OurFuture.org Blogs: Dean Baker2

Pecora Commission II: Super-Sleuths or Keystone Cops?

Dean Baker2 — Wed, 01 Jul 2009 07:42:29 -0700

Congress will be appointing a special commission to investigate the causes of the economic crisis and to determine who is to blame. This proposal originated among progressives who wanted to see a replay of the depression era Pecora Commission, which exposed the Wall Street corruption that laid the basis for the 1929 stock market crash and the depression that followed.

At the very least, a similar exposure of the greedheads at Goldman Sachs, Citigroup, and the rest could provide an element of justice to this disaster and possibly lay the basis for criminal prosecutions of the worst offenders. Undoubtedly there are many multi-millionaires at these institutions who would make far more appropriate prisoners than some of the 2 million current guests of our criminal justice system.

Unfortunately, there is a real possibility that the commission appointed by Congress may follow a different precedent. Instead of striving to uncover the truth, it may seek to conceal it.

There is precedent for this of cover-up commission. The Iran-Contra Committee that Congress appointed in 1987 strove to conceal fundamental and deliberate violations of the law. Congress had explicitly prohibited the use of government money to support the Contras who were fighting to overthrow the Nicaraguan government.

There was not much ambiguity about the Boland Amendment, the law that prohibited funding. This was deliberate, because President Reagan had in the past skirted Congressional intent on this issue.

Nonetheless, President Reagan supported a special operation in which the U.S. government made a profit selling weapons to the mullahs in Iran (President Amadinejad’s intellectual predecessors) and then used the profits to fund the Contras. The whole operation was concealed from Congress until it was exposed by an independent Lebanese newspaper in the fall of 1986.

Both sides of this operation prompted outrage. On the one-hand, President Reagan was giving weapons to the hardest line elements in Iran. This was not consistent with our efforts to isolate the regime, which included a near complete trade embargo. On the other side, he was secretly giving U.S. taxpayer dollars to the Contras, in direct violation of the law.

This is the sort of activity for which presidents are supposed to be impeached and people are supposed to do long stints of jail time. But that’s not the way the Iran-Contra Committee saw it. They put on lengthy and boring hearings that quickly buried the public in obscure details that had nothing to do with the simple facts: the President sent taxpayer dollars to the Contras in direct violation of the law.

Not only did the committee confuse the public (or at least the media), it also undermined efforts to bring the Iran-Contra criminals to justice. Going against the wishes of Lawrence Walsh, the special prosecutor appointed to deal with the case, the committee gave most of the key figures immunity for their public testimony. While Walsh had sealed the material used for the prosecution case prior to any public testimony, the courts subsequently ruled that because other witnesses’ court testimony may have been affected by the immunized testimony before Congress, the Iran-Contra defendants were effectively immune from prosecution.

In effect, the committee both concealed the real issues from the public and protected the defendants from criminal prosecution. That’s not a victory for justice.

The basic story of the current crisis is very simple. We had an $8 trillion housing bubble as house prices had hugely diverged from fundamentals in a way that had never happened before. The bubble was fueled by loans that were virtually guaranteed to go bad once house prices stopped rising. The banks that issued the loans didn’t care because they sold them in the secondary market. By the time the loans went bad, they had already cashed out their stake.

The investment banks that securitized the loans didn’t care because they sold their (investment grade) junk all over the world. The executives running the operations pocketed tens of millions before the music stopped and the bubble burst.

So, what questions does the commission have to ask? How about putting all the 7 and 8 figure executives under oath and ask them if they were really too dumb to see an $8 trillion housing bubble. For a follow-up, the commission can ask them what exactly they do to earn those multi-million dollar paychecks. Those questions should make for some very informative testimony.

Unfortunately, it is more likely that the commission will get buried in obscure details of collaterized debt obligations and credit default swaps. That would be a serious distraction from the real story and a waste of the taxpayers’ money.

Budget Deficits and Blow Up Dolls: It’s the Economy Stupid!

Dean Baker2 — Wed, 25 Mar 2009 13:59:21 -0700

In the movie Lars and the Real Girl, the main character imagines that a female blow-up doll is his fiancé. To humor Lars, his brother and sister-in-law go along with the charade. Over the course of the movie, more people are drawn into the circle, until eventually the whole town is treating Bianca the blow-up doll as one of its leading citizens.

This seems to pretty well describe the debate over the budget deficit, except it’s not clear that many people realize it’s a charade. The main story is that Lars’ budget hawk counterparts are upset that the deficits projected for 2013 or 2019 are too large. They want President Obama to commit to spending cuts and/or tax increases in order to bring these deficits to levels they consider acceptable.

The unreality of this picture is striking because the budget hawks seem not to notice that we are in the middle of an economic meltdown. People are losing their homes through foreclosures at the rate of more than 100,000 a month. The default rates on credit cards, car loans and other debt is at record levels. Most of our major banks are effectively insolvent.

Home and stock prices have plummeted, destroying most of the wealth of the baby boom cohort as they stand on the edge of retirement. The economy is shedding almost 700,000 jobs a month, with the unemployment rate rapidly approaching the highest level since the Great Depression.

In this context we are supposed to be up in arms over the deficit projections for 2013 or 2019? This is a bit like someone complaining about the lawn not being mowed at a time when the house is on fire, it’s just not the first priority. And the media all seem to go along with the charade – yes, they are very concerned about the projected deficit for 2013, just as the characters in the movie expressed concern about the health of Bianca the blow-up doll.

It is especially annoying to hear the whining from this group of deficit hawks since their whining in prior years helped to drown out serious discussion of the dangers posed by an $8 trillion housing bubble. While some of us were yelling at the top of our lungs about the imminent disaster that would hit the economy when the housing bubble burst, the media chose to focus on these deficit hawks with their dire warnings about budget deficits 40 or 50 years in the future.

Because the media and political elites chose to pay more attention to the deficit hawks than those warning about the housing bubble, we now get to enjoy the current economic crisis. And, one result of the economic crisis is (drum roll, please) ……..record deficits.

To put the point so simply that even a Washington Post editor can understand it: because the media highlighted the views of the people who were ranting about the deficit rather than the views of people who understood the economy, we both got a wrecked economy and larger deficits.

The moral to this story is that the economy must take priority, not only because the state of the economy is what most directly determines people’s well-being, but also because the state of the economy will be the most important determinant of the deficit.

The experience of the 1990s provides an example of exactly this sort of story. In January of 1994 the Congressional Budget Office projected that the deficit in 1999 would be $204 billion or 2.4 percent of GDP. This projection incorporated the impact of President Clinton’s tax increase and spending cuts.

It turned out that there was a surplus of $125 billion in 1999, or 1.4 percent of GDP. This shift from deficit to surplus of 3.8 percentage points of GDP (equivalent to $540 billion in 2009) was not caused by further spending cuts or tax increases, it was caused by the strong economic growth of the period.

There is no guarantee that President Obama’s policies will be successful in restoring strong growth, but they are clearly a step in the right direction. If we have strong growth, then our deficits will be manageable. If the economy remains weak, the deficit will remain a serious burden no matter how much we raise taxes or cut spending.

Someone has to tell the deficit hawks that their blow-up doll is not real. The issue is the economy, not the deficit.

Big Banks Go Bust: Time to Reform Wall Street

Dean Baker2 — Mon, 15 Sep 2008 08:45:45 -0700

With the demise of Fannie Mae, Freddie Mac, IndyMac, Bear Stearns and now Lehman Brothers, we’ve been treated to the failure of more major financial firms than during any year since the Great Depression. The sight of rich bankers getting the boot might be lots of fun if it were just a spectator sport. Unfortunately, we are in the game with these clowns.

As a result of their incompetence, irresponsibility and greed, the housing bubble was allowed to grow to dangerous proportions. Its collapse threw the economy into recession, putting millions of people out of work and lowering the wages of those who still have their jobs. The plunge in house prices has destroyed much of the life savings for tens of millions of people nearing retirement.

Meanwhile, the bankers who messed up and destroyed the companies who hired them are still multimillionaires. Most of them are still in their old jobs getting multimillion-dollar pay packages. This is a sector that badly cries out for reform and there is no better time than now to put it into place.

The first target for reform should be the outrageous salaries drawn by the top executives at financial firms. The crew that lost tens of billions at Citigroup, Merrill Lynch and the rest have received tens of millions, possibly even hundreds of millions, in compensation for their “work” over the last few years.

There is a general problem in corporate America of stockholders being unable to effectively organize to rein in top management. This problem is most serious in the financial industry.

Thankfully, the credit crisis gives us the tools we need to rein in executive pay. Currently, the major surviving investment banks (e.g. Merrill Lynch, Morgan Stanley, Goldman Sachs) are operating on life support. They are drawing money at below market interest rates from the Federal Reserve Board’s discount window. This privilege (for which they pay nothing) can easily be worth billions of dollars a year.

These banks are also operating with an explicit guarantee from Fed Chairman Ben Bernanke to their creditors that he will honor their loans in the event that an investment bank, like Bear Stearns, goes belly up. This guarantee is enormously valuable. Investors who make loans to Merrill Lynch or Morgan Stanley don’t have to worry about the health of these companies because Bernanke has said that, if necessary, he will use public money to pay them back.

While we don’t want a chain reaction of banking collapses on Wall Street, the public should get something in exchange for Bernanke’s generosity. Specifically, he can demand a cap on executive compensation (all compensation) of $2 million a year, in exchange for getting bailed out. For any bank that is not on board, Bernanke could make an explicit promise to their creditors – if the bank goes under, you will get zero from the Fed.

This can be an effective way to restore sanity to the salaries paid on Wall Street. And, this can be a good example for setting executive pay more generally. Any time a company comes to the public for a handout, like tax breaks for oil companies or low-interest loans for auto companies, the $2 million cap on all compensation goes into effect.

This is important directly because much of the country’s wealth has been steered into these folks’ pockets, but also because the outrageous compensation packages on Wall Street distorted pay structures throughout the economy. Presidents of universities often get over $1 million a year, and even top executives at private charities can often earn near $1 million a year. These salaries seem low when compared to their counterparts in the corporate world, but they are outrageous when compared to the pay checks of typical workers.

Of course we must go further in fixing the financial sector—most importantly by downsizing it. The financial sector accounted for more than 30 percent of corporate profits in 2004. Back in the 1950s and 1960s, the country’s period of most rapid growth, the financial sector accounted for less than 10 percent of corporate profit.

The financial sector performs an incredibly important function in allocating savings to those who want to invest in businesses, buy homes, or borrow money for other purposes. But shuffling money is not an end in itself. The explosion of the financial sector over the last three decades has led to a proliferation of complex financial instruments, many of which are not even understood by the companies who sell them, as we have painfully discovered.

The best way to bring the sector into line is with a modest financial transactions tax. Such taxes have long existed in other countries. For example, the United Kingdom charges a tax of 0.25 percent on the purchase or sale of share of stock. This is not a big deal to someone who holds their shares for ten years, but it could be a considerable cost for the folks who buy stocks in the morning that they sell in the afternoon.

Comparable taxes on the transfer of all financial instruments (e.g. options, futures, credit default swaps, etc.) could go a long way in reducing speculation and the volume of trading in financial markets. Such a tax could also raise an enormous amount of money—easily more than $100 billion a year. This would go a long way toward funding national health care insurance or a major green infrastructure project.

And, this tax would be hugely progressive. Middle-income shareholders might take a small hit; but it would be comparable to raising the capital gains tax rate back to 20 percent, where it was before it was cut to 15 percent in 2003. The real hit would be on the big speculators and the Wall Street boys, the folks who gave us the housing crisis. Given what the Wall Street crew has done for us, this is change that we can believe in.

The Bubble Boys and the Recession

Dean Baker2 — Fri, 29 Feb 2008 13:41:30 -0800

While the recession is just beginning, it’s not too early to start pointing fingers as to who is responsible. This is not just an exercise in vengeance (although that might be fun); the people who wrecked the economy should be held accountable. We also should be clear about the policies that gave us this mess so we don’t go this route again.

As everyone should know, we are having a recession because the housing bubble burst. This was not an accident or surprise – the housing bubble was clear visible to anyone who cared to look. There was an unprecedented run up in house prices in the decade from 1996 to 2006, which the price of a typical home rising by more than 70 percent after adjusting for inflation. Over the prior hundred years, house prices had just kept even with the overall rate of inflation.

Join Dean Baker, Theresa DiMartino, Al Meyerhoff and Lisa Ransom in a panel at Take Back America 2008 on the housing bubble and a prescription for change.

There was no change in the fundamentals of the supply and demand in the housing market that could possibly explain this sudden surge in prices. Population was growing far less rapidly during this period than it had in prior decades, especially among families in their prime home-buying years. Income growth was healthy in the years from 1996 to 2000, but very weak in the current decade. Clearly no changes on the demand side could explain the run-up in prices.

Similarly, there were no new constraints on the supply-side. Land has always been in limited supply, it did not suddenly become more limited in the mid-nineties. In fact, the growth of the Internet reduced constraints, since it is now possible for many people to do their work from anywhere.

Since there was no explanation for the run-up in house prices based on market fundamentals, then the obvious alternative explanation was that house prices were driven by a speculative bubble, just as speculation drove the stock market to record highs in late 90s. Of course bubbles burst, and when they do, it leads to very unhappy outcomes.

In the case of the stock market, the bursting of its bubble lead to the recession in 2001 and two more years of negative job growth. It also derailed many pension funds, as well as wrecking the retirement plans of millions of families who saw the value of their 401(k)s shrivel.

The story of the collapse of the housing bubble is likely to be even grimmer. The housing bubble created more than $8 trillion of housing bubble wealth, $110,000 for every homeowner. Most, if not all, of this wealth will be eliminated in the crash that is now underway. The result is the recession that we are now seeing, driven first by the collapse of the housing sector and more importantly by the falloff in consumption.

Homeowners had been spending their bubble wealth almost as fast as it was created, pulling money out of their homes through home equity loans or refinancing their mortgages. This massive borrowing drove the savings rate to almost zero. With prices now plunging at double-digit annual rates millions of homeowners no longer have any equity against which to borrow. That means that the music stops and consumption will go into the tank taking the economy with it.

This recession is likely to be painful. The unemployment rate is likely to rise to the highest levels since the early eighties. Millions of people will lose their homes. Tens of millions will see their life’s savings disappear as the money that they thought they had in home equity vanishes in front of their eyes. This will be especially hard for baby boomers at the edge of retirement, many of whom will now be entirely dependent on their Social Security.

The recession is also likely to be long. It’s not easy to recover from a recession brought on by the collapse of a financial bubble. The economy continued to shed jobs for more than two years following the beginning of the stock crash recession in 2001. It was only rescued by the growth of the housing bubble. It is unlikely that the Fed will find another bubble that can pull the economy out of this recession.

The list of villains in this story is long. Obviously the banks and mortgage companies that made predatory loans deserve a special place in hell, but almost all the experts on economic policy (especially those who promoted home ownership) also deserve blame. It is incredible that this crew, after having missed a $10 trillion stock bubble in 90s can miss an $8 trillion housing bubble just a few years later. If the world were fair, every one of them from Alan Greenspan on down would be unemployed for a long time into the future, or at least until they developed useful skills.