Read Part I, The Financial Crisis
(Swans - September 12, 2011) On the occasion of his fiftieth birthday early August, President Obama flew to Chicago on Air Force One, courtesy of the taxpayers. There, before attending a $35,800-a-head fundraising dinner, he told a Democratic audience that regarding the economic recovery, "I have to admit, I didn't know how steep the climb was going to be." Apparently, Mr. Obama and his brain trust have not yet realized that the crisis is not another recurrence of the business cycle -- another recession, even if more severe -- but the culmination of almost 40 years of a steady decline in capitalist profitability and levels of productive investments (the latter being substituted by investments in the nonproductive financial sector). Missing, or ignoring, the real picture, these folks rushed to the drawer where the previous administrations had stowed the playbook to deal with post-WWII business cycles. The book was not a thick tome, not at all. It was a single page, yellowed with age and oiled by the greased fingers of past presidents. It read:
1) Have the Fed lower the interest rate drastically and in short order.
2) Launch a stimulus package by increasing government spending. Be Keynesian.
3) Cut taxes; cut taxes more. It will put money in consumers' pockets, which they will spend. Be Friedmanian. (Don't worry about the contradiction with #2. Just triangulate politically.)
4) Open the credit lines as wide as possible so that people borrow and spend again.
5) Keep unemployment benefits and other programs (e.g., food stamps) high. The money will be spent immediately and social unrest avoided.
6) Keep a happy face. Offer optimism even when warning that bumps on the road may occur. Be positive. Optimism and positivism lead to more borrowing and spending, which will bring the economy back on track.
The federal funds rate was lowered to near zero -- a policy that is decimating savers and retirees -- so that banks would start lending again. In November 2008, the Fed began to buy bank debt and mortgage-backed securities in the hundreds of billions of dollars through Quantitative Easing (or credit easing). Then in February 2009, Congress passed a stimulus package, the American Recovery and Reinvestment Act, estimated at $787 billion, which included $288 billion in tax incentives, the expansion of unemployment benefits, and spending programs for education, infrastructure, health care, energy, fiscal relief for the states, etc.
While Keynesian economists a la Paul Krugman bemoaned the insufficient size of the stimulus (1) it did stabilize the economy that was then in free fall and significantly slowed the bleeding of jobs, until modest and by far insufficient job creation got on the positive side in March 2010. In July 2009, the government bailed out General Motors and Chrysler, and launched a "cash for clunkers" program that stimulated automotive sales (about 690,000 transactions, of which 360,000 were additional cars sold in two months).
All the policies were implemented according to a script that has been used for at least 35 years. The objectives were to have banks -- once made whole -- to lend, and people to borrow in order to consume, so that the economy would grow again. With near-zero Fed rates, housing mortgage rates were bound to go down dramatically, which they did (4.15 percent at this writing; the lowest 30-year fixed mortgage in 50 years). The housing sector is an essential component of the US real economy (in contrast to the financial economy). As Bill McBride, the finance & economics analyst, stated on his indispensable CalculatedRisk Blog, which he launched in 2005 when it became evident that a major economic crisis was in the making and that it would be triggered by a huge housing bubble: "Usually near the end of a recession, residential investment picks up as the Fed lowers interest rates. This leads to job creation and also additional household formation -- and that leads to even more demand for housing units -- and more jobs, and more households -- a virtuous cycle that usually helps the economy recover." Notice his use of the adverb "usually," (2) and notice the correlation between the unemployment rate and housing starts.
Nevertheless, with the strategy in place and confident in its magic potion, the Obama administration turned its attention to the non-reform reform of health care, which electrified the Tea Party movement. The economy grew modestly, allowing the secretary of the Treasury, Timothy Geithner, to celebrate and affirm in a New York Times Op Ed early August 2010 -- "Welcome to the Recovery" -- that the economy was "on a path back to growth" and concluding his PR piece: "We suffered a terrible blow, but we are coming back."
Something, however, did not play out according to plan. Banks that were supposed to lend and consumers to borrow did not. Banks, facing the fallout of the subprime mess, were hoarding cash in order to lower their 25:1 leverage (on average) down to a current and more manageable 16:1 and were disinclined to lend due to the lack of creditworthiness of consumers. The latter, burned out by the huge housing crisis, a high level of personal indebtedness, deep anxieties about the job market, flat wages, and a pessimistic outlook, were staying away from the mall. As Ben Bernanke put it last week, "One striking aspect of the recovery is the unusual weakness in household spending." With no lenders and no borrowers, the economy was not gathering much steam. This led the Fed to embark on a second round of Quantitative Easing ($600 billion) -- to little effect.
Following the November 2010 Republican sweep of the House, the administration was left with few options. In exchange for renewing unemployment benefits for another year, the administration relented to the Republican demand of extending the Bush tax cuts, which, leaving the situation as it was, had no benefit for the economy. Furthermore, payroll taxes paid by employees were lowered by 2 percentage points, from 6.5 to 4.5 percent. The rationale behind that fiscal choice was that consumers, having more money in their pockets, would drive to the mall, thus increasing demand, which would spur productive capacities and lead to the hiring of more workers. This, however, did not happen, for this payroll tax cut was largely offset by the increase in the prices of foodstuff and energy.
By January 2011, with the Republicans in solid control of the 112th Congress, the political circus moved to a different spectacle with a new narrative of spending cuts and austerity programs -- the kind of policies that are being so devastating to countries like Greece, Portugal, Spain, Ireland, and even the UK. In early spring the silly debt ceiling debate began in earnest, heightening the anxiety level of both businesses and consumers. The economy stalled, growing at a snail's pace, which has had immediate negative effects on employment (e.g. +20,000 in June, +85,000 in July, flat in August). This alarming situation prompted the Obama administration to ask Congress to pass a new $447 billion jobs bill, the American Jobs Act, on September 8, 2011. Unsurprisingly, tax cuts are a preponderant part of the bill ($250 billion), most of which occur through cutting payroll taxes in half for both employees and 98 percent of businesses on their first $5 million in payroll. (3) The remaining extends unemployment insurance benefits ($49 billion), aid to states for schools and teachers ($60 billion), infrastructure projects ($75 billion), and various others. What's missing from the bill, beside tax increases on the wealthy, is help to the housing sector, except for a plan to allow homeowners to refinance their mortgages.
Somehow, that's where the shoe rubs. Mr. Bush and Mr. Obama attended to the well being of Wall Street but never addressed in any serious way the crisis on Main Street that was by and large caused by the bursting of the housing bubble. Homeowners have been left to fend for themselves as they lost over $8 trillion in equity (4) while being burdened by personal debt. Not at any time did both administrations focus on the real problems beleaguering American workers. Their approach may have been according to script -- let banks lend more and consumers borrow -- but they constantly missed the scope of the crisis. They have failed to grasp that this crisis was not the usual business cycle, which could be solved with the panoply of orthodox policies, but the culmination of a crisis that began in the 1970s and never abated. They also failed to take the opportunity to change the structural and sociological paradigm. So the chickens are now coming back to roost in a hurry with full adversarial strength.
Not only are these people malevolent, they are indeed clueless.
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Gilles d'Aymery on Swans -- with bio. He is Swans' publisher and co-editor. (back)
Notes
1. What Krugman et al. are missing is that a) the Obama administration could not have gotten a larger stimulus package due to political realities, and b) the same Keynesians who point to the FDR era and deficit spending in order to redress the economy, forget that in the 1930s the U.S. had no debt and could go into deficit spending in abandon (which FDR unfortunately did not do in 1937). Today, the U.S. runs a $14 trillion-plus burden. One should take note of how the national debt has grown in the past 30-some years. Before 1981, the national debt was just about 7 percent. Under Reagan, it increased by over 13 percent. George H.W. Bush brought another 10.5 percent; Clinton, 9.8 percent; George W. Bush, a whopping 42.7 percent; and Obama, to date, is adding another 17 percent. (See this telling graphic, "Amount of debt accumulated by US presidents," Der Spieglel, August 15, 2011.) (back)
2. McBride adds: "However this time, with the huge overhang of existing housing units, this key sector hasn't been participating." In November 2006, McBride noted that "the recent sharp drop in sales is even worse than the decrease at the start of the 1990s housing bust. October sales have fallen back to the 2002 levels." He added: "One of the most reliable economic leading indicators is New Home Sales. New Home sales were falling prior to every recession of the last 35 years, with the exception of the business investment led recession of 2001. This should raise concerns about a possible consumer led recession in the months ahead." (back)
3. Note that payroll taxes are used to finance Social Security, which is being attacked by Republicans...for lack of funding. (back)
4. Our house in Boonville, bought in the fall of 2003, has lost over 25 percent of the price we paid. Actually, since there is no buyer, it's hard to know the real monetary value of the place. A year later, we were either prescient or just lucky to sell our house in the San Francisco Bay Area. The buyers, however, were neither prescient nor lucky. They took a second mortgage to make improvements and eventually defaulted and were forced to sell the place through a short sale, losing over 40 percent of their initial investment. (back)