise that wealth flows from its credit activities, the financial time frame tends to be short-run and economically corrosive. It supports growth in the debt overhead at the expense of the “real” economy, thereby taking an anti-labor, anti-consumer, anti-debtor policy stance.

Why on earth should the most important sector of modern economies – finance – be independent from the electoral process?

Over and above the independence issue, to be sure, is the problem that the government itself is being taken over by the financial sector. The Treasury Secretary, Fed Chairman and other financial administrators are subject to Wall Street’s advice and consent first and foremost. Lobbying power makes it difficult to defend the public interest, as we have seen from the tenure of Paulson and Geithner. I don’t believe Obama or the Democrats (to say nothing of the Republicans) is anywhere near rising to the occasion of solving this problem.

Allied to the “independence” issue is a fourth reason to reject Bernanke personally: the Fed’s secrecy from Congressional oversight, highlighted by its refusal to release the names of the recipients of tens of billions of Fed bailouts and cash-for-trash swaps.

Does it matter?

Now that the confirmation arguments against Bernanke’s reappointment have been rejected, what does it mean for the future?

On the political front, his reappointment is being cited as yet another proof that the Democrats care more for bankers than for American families and employees. As a result, it will do what seemed unfathomable a year ago: enable GOP candidates to strike the pose of FDR-type saviors of the embattled middle class. No doubt another decade of abject GOP economic failure would simply make the corporate Democrats appear once again to be the alternative. And so it goes … unless we do something about it.

The problem is not merely that Bernanke failed to do what the Fed’s charter directs it to do: promote employment in an environment of stable prices. The Republicans – and some Democrats – read out the litany of Bernanke abuses. The Fed could have raised interest rates to slow the bubble. It didn’t. It could have stopped wholesale mortgage fraud. It didn’t. It could have protected consumers by limiting credit card rates. It didn’t.

For Bernanke, the current financial system (or more to the point, the debt overhead) is to be saved so that the redistribution of wealth upward will continue. The Congressional Research Service has calculated that from 1979 to 2003 the income from wealth (rent, dividends, interest and capital gains) for the top 1 percent of the population soared from 37.8 per cent to 57.5 per cent. This revenue has been expropriated from American employees pushed onto debt treadmills in the face of stagnating wages.

Meanwhile, the government is permitting corporate tollbooth to be erected across our economy – and un-taxing this revenue so that it can be capitalized into financialized wealth paying only a 15 per cent tax rate on capital gains. It pays these taxes not as these gains accrue, but and only when they realize them. And the tax does not even have to be paid if the sales proceeds of these assets is reinvested! Financial and fiscal policy thus reinforce each other in a way that polarizes the economy between the financial sector and the “real” economy.

Michael Hudson is a former Wall Street economist.
http://www.counterpunch.org/hudson02022010.html

Wall Street Moves in for the Kill
By MICHAEL HUDSON
February 17, 2010

Former Treasury Secretary Hank Paulson wrote an op-ed in The New York Times yesterday, February 16 outlining how to put the U.S. economy on rations. Not in those words, of course. Just the opposite: If the government hadn’t bailed out Wall Street’s bad loans, he claims, “unemployment could have exceeded the 25 per cent level of the Great Depression.” Without wealth at the top, there would be nothing to trickle down.

The reality, of course, is that bailing out casino capitalist speculators on the winning side of A.I.G.’s debt swaps and CDO derivatives didn’t save a single job. It certainly hasn’t lowered the economy’s debt overhead. But matters will soon improve, if Congress will dispel the present cloud of “uncertainty” as to whether any agency less friendly than the Federal Reserve might regulate the banks.

Paulson spelled out in step-by-step detail the strategy of “doing God’s work,” as his Goldman Sachs colleague Larry Blankfein sanctimoniously explained Adam Smith’s invisible hand. Now that pro-financial free-market doctrine is achieving the status of religion, I wonder whether this proposal violates the separation of church and state. Neoliberal economics may be a travesty of religion, but it is the closest thing to a Church that Americans have these days, replete with its Inquisition operating out of the universities of Chicago, Harvard and Columbia.

If the salvation is to give Wall Street a free hand, anathema is the proposed Consumer Financial Protection Agency intended to deter predatory behavior by mortgage lenders and credit-card issuers. The same day that Paulson’s op-ed appeared, the Financial Times published a report explaining that “Republicans say they are unconvinced that any regulator can even define systemic risk. … the whole concept is too vague for an immediate introduction of sweeping powers. …” Republican Senator Bob Corker from Tennessee was willing to join with the Democrats “to ensure ‘there is not some new roaming regulator out there … putting companies unbeknownst to them under its regime.”

Paulson uses the same argument: Because the instability extends not just to the banks but also to Fannie Mae and Freddie Mac, Lehman Brothers, A.I.G. and Wall Street underwriters, it would be folly to try to regulate the banks alone! And because the financial sector is so far-flung and complex, it is best to leave everything deregulated. Indeed, there simply is no time to discuss what kind of regulation is appropriate, except for the Fed’s familiar protective hand: “delays are creating uncertainty, undermining the ability of financial institutions to increase lending to businesses of all sizes that want to invest and fuel our recovery.” So Paulson’s crocodile tears are all for the people. (Except that the banks are not lending at home, but are shoveling money out of the U.S. economy as fast as they can.)

As Obama’s chief of staff Rahm Emanuel put it, a crisis is too good a thing to waste. Having created the crisis, Wall Street wants to use its momentum to knock out any potential checks to its power. “No systemic risk regulator, no matter how powerful, can be relied on to see everything and prevent future problems,” Paulson explained. “That’s why our regulatory system must reinforce the responsibility of lenders, investors, borrowers and all market participants to analyze risk and make informed decisions,” In other words, blame the victims! The way to protect victims of predatory bank lending (and crooked sales of junk securities) is not new regulations but just the opposite: “to simplify the patchwork quilt of regulatory agencies and improve transparency so that consumers and investors can punish excesses through their own informed investing decisions.” Simplification means the Fed, not a Consumer Financial Protection Agency.

Moving in for the kill, Paulson explains that the Treasury is bare, having used $13 trillion to bail out high finance in 2008-09. So he warns the government not to run a Keynesian-type budget deficit. The federal budget should move into balance or even surplus, even if this accelerates the rise in unemployment and decline in wage levels as the economy moves deeper into recession and debt deflation. “We must also tackle what is by far our greatest economic challenge — the reduction of budget deficits — a big part of which will involve reforming our major entitlement programs: Medicare, Medicaid and Social Security.” The economy thus is to be sacrificed to Wall Street rather than reforming finance so that it serves the economy more productively. It is simple mathematics to see that if the government cannot raise taxes, it must scale back Social Security, other social welfare spending and infrastructure spending.

What is remarkably left out of account is that today’s financial crisis, centered on public debts, is largely a fiscal crisis in character. It is caused by replacing progressive taxation with regressive taxes, and above all by untaxing finance and real estate. Take the case of California, where tears are being shed over the dismantling of the once elite University of California system. Since American independence, education has been financed by the property tax. But Proposition 13 has “freed” property from taxation – so that its rental value can be borrowed against and turned into interest payments to banks. California’s real estate costs are just as high with its property taxes frozen, but the rising rental value of land has been paid to the banks – forcing the state to slash its fiscal budget or else raise taxes on labor and consumers.

The link between financial and fiscal crisis – and hence the need for a symbiotic fiscal-financial reform – is just as clear in Europe. The Greek government has pre-sold its tax revenues from roads and other infrastructure to Wall Street, leaving less future revenue to pay its public debt. To cap matters, paying income tax is almost voluntary for wealthy Greeks. Tax evasion is hardly necessary in the post-Soviet states, where property is hardly taxed at all. (The flat tax falls almost entirely on labor.)

Throughout the world, scaling back the 20th century’s legacy of progressive taxation and untaxing real estate and finance has led to a public debt crisis. Property income hitherto paid to governments is now paid to the banks. And although Wall Street has extracted $13 trillion in bailouts just since October 2008, the thought of raising taxes on wealth to pay just $1 trillion over an entire decade for Social Security or health insurance is deemed a crisis that would lead Wall Street to shut down the economy. It is telling governments to shift to a regressive tax system to make up the fiscal shortfall by raising taxes on labor and cutting back public spending on the economy at large. This is what is plunging economies from California to Greece and the Baltics into fiscal and financial crisis. Wall Street’s solution – to balance the budget by cutting back the government’s social contract and deregulating finance all the more – will shrink the economy and make the budget deficits even more severe.

Financial speculators no doubt will clean up on the turmoil.

Michael Hudson is a former Wall Street economist.
http://www.counterpunch.org/hudson02172010.html

These guys seem to be keeping an archive of Hudson's work at their blog.

Michael Hudson On Dandelion Salad
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