Politics and Social Justice Archive

Don't Blame Bernanke

Monday, August 13th, 2012

Let's not expect central bankers to bail out the continuing economic mess. That's not who they are, and cheap money can only do so much to levitate a deflated economy.

This past week, Mario Draghi, president of the European Central Bank, said that he would not in fact do "whatever it takes," as he had pledged a week ago Thursday, to save the euro and the European economy. After Draghi floated a commitment buying more government bonds without demanding rigid austerity policies in return, his trial balloon was shot down by Jens Weidmann, president of the German Bundesbank. Draghi will remain captive to the budget hawks led by the Germans who are keeping Europe depressed.

Here in the U.S., the policy-setting Open Market Committee of the Federal Reserve met on Wednesday and decided against taking any further action for now. Financial commentators clucked that the Fed perhaps should have done more.

But, face it, there is not much more that that the Fed can do, and we should not expect it to perform miracles. Interest rates are already at record lows, and that is not enough to revive an economy suffering from the aftermath of a financial collapse. After the crash of 1929, critics called the fantasy that cheap money alone could rescue a deflated economy "pushing on a string."

Today, consumer demand is deflated by high unemployment, low wages, and diminished capacity to borrow. Growth slowed to an annual rate of just 1.5 percent in the first half of 2012.

Banks are willing to lend only to their best customers. Corporate America is sitting on nearly two trillion dollars that corporations won't invest because they don't see demand for their products.

Homeowners are out several trillion dollars in net worth because of the housing bust. Wage earners, who supported economic growth in the 1990s and early 2000s by borrowing against their homes, have less to borrow against, and have been paying down debt.

In these circumstances, interest rates could be zero, and it wouldn't provide enough stimulus.

Government needs to do two things that neither Democrats nor Republicans have been willing to do.

First, we need a massive program of mortgage refinance, not just for borrowers with plenty of equity (who have been refinancing) but for underwater homeowners with negative equity.

The administration has been unwilling to embrace such a strategy for fear of the impact on bank balance sheets. However the Treasury has supported the idea of Fannie Mae and Freddie Mac supporting more refinancings. But Ed DeMarco, head of the agency that regulates Fannie and Freddie has opposed the idea. DeMarco's own agency thinks the approach would be helpful.

DeMarco's stance makes no sense. He is acting head of the Federal Housing Finance Agency, and he is not a policymaker. Obama should begin the shift to a far more aggressive program of mortgage refinance by firing DeMarco.

But even with more robust efforts to deal with the overhang of excessive mortgage debt and depressed housing prices, the economy will still be stuck in a hole.

We need massive public investment on a scale that is far outside mainstream debate. How massive?

It took World War II to cure the Great Depression, and during the war the government ran deficits averaging 25 percent of GDP for four straight years.

Government also had high surtaxes on the wealthy, with top rates of 91 percent. It turned around and spent and invested that money. The war restored the productive capacity of America, put fifteen million people to work, and restored household purchasing power — even though most of that production was blown up.

If you watched any of the PBS encore broadcast of the Ken Burns documentary, The War, this past week, you have some sense of what kind of a production machine can be energized by government contracts in the face of a depressed economy.

There is so much that we could spend that money on — energy self sufficiency, infrastructure, a smart electrical grid, public transportation, better education at all levels — all of which would not only create economic activity and jobs, but would make for a more productive economy.

But nothing like this is part of the mainstream conversation. If you propose this sort of thing, you are packed off to the Museum of Un-reconstructed Keynesians. White House economists quietly admit that you are right, but you are politically radioactive (even with a Nobel Prize.)

Though President Obama strikes the right rhetorical notes, the actual budget debate is the Republicans demanding that we cut more while the Democrats respond that we should cut a little less. Nobody is declaring that only massive public investment will cure the shortfall in private purchasing power.

And so we will continue with growth depressed, and unemployment stuck above 8 percent, with some slightly better months of job growth like July, and some worse ones like April, May, and June.

Despite this feeble performance, President Obama may get re-elected, thanks to the reliable ineptitude of Mitt Romney. Unless Obama's feistier campaign performance translates to a Democratic Congress and a much bolder recovery program, Obama's second term will be a time of continuing economic frustrations.

By opening the monetary floodgates, Fed Chairman Ben Bernanke helped save the economy from a second Great Depression; and for this he deserves our thanks. But what we have now is a prolonged Lesser Depression that the Federal Reserve can't cure.

Originally published by The Huffington Post.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

A Tale of Two Central Bankers

Monday, August 6th, 2012

Federal Reserve Chairman Ben Bernanke has been desperately trying to levitate a sinking economy, by buying government and commercial bonds in whatever quantities it takes to keep interest rates at record lows. This policy has kept the Great Deflation from being even worse, but it hasn't produced a robust recovery.

The reason: Consumers are suffering from rising unemployment and declining wages, and aren't eager to spend. Still wounded banks, meanwhile, aren't eager to lend. Business is sitting on about two trillion dollars in cash, and isn't eager to invest when it doesn't see customers.

Even 30-year mortgages at record lows of 3.5 percent interest have not revived the sagging housing market. The government, despite a token program of mortgage relief known as HAMP, has not been willing to get serious about reducing the principal of mortgages where the debt exceeds the value of the house.

Prospective buyers, no longer confident of whether housing is a good investment, continue to rent, waiting for housing prices to bottom out. But prices are still falling in most metropolitan areas.

Bernanke, under fire from conservatives in Congress and in his own Federal Reserve System for courting inflation (also at near-record lows), keeps sending the politicians delicately coded messages: The Fed can't do it all. He warns that things will be even worse if the economy goes off a "fiscal cliff" in January, when the Bush tax cuts expire and automatic budget-cut triggers go off unless Congress reaches a budget deal.

Bernanke means that all this would worsen the slump by producing an ill-timed fiscal contraction. What he almost says, but not quite, is that the economy needs a big dose of fiscal expansion — more public spending even at the cost of a short run increase in the deficit, so that faster growth will bring the deficit down over time.

The Republicans would crucify him if he said that.

Bernanke's warning on the fiscal cliff, if anything, has been ill-used by the right as demonstrating the need for more tax cuts and more stringent budget balance, even though those two goals are at odds with each other and this is the opposite of what Bernanke meant.

Bernanke has also discretely prodded the administration to get more serious about solving the mortgage mess, since the Fed can't succeed on that front by itself either.

This message is also unwelcome, especially to the Obama Treasury, where Secretary Tim Geithner is determined to protect prettied-up bank balance sheets from booking any losses on underwater mortgages.

Bernanke is torn between protecting his institution and getting more aggressive about prodding the other branches of government to do their part. He defaults to protecting the Fed. Give him an A for effort, but a D for too much discretion.

Meanwhile, Mario Draghi, Bernanke's counterpart at the European Central Bank, lifted hopes and markets last week when he said that he would do whatever it takes to rescue the euro. Markets took this as a sign that the ECB would get a lot more serious about buying the government bonds of nations under attack by speculators in money markets.

So far, the ECB has bought less than $300 billion of European government bonds, while the Fed has bought around $3 trillion of securities to keep U.S. interest rates low.

But Draghi is under even more constraints than Bernanke. When the ECB was created in 1993, the treaty establishing the euro explicitly included a "no bail-out" clause. The Germans wanted to be certain that Europe would not become a "transfer union" and that stronger nations would not be responsible for helping weaker ones. As Europe has sunk back into recession, German Chancellor Merkel has appointed herself enforcer of this policy.

That in turn has led to utterly perverse responses to the speculative attack on the bonds of Europe's weaker peripheral economies. Just when Europe's financial markets are about to go off their own cliff, Merkel relents just enough to allow a temporary stopgap. The ECB gives Europe's banks a jolt of cheap loans. Or it buys government bonds on the secondary market, which does not technically violate the bailout clause and Mrs Merkel discretely looks the other way. Or the Europeans set up a jury-rigged facility with a clunky name (the European Financial Stability Facility) to buy the bonds that a real central bank should be buying.

To compensate for her lapse into monetary sin, Ms. Merkel then imposes even deeper fiscal penance on Greece, Spain, Portugal and Europe generally. Markets then rally briefly, borrowing rates for nations like Spain and Italy temporarily subside. But then it becomes clear that austerity is only driving Europe deeper into recession and that the European Central Bank lacks the will to prevent the next round of speculative attack. The same cycle has been repeated at least four times since the attack on Greek bonds began in late 2009.

What doomsayers about the euro forget is that Europe was on path to a (too-slow) recovery until hedge funds began betting against Greek bonds. But because of the Merkel austerity policy and the limits on its own authority, the ECB was not able to decisively take the other side of the bet and didn't even try until the fire spread to larger nations.

You can be confident that markets will slump again and Spanish and Italian borrowing costs will rise again as soon as investors realize that Draghi, despite his best intentions, can't quite deliver. His bank's board is due to meet Thursday, and the Germans remain adamantly opposed to allowing Draghi to get serious about bond purchases.

Draghi, like Bernanke, keeps warning that central bankers can't fix the economic mess by themselves. Europe needs to reverse its austerity policies, to take shared responsibility for dealing with the legacy debt of its weaker members, and to turn the ECB into a true central bank. None of this is likely to happen.

Draghi has done better at resisting the austerity hawks than his predecessors. He is certainly a breath of fresh air compared to the Bundesbank official who was in line to head the ECB, Axel Weber, who withdrew in protest against the pressure from other European governments to at least let the central bank make bond purchases on the secondary market. But Draghi does not have the leverage or the will to reverse Europe's larger economic folly and slide into deeper recession.

Draghi is a relative hero amid a very sorry lot. Like Bernanke, he puts the health of his own central bank first. Give him an A for effort and a D for too much discretion.

Originally published by The Huffington Post.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

The Fiscal Cliff and the Political Chasm

Wednesday, August 1st, 2012

Question of the Day: How can the Fiscal Cliff be giving aid and comfort to the Bowles-Simpson crowd? The cliff would create a major economic contraction; so would Bowles-Simpson.

The "fiscal cliff" is Beltway shorthand for a combo of automatic tax increases and budget cuts set to go off Jan. 2. The timing of the two is a coincidence.

One part is the expiration of the Bush tax cuts. A second part is the due date of a budget trigger created last year when a super-committee of Congress failed to reach agreement on a budget deal.

Under the automatic fallback created by the 2011 Budget Control Act, $1.2 trillion of ten-year spending cuts ("sequesters") begin biting in January, half from military spending and half from domestic programs. Other fiscal bomblets go off as well, such as the end of the cut in payroll taxes and of extended unemployment benefits, unless Congress acts.

The Cliff is universally regarded as an impending disaster because it would create a sharp fiscal contraction, at a time when the recovery is weak to non-existent. The Congressional Budget Office calculates that the Cliff would create a deficit reduction of 4.7 percent in FY 2013, causing the economy to go back into recession.

Meanwhile, Erskine Bowles and Alan Simpson are back — fiscal zombies who just won't die. The latest Bowles-Simpson deal would… cut spending and raise taxes, which in turn would, uh, create a sharp fiscal contraction at a time when the recovery is weak to non-existent.

In other words, an alternative fiscal cliff. Investment banker Bowles, God help us, is even being proposed in some quarters as a successor to Treasury Secretary Tim Geithner (he says he doesn't want the job.)

B&S have been working with a group of House and Senate deficit hawks of both parties, cheered on by sycophants in the press. Their latest caper, according to a breathless, cheer-leading piece by Steve Pearlstein in The Washington Post, is a coalition of corporate CEOs called Fix the Debt.

The CEOs plan to raise $50 to 100 million in the next two months to promote a Bowles-Simpson style cliff — tax increases and spending cuts.

You can just imagine the kind of tax increases these corporate stalwarts are likely to propose. Hikes in capital gains taxes? Corporate income taxes? A top bracket on the personal income tax? A financial transaction tax? No way.

So, why is a fiscal cliff an economic disaster when it is the product of legislative default and joy to behold when it is the work of Bowles, Simpson, and their corporate cronies? It's the same misguided fiscal contraction at a time when a fragile economy needs more public spending.

Part of the reason is that the automatic budget cuts are seen as the result of a failure of politicians to agree on a more measured set of deficit cuts. Another reason is absolute horror at the prospect of cuts in military spending, or the end of the Bush tax cuts.

For more than a decade, deficit hawks and their allies in the media have been promoting a grand bargain whereby Republicans agree to tax hikes and Democrats agree to cut social programs like Social Security and Medicare. That, in turn, will put the deficit on a downward path and presumably restore economic growth.

The trouble with this premise is that the current deficit is mainly the result of the recession itself plus the Bush tax cuts and military spending increases. It has nothing to do with Social Security; the projected increases in Medicare spending are only the result of failure to tackle deeper health care reform.

The idea that smaller deficits will somehow increase growth (Paul Krugman's "confidence fairy") has the economics backwards. Deficits will fall when growth is restored, not vice versa; and fiscal contraction will reduce growth.

Bowles and Simpson have credibility in part because President Obama, at a moment when he was driving under the influence of dubious potions concocted by in-house deficit hawks like former budget director Peter Orszag, created the commission that bore their name. Obama hoped that the commission would give him fiscal credibility and get him through the 2010 mid-term election. We saw how well that worked. In the meantime, Obama facing his own re-election, has moved off deficit-hawkery and sensibly proposed new job creation measures of $450 billion. But Bowles, Simpson and company have taken an afterlife of their own.

In spite of this, fiscal events are now breaking Obama's way — if he has the courage to lead. For starters, the fact that all of the Bush tax cuts expire Jan. 1 gives Obama a huge tactical advantage.

Republicans are holding out for extending all of the tax cuts. But if they refuse to pass Obama's proposal of extending the cuts for the bottom 98 percent, the calendar works in Obama's favor. As Sen. Patty Murray proposed, Democrats can let all of the tax cuts expire on schedule, then challenge Republicans to join them in supporting a break for all but the wealthiest 2 percent.

The $600 billion in defense cuts scheduled if the sequester goes off also gives progressives a huge tactical advantage — again, if Obama is prepared to play hardball. Democratic military hawks will scream, but Obama can challenge Republicans to support a reasonable budget. If not, let the military cuts start happening.

What's required is a resolute presidential speech making clear that Social Security and Medicare are not going to be on the chopping block; and that Obama is not going to trade one fiscal cliff for another by embracing Bowles-Simpson 3.0. The president has made a good start by promising to limit tax breaks to the bottom 98 percent. Now he needs to explain why belt tightening in a severe slump is a terrible idea — whether the work of an automatic formula or of the corporate elite as organized by Bowles and Simpson.

Originally published by The Huffington Post.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

An Eminently Bad Idea

Thursday, July 26th, 2012

You may have noticed news items that a company called Mortgage Resolution Partners (MRP) is proposing to have strapped localities use the public power of eminent domain to deal with the problem of underwater mortgages.

Officials of San Bernardino County, California, where one home in two is worth less than the value of the mortgage on it, are very interested in the idea. (San Bernardino has just voted to file for bankruptcy). The New York Times' Joe Nocera wrote a favorable column on the proposal, calling it the "last chance" to resolve the mortgage mess.

The idea is to have the county use its power of eminent domain to take these mortgages out of securitized packages of loans, purchase them at a steep discount, write them down to fair market value, and then create a new mortgage with a much reduced principal and monthly payment. MRP puts up the capital to make these purchases. Then MRP makes some money on the deal and the homeowner gets a break on the payments.

But if using eminent domain as a way to address crisis in underwater mortgages is a promising idea, this particular scheme is not. For starters, MRP, a for-profit company, is not proposing to acquire vacant homes or even homes where residents have stopped paying on their mortgages. It wants localities to use eminent domain so that it can acquire performing mortgages.

Who needs MRP as middleman? By skimming off only the best mortgages, it is taking almost none of the risk and stands to reap windfall profits for raising capital and shuffling paper. If the federal government got serious about this concept, it has plenty of resources through its feeble HAMP program to acquire distressed mortgages, reduce the principal to fair market value, and give the homeowner all of the break.

The Times has been treating the use of eminent domain as a new idea for solving the mortgage crisis, and crediting it to the vulture — I mean venture — capitalists at MRP.

But Professor Howell Jackson of Harvard Law School has been advocating this approach since 2008, and I urged creation of a new Home Owners Loan Corporation with eminent domain powers in my 2010 book, A Presidency in Peril.

Rep. Brad Miller of California proposed a version of the Home Owners Loan Corporation idea more than two years ago, without new financial industry middlemen. Miller recently criticized the securitization industry for trying to block the MRP proposal, but that doesn't make it the best way to proceed. For a smart technical discussion, see Yves Smith and David Dayen on Firedoglake.

There was money in the 2009 Recovery Act for local governments and non-profits to acquire abandoned and foreclosed homes. The last thing we need is for one more layer of entrepreneurs to skim off the most potentially lucrative layer of distressed mortgages.

A Homeowners Loan Corporation using eminent domain could be a full service solution. It could pull distressed mortgages out of securitized pools, provide principal reductions on both performing mortgages and ones where homeowners are behind on their payments. And it could purchase foreclosed homes at deep discount and convey them to nonprofit groups to be returned to the supply of affordable housing. (In the absence of adequate government action, that function is mostly being performed by speculators, too.) Even without legislation for a new HOLC, the government could use existing entities to perform this role.

Think about it. Once upon a time, in the era of It's A Wonderful Life, before the sharks ruined it for everybody, the business of supplying mortgages was simplicity itself. Nonprofit savings banks and savings and loans provided mortgages. Their money was replenished by the original Federal National Mortgage Association (FNMA) so that they could make mortgages. Very low down-payment mortgages could be had through the GI Bill and FHA. There was no for-profit securitization.

Then the wise guys invented securitization and subprime. At least five layers of middlemen took their cuts. The guy who originated the loan, the guy who took it off his hands, the guy who packaged it and sold mortgage-backed securities, the credit rating firm that gave the package a bogus triple-A rating, and other players who bought and sold the paper for profit. FNMA was privatized as one more dubious actor. And then the show went bust, taking the economy down with it.

How fitting, in this corrupted era, that the supposed savior is now yet another entrepreneur. When are we going to get smart enough to figure out that the whole thing works better when government does its job rather than being the enabler of financial middlemen?

Eminent domain is in the Constitution to serve public purposes. In the 5 to 4 Kelo v. City of New London decision of 2005, the Supreme Court held that a local government could lawfully use eminent domain to condemn a property and convey it to a private developer. But even if constitutional, the use of eminent domain for private profit isn't good policy–even less so when the public sector can do the job more fairly and efficiently.

Until government reclaims its proper role, financial middlemen will keep on creating crises–and then profiting from efforts to resolve them. It's a wonderful life.

Originally published on The Huffington Post.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

Waiting for Lefty

Thursday, July 12th, 2012

The economy is plainly stuck in second gear. For the third month in a row, new job creation in June, at just 80,000, was barely enough to keep the unemployment rate from rising, and not nearly sufficient to accommodate new entrants to the labor market and unemployed people looking for work.

Not only did the private sector fail to create enough jobs. With the crisis in state and local budgets and the absence of federal aid, the loss of public sector jobs continued. Ordinarily in a slump, public employment takes up some of the slack. In this recession, government has shed 627,000 jobs.

Here's the deeper worry. Not only could a weakening economy cost Barack Obama the election — this slump could literally go on indefinitely.

In the aftermath of a financial collapse, the economy gets stuck in a downward spiral. Banks are too traumatized to lend, businesses see too few customers to invest, and there is too little purchasing power among consumers who are either out of work or who haven't seen a raise in a decade. The housing bust only adds to the downward drag.

Exports have been a bright spot, but as Europe succumbs to a similar vortex of recession compounded by austerity, Europe's even worse economic woes are likely add to America's.

Something similar happened in the late 1930s. Though economic growth returned, it wasn't strong enough to repair the damage of the Great Depression or create enough jobs. Despite the New Deal, unemployment remained stuck at around 12 percent.

World War II solved the problem — it was the greatest accidental economic stimulus in economic history. It put people back to work, retrained the unemployed, and recapitalized industry. But today, there is nothing in the wings waiting to play the role of the Second World War.

During the war, federal deficits averaged more than 25 percent of GDP, nearly triple today's deficits. But that's what it took to blast out of the depression. After the war, high growth rates paid down the accumulated national debt.

What's needed today is a massive investment program, to shift the economy to a clean energy path, modernize infrastructure, increase productivity — and along the way create millions of good jobs and restore consumer purchasing power. Then, the vicious circle could be reversed.

The problem is that neither party is proposing such a program. It is entirely outside mainstream debate.

President Obama is willing to have the federal government spend more money. But he has partly bought the story that deficit reduction has to come first. The Republicans would further gut the public sector.

Contrary to the conventional view that deficit reduction would somehow "restore confidence" and increase business investment, that's not how economies work. Businesses invest when they see customers with open wallets. Though the Congressional Budget Office projects higher growth returning around 2014, it bases these projections on a "return to trend." There is no plausible story about where the higher growth will come from.

If we don't get a drastic change in policy, we will be stuck in this rut for a generation or more.

The best case for November is that Obama is re-elected and somehow the Democrats take back the House and hold the Senate. If this happens, it will not be due to green economic shoots or a persuasive Democratic program but because Mitt Romney is such a dismal candidate.

However, with dozens of Senate Democrats senators committed to the folly of deficit reduction first, there is no prospect of an investment program on a scale that could make a difference.

I am an optimistic by temperament, but I don't see much to make me optimistic about either economics or politics. Though the recession nominally ended in June 2009 when weakly positive growth returned, there is little doubt that the economy is stuck in a long-term slump that could well deepen between now and November.

Frankly, the best hope is that whether Obama wins or loses, progressives take back the Democratic Party so that a candidate genuinely committed to full employment runs and wins in 2016. But that's an awfully long time to wait. And in the meantime, as government fails to improve things, more people are likely to give up on politics or to turn to demagogues.

It is also possible that Barack Obama in a second term, freed of the need to win re-election and looking to his legacy, could become more of the leader we thought we were electing in 2008, shaming Republicans and rallying Democrats to back a true recovery program. Nobody would be more surprised or pleased than your faithful writer.

Originally published on The Huffington Post.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

Can Merkel Be Moved?

Tuesday, June 19th, 2012

Berlin — Ever since the march to European union began in the late 1940s, French-German collaboration has been at the heart of the project. Until the recent defeat of French President Nicolas Sarkozy, his close alliance with German Chancellor Angela Merkel continued this tradition, albeit on behalf of policies that have driven Europe deeper into depression and inflicted brutal austerity on smaller nations such as Greece and Portugal.

With the May 6 election of French Socialist Francois Hollande on an anti-austerity program, Paris and Berlin are now at odds. If a Social Democratic-Green coalition wins next year's German elections, expected in September 2013, that would create a progressive Paris-Berlin axis.

There are, however, two huge problems. September 2013 is an eternity away and the European project could go up in smoke in the meantime. The other problem is German public opinion.

Though Chancellor Merkel's Christian Democratic Union suffered two election defeats in recent state elections, including in Germany's largest state, North Rhine-Westphalia, this is not because the German electorate rejects her austerity policies for the rest of Europe. If anything, some voters fear that Merkel is a little soft on Europe.

Thus the dilemma for the opposition Social Democrats. Whenever there is the slightest departure from Merkel's austerity line, the tabloid press is quick to accuse the Social Dems of "treason" to the fatherland, and organs like Der Spiegel question their competence to govern.

The German Bundestag faces a crucial vote on whether to ratify the latest European Stability and Growth Pact, a key Merkel goal that provides for even more stringent deficit and debt targets, with penalties for violating them. Because this requires two-thirds approval, the Social Democrats as the largest German opposition party have the power to block it, which would be a huge defeat for Merkel.

But my social democratic sources say the Party in all likelihood will not have the nerve to vote no, because party leaders are fearful of defying public opinion. Social Democratic economic policy documents and speeches by leaders, calling for wage increases and more public investment, invariably seek to bullet-proof the Social Democrats by reiterating the call for budgetary toughness. The Green leaders I've spoken with have admirable plans for a green investment agenda, but are basically in the same place on austerity.

Why this German embrace of austerity (for everyone else)? Because it serves Germany just fine. The French situation, with rising unemployment, rising deficits and falling exports, could not be more different.

Postwar Germany, fearful of inflation, has always pursued a policy of fiscal and monetary prudence combined with a strong export economy. But the shift to the Euro supercharged this strategy in unanticipated ways.

Because of the wide divergence in economic performance between Germany and, say, Greece, the same currency cannot possibly be right for both countries. So the Euro is overvalued in Greece and under-valued in Germany. This gives German exports an added lift. Based on divergent growth rates since the Euro was introduced in 1999, if Germany had its own currency, it would be valued at something like 50 percent more than the Euro, reducing Germany's export advantage.

In addition, the bank run on the rest of Europe and speculation against the bonds of weaker European economies has led to a flight of capital to Germany, reducing interest rates here to record lows. The two-year German government bond actually pays a negative interest rate.

So Germany benefits from the rest of Europe's suffering in two ways — expanded exports and dirt-cheap money. These are subtleties of monetary policy are lost on the average German voter.

To the ordinary citizen, Germans work hard, balance their budgets, took wage cuts when times were tough — and other nations should do likewise. Southern Germany today has full employment, and even employers are talking of the need to raise wages by three to four percent.

Obviously, not every nation can enjoy an export surplus, and if every other major economy is shrinking, even Germany starts losing the market for its products. But Merkel continues to pursue Germany's narrow self-interest.

This past week, Merkel and her ministers rejected pleas to loosen the screws on Spain, whose banking system is in dire crisis. The German position is that in exchange for assistance from Europe's common bailout fund, the 500 billion Euro European Stability Mechanism, Spain will be expected to impose even more economic austerity in order to meet the deficit targets required by the stability and growth pact and its predecessor treaty.

Speaking Thursday in Brussels, the European Union's Vice President and Commissioner in charge of economic affairs, Olli Rehn, a Finn who closely follows Merkel's lead, made a big deal of the fact that Spain will be given an extra year to meet the target of a deficit of 3 percent of GDP. But because austerity policies cut growth and reduce revenues, any sane person expects that Spain's deficit this year and next cannot avoid being in double digits. Rehn even took a swipe at France's deficit.

As Merkel speaks grandly of a closer European Union and a common (very austere) European fiscal policy, her flawed vision and blunt use of German economic power are destroying the European project. And because Germany, uniquely among European nations, is enjoying an economic boom, it will take real courage for the German Social Democrats to propose a fundamentally different course.

Alert readers may have noticed some parallels and differences with the budgetary politics of the United States.

Merkel's perverse view of the need for budget balance in a recession and the need for sanctions for sinners sounds eerily like the Bowles-Simpson Commission. The reluctance of the German Social Democrats to challenge the logic and the entire approach calls to mind the fiscally conservative American Democrats who have pushed President Obama into the austerity camp.

But there is one huge difference. Because of its undervalued currency and export strength, budgetary austerity actually works for Germany and voters approve. It doesn't work for the rest of Europe or for the United States, and our voters want something better. If they can't get a recovery from Obama, they will look to Romney — even though his views on deficits are crazier than Merkel's.

Such are the upside-down times in which we live.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

You've Come a Long Way, Ben

Thursday, April 19th, 2012

I heard a terrific speech last Friday by the Federal Reserve Chairman, Ben Bernanke.

In his address, to a Russell Sage-Century Foundation Conference on the causes and cure of the financial crisis, Chairman Bernanke said just about everything a progressive would want to hear. Read it for yourself and see if you agree.

The financial industry, he said, had been characterized by "high levels of leverage; excessive dependence on unstable short term funding; deficiencies in risk management in major financial firms; and the use of exotic and non-transparent financial instruments that obscured concentrations of risk." In other words, Wall Street went berserk; and markets did not correct themselves. Add a little more invective about Goldman Sachs and Rolling Stone's Matt Taibbi could not have put it better.

As for the regulators, "gaps in the regulatory structure" allowed very large firms and markets "to escape comprehensive supervision." There were "failures of supervisors" and "insufficient attention to the stability of the system as a whole."

Bernanke added that though the immediate losses in the tech bust of 2000 were about the same as the losses in the value of housing — $7 to 8 trillion — the dot.com crash "resulted in a relatively short and mild recession with no major financial instability," while the sub-prime collapse brought down the entire economy. Why? Because of the massive disguised leverage and related abuses in the shadow banking industry that caused financial markets to grind to a halt.

Bernanke defended the Fed's policy of driving interest rates nearly to zero, including buying securities as necessary from the Treasury and from private financial markets. In pursuing these policies, he has braved attacks by the right and by several inflation-phobic regional Federal Reserve Bank presidents.

So does Bernanke deserve the accolade bestowed in the April Atlantic magazine cover profile by Roger Lowenstein, "The Hero?" Not entirely.

Bernanke certainly gets an A for using monetary policy to keep the economy from collapsing. But if you look at Bernanke over the past ten years, what you see more than anything else is a learning curve on matters of regulation. Lowenstein misses that.

Supreme among those supervisory agencies criticized in his speech that failed to contain escalating abuses was the Bernanke Fed itself.

Bernanke, in his scholarly writings about the failure of the Federal Reserve to head off or cure the Great Depression, emphasized failures of monetary policy. He said not word one about regulatory failures.

"The correct interpretation of the 1920s," he wrote in 2002, "is not the popular one — that the stock market got over-valued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock market prices."

But that view is not only wrong but at odds with the views that Bernanke espouses today. The over-leveraging, conflicts of interest, and regulatory lapses of the '20s were precisely analogous to the market abuses and supervisory corruption that caused the bubble and crash of our own era.

Bernanke also gave a now (in)famous scholarly paper in 2004, in which he spoke of "The Great Moderation," meaning a world of "reduced volatility", low interest rates and plentiful capital. Bernanke utterly missed what was really occurring. Today, he would recognize that "moderation" as a fools' paradise — the result of the reckless and un-policed creation of leverage by the shadow banking system.

Though Bernanke was determined not to repeat the mistakes of his predecessors once the system crashed in 2008, when he acted to pump in as much money as necessary, it was only later that he learned the regulatory lessons. In the spring of 2009, he was on the side of Larry Summers and Tim Geithner in wanting to prop up large, effectively insolvent banks rather than acting to nationalize them and break them up in the public interest. The Fed also resisted releasing documents on the bailout, whose disclosure was required by Dodd-Frank, until ordered by the courts.

Today, however, Bernanke is increasingly on the side of the regulators in wanting to crack down on abuses in the banking and shadow-banking systems. Which is a very good thing, because the Dodd-Frank bill, which is only a partial solution to those abuses, is under assault from all sides, and so are the other regulatory agencies.

The Republican House, urged on by Wall Street, is trying to gut Dodd-Frank's regulation of derivatives. Thousands of Wall Street lawyers and lobbyists are flooding the zone to undermine the rule-making process necessary to implement Dodd-Frank. Congress is also trying to starve regulatory agencies that have new enforcement responsibilities.

The D.C. Court of Appeals threw out the SEC's first set of rules to implement Dodd-Frank on the ground that the Commission failed to do an adequate cost-benefit analysis. This brand of cost-benefit analysis mainly looks at compliance "costs" of banks. It ignores the cost, running into the tens of trillions, of the collapse itself.

The Fed's actions are not subject to this brand of cost-benefit analysis. Nor is the Fed captive to Congressional actions limiting its enforcement budget, since the place creates money.

It is an odd feeling, certainly, seeing the largely undemocratic Fed, long an agency historically beholden to Wall Street, as an important ally in the effort to clean out the financial system and to prevent the next collapse. I'd be much happier if Congress had passed even tougher legislation, and if President Obama and his Treasury Secretary — that would be Tim Geithner (!) — were leading a popular crusade for deep financial reform.

Bernanke, thanks to his baptism by fire in the crisis, has steadily moved from regulatory dove to regulatory hawk. Several of his colleagues deserve credit, too, notably Governor Sarah Bloom Raskin, who prodded the Fed to take an assertive stance pressing for more housing and mortgage relief, and Governor Daniel Tarullo, the Fed's point man on banking regulation.

The Fed remains a deeply undemocratic institution, structurally in bed with the financial industry. But in times like these, we take allies where we can find them. And Ben Bernanke's odyssey deserves our respect.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

The Volcker Rule: Return to Sender

Monday, March 5th, 2012

Paul Volcker deserves better. In the hands of Tim Geithner's Treasury, the Rule named for Volcker supposedly limiting speculative mischief by government-guaranteed banks is fast becoming a cumbersome parody of itself.

Financial regulatory officials, at the behest of Wall Street, have turned a simple bright line into a convoluted monstrosity. The questionnaire alone, inviting comments, runs 530 pages.

The bankers and their allies in government have succeeded once again in making their financial engineering too complex to regulate. The Volcker Rule, in the spirit of the 1933 Glass-Steagall Act, was supposed to simplify matters. But the regulators are helping Wall Street by adding to the complexity. See Jesse Eisenger's analysis from Propublica.

The capacity of Wall Street to create new mutations of derivatives that are not quite explicitly covered by this or that sub-sub-sub rule is of course endless. In the absence of a clear line, Wall Street can always field more lawyers than the government can spare regulators, and what an awful waste of taxpayer money.

It reminds you of Mad Magazine's Spy vs. Spy, an infinite regress of move and counter-move, giving regulation itself a bad name and providing fodder for Wall Street Journal editorial mockery.

Unless the Treasury and the other agencies reverse course and drastically simplify the regulation, Volcker should return the Rule to sender and refuse to have his still honorable name attached to this travesty. Better to call it the Geithner Rule.

The back story: In the infighting of late 2008, President Obama's incoming economic team of Larry Summers and Tim Geithner marginalized Volcker as a senior official of the new administration, despite the fact — no, because of the fact — that Volcker had been one of Obama's earliest supporters and understood the dynamics of the financial collapse far better than either of them. They gave Volcker a ceremonial advisory position with no real power. Volcker was a menace because he was counseling more constraints on bank powers than Summers and Geithner wanted.

It speaks volumes about this administration that the most radical person in the room on the subject of banking reform was usually the former chairman of the Federal Reserve.

Then in early 2010, Scott Brown stunned Washington with his upset win of Ted Kennedy's former Massachusetts senate seat. The White House political team desperately needed a populist pivot and an emblem of tough financial regulation. Obama quickly sent for a surprised Volcker, who had never before been in the role of populist (but then everything is relative.)

The White House, using Volcker as a prop, conjured up a "Volcker Rule," in the spirit of the Glass-Steagall Act (which Summers and Geithner in their Clinton-era roles had helped repeal). Despite Volcker's gracious endorsement, the proposed rule was not as elegantly simple as Glass-Steagall, or as tough as Volcker's own counsel.

The thrown-together Rule was vague; it did not propose to separate investment banking from commercial banking. It constrained but did not entirely prohibit proprietary securities trading by government-guaranteed banks. By the time the industry got through with its legislative lobbying, the version that passed Congress as part of the Dodd-Frank Act was tough in principle but left room for mischief in the administrative rule-making.

As Joseph Stiglitz and Robert Johnson observe in a letter to the regulators that is must-reading if you care about this stuff:

To the extent the Volcker Rule is too complex, that is at best a reflection of the incredible complexity that banking itself has created, and at worst a reflection of the proposed rule's timidity: it attempts to protect the complexity of the status quo and implement a law that directs a reduction of trading by banks without reducing trading by banks or trading overall. These contradictions must be rejected. For the U.S. to rebuild a healthy financial system — one where savings go to productive investments, and the returns go back the investors — the Volcker Rule's mandate to reduce bank involvement in complex trading activities must be implemented. Naturally, banks are resistant to these demands because they have taken refuge in complexity to extract massive margins and fees that generate bonuses, while avoiding the harsh sunlight of competition and the risk-reducing incentives of the threat of failure.

Or as Paul Volcker himself declared, in his own comments on implementation of the rule that bears his name:

In essence, proprietary trading activity, hedge funds, and equity holdings should stand on their own feet in the market place, not protected by access to bank capital, to the official safety nets, and to any presumption of public assistance as failure threatens.
Amen. Most of the financial engineering that caused the collapse was not about innovation to improve economic efficiency. New creations such as collateralized debt obligations or credit default swaps had two core purposes — to disguise the real amount of hidden leverage and risk; and to protect outsized bank profits from the sunlight of real competition.

There is no good reason to allow a commercial bank to trade for its own account. The bank is likely to trade on inside information, creating a blatant conflict of interest between the bank ands its customers, as well as a moral hazard that the bank's extreme leverage will put the larger economic system at risk — in just the way creation and trading of opaque derivatives caused the collapse.

How, after all, did the banking system function without these innovations, which only date to the 1990s? Answer: with a lot more efficiency, more modest profits for bankers, and far less potential to wreck the rest of the economy.

What the banking system needs now is drastic simplification. Commercial banks should take deposits and make loans. Investment banks, risking only their own money, should underwrite securities. Anybody who wants to gamble in securities trading should not also enjoy the privileges of being a banker.

The great unfinished remedial business of the post-crash reform is to study which innovations, if any, are worth keeping and how to carry out the overdue simplification of the financial system. The original Glass-Steagall Act ran only 37 pages. Investment banks and commercial banks were strictly separated, end of story. A properly fashioned Volcker Rule should be just that straightforward. Back to the drawing board.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos.

A Presidency in Peril Robert Kuttner is the author of A Presidency in Peril.

Saving the Middle Class

Monday, February 13th, 2012

Last week, the New York City hotel workers union announced a stunning 7-year contract with the Big Apple's hotel industry providing for wage increases averaging 27 percent. The contract is due to be ratified by the membership Monday. The City's hotel trades council, whose master contract covers nearly every large hotel in Manhattan, already has the industry's best wages and health benefits. Room-attendants earn over $50,000 a year, and their earnings will go to $60,000. Everyone in the local makes a middle class income.

How on earth did the union achieve that? Through relentless organizing, professionalism, and development of the rank and file into a vigilant force that protects worker rights.

The higher wages will not increase room costs, because hotels are already charging whatever the market will bear. A higher share of these earnings will go to wages rather than profits.

After the Strauss-Kahn affair, where the union successfully demanded panic buttons for workers, I wrote a long profile of what has to be America's most effective union local for The American Prospect.

In it, I asked two questions: Are New York hotel workers unique? And what will it take for other workers in the service sector to do as well?

The issue of stagnant worker wages is, after all, the great economic question of our time. The conventional wisdom holds that there is not much our nation can do about it. Foreign competition from lower-wage economies has battered down wages in manufacturing. Many service sector jobs require only modest skills, and offer modest earnings to match.

The best that much of the economics profession can offer is to commend more education — at a time when millions of young people with college degrees are having to settle for jobs that only require a high school diploma. The trend is for an over-educated, under-compensated workforce.

The hard rightwing explicitly places the blame on workers. Charles Murray, the conservative pamphleteer whose 1984 book, Losing Ground, blamed deteriorating economic conditions for blacks on the welfare state, has now shifted ground in a new, much-remarked book, Coming Apart. For Murray, the further decline in working class earnings is now all about deteriorating values.

Rightwing commentators are euphoric. They now have a handy scapegoat for the worsening economic conditions of American workers — the workers themselves.

You could have fooled me. The same diligent workers who earned decent wages a couple of generations ago are now working just as hard for a lot less. Workers are better educated than ever. Something has sure changed, but it isn't the work ethic.

Note also the sleight of hand. In his 1984 book, Murray contended that the killer was incentives that rewarded idleness over work. Congress and President Clinton duly took note. AFDC was repealed, incentives were shifted to reward work — and the decline in wages just continued. Apparently, incentives were not the problem. Murray, despite the attention, is Losing Ground. The main thing that's Coming Apart is his logic.

The fact is, American productivity has nearly doubled in a generation. The problem is that the fruits of that productivity have gone to the wrong people. Money that might have gone to wage-earners has gone to the top one percent, and to the top one-hundredth of one percent.

It is hard to swallow the idea that today's one percent has higher skills and somehow earned these astronomical rewards. After all, this is the gang whose speculations just crashed the economy. How skilled is that?

The middle of the economy — factory workers, nurses, technicians, even retail clerks — work with much more advanced technology than a generation ago. But their wages have lagged. Take a good look at the clerk at the photo counter of your local drugstore, and the technological marvel that she's learned to operate. She's lucky to make nine bucks an hour.

So the question — the most important economic question of our era — is how do we make sure that more of society's total product goes to ordinary workers and not so much of it to the one percent?

Better education helps, but it is no silver bullet. In the 1950s, most of the blue collar middle class hadn't even graduated high school, but working people got a much larger share of the total national product.

There are only four ways to do it. We can allocate more of the total product socially, by taxing the best off and using the proceeds to finance expenditures that provide a higher living standard for all. Places like Germany and Canada do that. It doesn't seem to hurt their productivity at all. On the contrary, a more secure population makes for a more reliable workforce.

We can use regulations to make it a little harder for the super-rich to rig the economy in their favor — for instance banking regulations that prohibit getting filthy rich via ruinous speculation.

We can condition foreign trade on decent social standards, so that we don't import the wretched wages and working conditions along with the produces.

Or we can raise wages directly, through institutions like strong unions.

In this regard, Sunday's New York Times has a remarkably misleading, if encyclopedic, piece on America's safety net. In it, the authors find it surprising and alarming that more of our social outlay is going to the middle class, as opposed to the poor.

Authors Binyamin Applebaum and Robert Gebeloff write, "The government safety net was created to keep Americans from abject poverty, but the poorest Americans no longer receive a majority of government benefits." And they use the case of a Tea Party member, Ki Gulbranson, who makes about $39,000 who benefits from the Earned Income Tax Credit and whose mother gets surgery courtesy of Medicare to show the inconsistency of critics of government.

Nice touch — but the safety net was never just for the poor. Programs like Social Security, Medicare, not to mention free public education, were intended for the whole population. The whole point of the Earned Income Tax Credit is to keep people out of poverty. The fact that a great many of its recipients manage to stay (barely) middle class, like the Tea Party member, is an emblem of its success.

The piece is also unhelpful because it contributes to the mythology of an "entitlement crisis."

The fact is that nations like Canada and Germany spend more of their entire product socially. They have less poverty and a more secure middle class. They also have higher prevailing wages. We can afford more generous social outlays without deficits if we just resolve to pay for them.

Which brings me to the punch line. Programs of social outlay can help build a more just and secure society, but most income is still wage and salary income. And if wages keep declining, social transfer programs will keep swimming upstream.

That in turn brings us back to the New York hotel workers union. It may be a bit easier to organize a strong union in the New York hotel industry because New York is a tourist destination and the New York Hilton is unlikely to move to Bangladesh in search of lower wages.

That said, there are lots of cities in the U.S. that are also tourist destinations that have weak hotel locals and lousy wages. If workers can build a strong union in the New York hospitality industry, they can do it in the rest of the service sector — if the government just enforces the law that empowers workers to choose a union. The war against unions by Republican governors is a war on behalf of the one percent.

So don't let anyone tell you that some fateful structural change has made it impossible for working people to get decent earnings. America, on average, is richer than ever. The trouble is that too much of the total pie is going to the wrong people.

This is an enduring struggle, which will require us to use every bit of available leverage.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is "A Presidency in Peril".

Wild Cards, Economic and Political

Friday, January 27th, 2012

President Obama is exceptionally lucky when it comes to the weaknesses of the Republican field and its stunning penchant for mutually assured destruction. Who would have expected, for instance, that Newt Gingrich's billionaire-backed super-PAC, aiming to destroy front-runner Mitt Romney, would produce a documentary advertisement on private equity slightly to the left of what we might have expected of Michael Moore? Or that Gingrich, reprimanded by leading free-market ideologues, would then request that the ad be pulled? In this hilariously bungled caper, Marx meets the Marx Brothers.

But it remains to be seen whether Obama will be as lucky when it comes to the shape of the economy as the election year unfolds. Some of what will occur this year is partly within the president's control; much is not.

Consider the several vulnerabilities of the still fragile recovery:

The Jobs Mirage. Democrats were cheered and Republicans caught off guard when the Labor Department's December jobs numbers showed a net increase of 200,000 jobs — a nice improvement over previous months. However, a closer look showed that some 42,000 of these were seasonal courier jobs — all the people hired to deliver holiday gifts purchased via Amazon and other online vendors.

Jared Bernstein, the former senior Administration economic advisor now at the Center on Budget and Policy Priorities, calculates that the 200,000 jobs number should be deflated by about 30,000. This brings it closer in line with other recent months, and suggests that the economy is still a ways from a strong recovery.

The biggest problem retarding a strong recovery is that wages are lagging far behind the economy's productivity growth. Recent Federal Reserve statistics show that consumers increased their borrowing to finance their holiday spending, but that can't last unless wages begin following.

Stronger economic stimulus is beyond the control of the administration, given the Republican strategy of wall-to-wall legislative roadblocks. The one thing that Obama could do that he isn't doing is a more aggressive stance on relief for underwater homeowners. With housing prices still falling in nearly every metropolitan area, the housing sector is still depressing the overall economy.

Euro-Drag. From the perspective of Obama's re-election, probably the best case for the Euro this year is that the leaders of the EU keep kicking the can down the road and keep the currency from collapsing. But that may not be good enough. (As the Financial Times' Martin Wolf puts it, the can is filled with gasoline.)

Even if the Euro holds together, the price Europe's financial elites have extracted for keeping weaker European economies afloat is prolonged austerity. That not only depresses Europe's prosperity but weakens U.S. export markets.

Treasury Secretary Tim Geithner's European diplomacy has been directed at one goal: The European Central Bank should behave more like the U.S. Federal Reserve and flood European credit markets with cheap money. But the ECB, responsible to austerity-minded political leaders, is only going part of the way. The S&P's downgrading of the sovereign debt of nine nations that use the Euro only pours oil on the flames.

For the most part, Europe's self-inflicted financial folly is beyond the reach of the Obama Administration. But it could sink the U.S. recovery and Obama's prospects.

The Oil Slick. Iran's continued nuclear program is among the most vexing of foreign policy challenges. The West has had some success in keeping Iranian oil off world markets. The Iranians, in turn, have threatened to block the shipping lanes of the crucial Straits of Hormuz, a 19-mile-wide shipping lane through which about one-fifth of the world's oil supply passes. Reportedly, the Obama administration has told the Iranians that this could be considered crossing a red line, close to an act of war, and that closure of the strait would be met by military force.

But this game of geo-political chicken also has grave consequences for the price of oil. Even if shipping lanes stay open, oil supply could come under pressure. The price of oil has stayed well-behaved, ironically enough, because the weak recovery has depressed demand. But a spike in the price of oil could be a spike in the heart of economic growth.

According to standard political-science analysis of presidential re-election chances, the most important single factor is the state of the economy in the presidential year. This means not just the absolute unemployment and economic growth numbers, but whether voters feel things are improving.

Yale's Ray Fair, whose economic model has been uncannily accurate in predicting presidential winners, surprised many observers last November, when he projected a narrow Obama win based largely on improved economic growth in 2012. But Fair's economic projections now look quite optimistic.

Bottom line: It is hard to recall a presidential year when there were so many economic wild cards, any one of which could tip the election's outcome. On the other hand, it is hard to recall a weaker or more bizarre Republican presidential field. Which will prove decisive?

Despite what is likely to be a mediocre economic picture at best, and the demonizing of Obama by his opponents, and the disappointment in this president on the part of many of his most fervent 2008 supporters, by next November Obama may yet strike a plurality of voters as the safer and saner of the candidates. But any number of imponderables could upset that calculus.

Robert Kuttner is co-editor of The American Prospect and a Senior Fellow at Demos. His latest book is A Presidency in Peril.