Bubble, bust, repeat...bubble, bust, repeat...bubble, bust, repeat...
For the last few decades, that's been the American growth recipe. The damage done by these cycles is evident in both the current downturn and the daily headlines featuring systemic failures large and small. But what may be unique about today's climate is that this dysfunctional process is clear to anyone willing to take close look at it. This should be especially notable to that group whose approval rating just hit record lows: the US Congress.
One reason for those in the tank ratings is that we're looking for smart, aggressive action on these issues that get policy makers ahead of the economic curve, instead of where they've been: reacting to every bit of bad news like deer in the headlights, pulling a new bailout plan out of their antlers (I was actually thinking of a different part of the deer's anatomy, but this is a family post).
What are "these issues?" What are the processes that generate the shampoo economy?
As is often the case, there's no single smoking gun. Instead, there's a bunch of bloody knives.
It starts with ideology (doesn't it always?). YOYO economics -- the "you're on your own" market fundamentalism that has a) dominated policy makers thinking and b) is impermeable to empirical facts revealing its failures -- convinces policy makers that deregulation of key markets is necessary to promote growth. They've even got the matrix algebra to prove it.
Next, investment begins to flow into some corner of these markets -- usually either financial markets, housing markets, or some exotic new product market (could be tulip bulbs, could be fiber optic cable) -- where returns have been above average. Next, as George Soros explains very compellingly in his new book, the process feeds on itself as turbo-charged investment flows lead to higher prices, which lead to more investment, higher prices, and the bubble is underway.
In this last episode, add a new dimension: a level of financial "innovation" that added growth hormones to the process. Some of these ideas, like shadow accounts that investment banks could legally keep off their balance sheets were just chicanery, but others were legitimately designed to diversify, and thus reduce, investment risk.
Take, for example, the process of bundling mortgage debt into "mortgage-backed securities," a debt instrument comprised of different parts with varying quality. The idea was to spread the riskier debt around so that its downsides would be diminished and offset by the higher quality stuff. But it clearly had the opposite effect, such that the bad debt infected the rest in ways that eluded both rating agencies and investors.
Part of the problem stemmed from the greater distance between the original lender and the ultimate debt holder, a development that requires stricter lending standards -- the exact opposite of what we got -- because market discipline is unlikely to punish careless lenders when they're not holding the loan. It's a good example of how the ideology and the market innovation fed off of each other in precisely the wrong way.
Note a key point above. The YOYOs will always argue "market discipline" is the ultimate regulator. That is, they'll do so until the weekend when the bank actually fails. Then it's handout time.
In this manner, the last two, and arguably last three recessions have been self-inflicted. They've been brought to us by exploding bubbles, in housing (today), IT (2001), and banking/housing again (1990-91).
The thing is, this tendency of financial markets to go off the rails is well known. Since Adam (Smith), it has been recognized that self-interest and greed must be checked with regulation. Of course, regulators always walk a fine line, particularly in financial markets, where innovation and leverage have long played important and useful roles. It is also the case that when disaster strikes, the tendency among policy makers can be to become too zealous and overcompensate, imposing regulations that go too far in restricting necessary freedoms.
Yet few would disagree that the pendulum has swung much too far in the direction of unregulated markets, and the results have been costly. They can be measured in macro, micro, and financial terms. Lending institutions are in the process of writing off hundreds of billions of dollars in failing debt. Millions of homeowners face foreclosure, and tens of millions face "underwater" debt burdens. The spillovers from the bursting housing bubble helped pave the way for what is surely a recession waiting to be officially labeled as such, one for which working families are uniquely unprepared, given their failure to benefit from much of the growth over the 2000s business cycle.
To not make some version of these changes would pose a greater threat to financial markets than those posed by the recommendations themselves. Investment analyst Michael Lewitt puts it well (pdf):
"[One] often hears the argument that too much regulation will force business offshore and render the U.S. financial industry less competitive. Our response to that argument is that institutions and fiduciaries in the end will gravitate to the system with the strongest and wisest regulatory protections. Moreover, we should be pushing the most reckless practices out of our markets and into other markets. We should be creating global competition over best regulatory practices, not worst ones."
Our system of borrowing, lending, and financing investments by both businesses and households is a national treasure, one which we have squandered in recent years. Excessive deregulation has thwarted the transparency that is integral to creating appropriate price signals. Risk has been consistently underpriced, contributing to bad underwriting, negligent risk management, and deeply damaging bubbles. When policy makers ignore these dynamics, as they have in recent years, our economy is put at great risk.
The time has come to re-regulate these markets. I've got some ideas which I'm planning to present in testimony to the Joint Economic Committee this Wednesday, and I'll be sure to post it on the EPI website as well. Nothing fancy, just obvious stuff regarding mortgage underwriting (actually, we've got decent rules already in this area; we've just been ignoring them), capital reserves (the faster and looser you play it, the more dough you need around when the deal goes bad), and transparency (if you're too big too fail, then Congress must oversee your market exposure).
Our worst enemy here is not over-reacting. It's doing nothing. Stay tuned.
Nice piece. I think of the regulatory system as the mechanism that perfoms a few very important functions.
1) It defines the rules under which companies in the "free market" compete. Note I did not say "constrains competition" - these rules simply provide the "operating instructions" under which everyone must figure out how to best compete.
2) It serves to balance the legitimate power and interests of private enterprise and the public. It ensures that companies do less of what they've been doing to such excess over the last couple of decades, i.e. stealing from the public domain and offloading legitmate costs of production back into said public domain - primarily our air and water.
3) It protects the "Commons," and it places legimate restrictions on the right of private companies to invoke the protections of the Bill of Rights (which were actually intended by our Founding Fathers to be ours and never theirs).
and 4) It ensures that private corporations - entities that are fundamentally amoral - must behave in ways that pay attention to a few of the values that the majority of us believe to be important. Back to that issues of the Commons again because that's what we've borrowed from our children. It forces amoral entities into semi-ethical practices.
The regulatory system is "Us." We are the regulatory system, it speaks with "Our voice," and it acts on "Our behalf." It's time to put the teeth back into
1) It defines the rules under which companies in the "free market" compete. Note I did not say "constrains competition" - these rules simply provide the "operating instructions" under everyone must figure out how to best compete.
2) It serves to balance the legitimate power and interests of private enterprise and the public. It ensures that companies do less of what they've been doing to such excess over the last couple of decades, i.e. stealing from the public domain and offloading legitmate costs of production back into said public domain - primarily our air and water.
3) It protects the "Commons," and it places legimate restrictions on the right of private companies to invoke the protections of the Bill of Rights (which were actually intended by our Founding Fathers to be ours and never theirs).
and 4) It ensures that private corporations - entities that are fundamentally amoral - must behave in ways that pay attention to a few of the values that the majority of us believe to be important. Back to that issues of the Commons again because that's what we've borrowed from our children. It forces amoral entities into semi-ethical practices.
The regulatory system is "Us." We are the regulatory system, it speaks with "Our voice," and it acts on "Our behalf." It's time to put the teeth back into that system.
If you want to live in a society without law, a monetary system, and medical science, you go right ahead. I hear the Amazon is very nice this time of year.
During the early 90s a writer in a popular magazine asked a series of general questions about the economy that still resignate with me: What is an economy, what is it for, who does it serve. He noted at the time that the thinking in vogue regarding the last question was that the economy served the capitalist and the rest of us would be served as the effects trickled down. About the same time, Jane Jacobs published a novelize treatment of the middle question where she proposed that an economy is a system of survival, a way of getting a living. I think hers is the better way of thinking about the economy.
Congress was pressured into passing the Telecom Deregulation Act by the Federal Reserve and others who wanted to make money supposedly in the name of free enterprise. After paying for the equipment and infrastructure over a fifty year year period, TelCos were forced to provide access to their property, at less than market rates, to anyone who wanted to be a telephone company while continuing to be restricted to their approved service areas and rates. This was not deregulation. It was government theft of private property. What it did do is create a need for money which the banks were more than happy to provide.
Our oil companies have changed into resellers of foreign oil, making more money than they ever have, and have no incentive to make the investment required to drill. The TelCos, which used to be investments that you could count on for retirement, no longer make money.
If the government had not been illegally regulating, they would not have been susceptible to pressure and none of this would have happened.
This country became great with the best economy in the world precisely because we were on our own without government interference. Then the government got involved.
The cause of the Great Depression was an unregulated economy. It was only when the government stepped in and began to regulate industry and finance that this country was able to recover, and, in fact, become the economic powerhouse of today. It is only because of conservative politicians actively undermining these regulations for the past 30 years that we've returned to a pre-Great Depression state economically. If there continues to be little or no regulation, well, you can imagine where we might end up.
And, I've never taught Constitutional law like Barack Obama, but doesn't it state in there somewhere that Congress has the power to regulate interstate commerce?
This isn't new, it's been going on since the '80s. It's just that the system's starting to run out of shells to swap and bubbles to exploit. There is an actual answer here - reduce expectations for quick and easy money and instead return to slower, but more solid and steady returns. Forget Wall Street and start investing in Main Street. Accept that a five or six percent return over time is better than a quick 25 percent that will end up in red on the balance sheet within a couple years.
I don't know how many are willing to give up the prospect of a quick buck - but if we're to get out of this mess it's going to have to be a long, slow, and steady climb.
Deregulation continues on it's cliff dive. Here in PA electricity is next, with an estimated 30% initial rise in rates. There must be oversight to protect us from the greedy but with such a greedy administration that will not happen.
Yo. So what your saying is all of these fat-cat real estate moguls and the Fed are all in cahoots with each other in their never ending quest to scam their way to riches or in other words "follow the American Dream".....
Actuaries, Underwriters, economists & financiers all knew what was eventually going to happen as a result of these shady busniess practices. Implosion. The collapsing under the weight of huge bad debt.
And now for the bailout. It's a beautiful scam. as good as any I've ever seen.
That is what leads a society to repeat its same mistakes over and over until it perishes.
I also think that coincidental to your points is "Confidence".
If there was a natural disaster, we could count on help from the government.
If there was an enemy posing a danger to us or the world, assuredly we would oppose it.
Now, after seeing that we were not prepared when a hurricane hit, that we start unjustified wars, torture others, or no longer support many Americans greatest aspiration to own a home, we have lost all confidence in our systems. Confidence comes from positive past experience, and our recent history has been negative to say the least.
We must turn these things around. Regulation of the economy is absolutely required, but so to is oversight of the other unethical actions we have taken of late, many of which, as you point out, are motivated by greed.
America is the still the greatest nation, but we put it at risk when we act as we have, and we begin to destroy the long held confidence we derive from our just, ethical, measured, and regulated ways.
Quote
"Our worst enemy here is not over-reacting. It's doing nothing."
At what point does doing nothing become the crime? Its endemic. And all major policy practically relies on it as a central ideological foundation.
Iraq: Do nothing. Result: Ensured Chaos extended conflict.
Afghanistan: Do nothing. Result: Extended Chaos.
Economy: Do nothing. Result: Financial Meltdown (for the majority)
Regulation (all arenas): Do nothing. Result: All sorts of chaos.
Natural Disasters: Do nothingn Result: Unnatural disasters.
Foriegn Policy: Do nothing. Result: A planet charging towards another (hat-trick for west) world war.
All of this is not down to sheer incompetence. Its deliberate. These people know that most of the chaos, if any, will not affect to top few percent of society. And they know that nobody can be put up against the wall for it.
Its plain old corruption given a new jacket for the 21st century.
I don't disagree with any of your points but one: "And they know that nobody can be put up against the wall for it." You should've substituted "think" for "know." 'Cuz if there's anything history teaches us, it's that members of the privileged caste -- the ancien regime, the autocracy, whatever you want to call it -- usually get purged in orgies of bloodshed as the eternally frustrated masses finally make someone pay for their misery. America's economic/political elites are living on borrowed time and if they don't step up to the plate, admit their errors and wrongs and part with a fairly big chunk of the filthy lucre they've stolen from the people, the people will take collection matters into their own hands.
Not that I'm advocating anything . . . .
As far as the Yoyo's go, I'm saddened to say nothing has changed, and probably never will.
Here's a little history from Ben Graham (no relation to Phoreclosure Phil) that backs up that point.
http://downside.com/news.html
"12.9.2000 - This isn't the first time
"When the going is good and new issues are readily salable, stock offerings of no quality at all make their appearance. They quickly find buyers; their prices are often bid up enthusiastically right after issuance to levels in relation to assets and earnings that would put IBM, Xerox, and Polaroid to shame. Wall Street takes this madness in its stride, with no overt efforts by anyone to call a halt before the inevitable collapse in prices. (The SEC can't do much more than insist on disclosure of information, about which the speculative public couldn't care less, or announce investigations and mild punitive actions of various sorts after the letter of the law has been clearly broken.) When many of these minuscule but grossly inflated enterprises disappears from view, or nearly so, it is all taken philosophically enough as "part of the game." Everybody swears off such inexcusable extravagances - until next time."
-- Benjamin Graham, in his The Intelligent Investor, p. 216. Sound like the current market? That was written in 1973. If this surprises you, buy the book; you need it."
And it's really worse, this is all based on a near infinity of accounting entries and now, electronic transfers.
McCain wants us to do more of the same.
During the Clinton admin he was instrumental in pushing for the odious "welfare reform," destruction of the Glass/Steagal Act (look it up in Wikipedia); and much de-regulation of the markets that contributed grossly to the mess we are in now.
Both parties carry lots of blame here...and the American people for being so gullible to expect something for nothing.
"To make the story overly crude, Congress repealed the law against usury. It was done in 1980 by a Democratic Congress, Democratic President. And, of course, the Republicans all piled on and voted for it. And that was the first stroke, only the first of many, in which they stripped away the regulatory laws from the financial system and from banking."--from http://www.pbs.org/moyers/journal/07182008/transcript4.html
Progressives try to learn from our mistakes. Regressives keep making the same mistakes again and again, so long as they are able to take the money and run. How bad must it get before American voters can see what stands right before our eyes? Our treasury has been plundered, our land has been polluted, and our youth are being punished playing policeman to the world. How much longer?
Another thing about those mortgage-backed securities you mentioned (AKA: CDO's), whose purpose was supposedly to spread risk by adding some not-so-good loans in with the good ones. The problems with CDO's is that no one knew how much of the good or the bad loans they were getting when they invested. They didn't have to tell anyone -- especially in the absence of regulations requiring it. In other words: No transparency. Investment firms bought these things upon the words and reputations of these shysters -- all of which was driven by the idea of getting 10% - 20% yields. And to do it, all they had to do was to hoodwink and then fleece those who could least afford it, by giving them ticking time-bomb 2-28 subprime loans.
The ultimate irony? The low-to-middle income families who are now losing their homes to foreclosure, got soaked. And so did the middle-to-upper-middle income retirees, whose pension funds and other large instituional investors took the bait. A lot of retired teachers, police officers and firemen.
Only the CEOs came away with anything is this deal. And with our money. Again.
Thanks Wall Street.
And therein lies much of the economic grief of the middle class... Economics is a language most of us, irrespective of education levels, simply don't speak. We're ripe for the picking, and there are many institutions out there with tall ladders.
A LOOOONG time ago my mother said " There is a great distance between being able to buy something and being able to afford it," and this is the guideline I've followed all my life. Consequently, while certainly not rich, I'm comfortable and relatively safe. And, as a teacher, I had access to several saving options/firms through the School District. I chose the most conservative with fixed conservative rates and have been very very grateful over time that I did.
My youngest daughter recently bought a house, and it was an enlightening experience. An immense amount of pressure was put on her to get an adjustable rate mortgage. Very tempting initial rates were dangled ( immorally, I thought ) but she held firm. Again, not reaching too high saved her tail...those initial rates have since doubled and she surely would have been in the soup.
The point here is that there are few ethical people in the money business, and, being overly simplistic, they earn THEIR money by taking ours.
Perhaps it's time for some real oversight for this industry, although I suspect it would amount to asking a fox to watch the hen house. Yummmm!!