Capitalism Has the Last Laugh (Again)

There can no longer be any doubt that the U.S. and global economies came out of the tunnel of the Great Recession into the light of an economic recovery in the middle of this year. The trouble is that most people don't see the light at the start of an economic recovery. Unemployment always continues to rise, sometimes up to two years after the recovery begins, and this has become more pronounced over time. Worriers, having been proved right in the immediate past, continue to worry. Some people make a living from worrying -- selling newsletters or gold coins and other alternatives to money, stocks and bonds. Others, with a dislike of the adverse moral and environmental consequences of capitalism, hope that the crisis will re-emerge and worsen thus undermining the very existence of capitalism.

The most reasonable argument that this is not a real recovery starts by observing that most of the economic growth in the world is a direct result of the stimulus measures undertaken by governments all over the world. The argument continues that the damage done to the ability of households and businesses to pay their debts will depress consumer spending and business investment for many years to come. This second point is reasonable but by no means indisputable. Consumers, especially in America, have repeatedly surprised everyone by bouncing back after economic contractions with new levels of spending and borrowing beyond previous peaks. Unfortunately, these worriers conclude, the spending stimulus packages generally only last for another year or two, as with the Obama stimulus which will essentially be over by the end of September next year, and the monetary stimulus measures have stopped growing and in some cases are already being cut back.

This last point, that the world's economies will start to collapse as soon as the current stimulus plans are finished, is equivalent to contending that illiteracy in America is about to skyrocket as most school budgets extend only through the coming year. The reason we have had such a quick recovery is that virtually every country in the world produced stimulus plans that were not only more multilateral than ever before but also more timely and bigger than ever before. In most cases monetary stimulus is already in its third year and fiscal stimulus is in its second year. Policy makers everywhere know about the Japanese mistake of cutting back on stimulus too soon in the Lost Decade and the American mistake in cutting back too soon during the Great Depression, each after five years of recovery. Given their unprecedented actions to date and their lavish attention to these historical mistakes it seems extremely unlikely that they will reverse the most successful stimulus ever, even faster than these previous misguided reversals.

If you want to be foreboding, just because it suits you or you hope to attract readers to your blog, here is something to worry about that you can also be angry about. As there can be no doubt that we are in a recovery, there can be even less doubt that the steps taken to get us here have been overwhelmingly crafted to benefit the rich and powerful. The public has been correct in its perception that the banks were bailed out along with other corporations which had been very badly managed, while workers, homeowners and most everybody else got a few crumbs from the bankers' feast. In a recent New Yorker profile of the wise five who provide daily briefings on the economy to President Obama, the usually careful New Yorker got suckered into presenting the Administration's defense of its economic policies as if it were reporting just the straight forward facts.

A long list of reasons is given for not "nationalizing" the banks -- where nationalizing is employed as a frightening synonym for making shareholders take the first losses, as they are supposed to do, and controlling the employment and pay of those who had created the worst economic crisis in the world since the Great Depression. All of the reasons are specious: after all, a large number of financial firms actually have been nationalized with the federal government investing more than the existing equity, guaranteeing vast amounts of debt and settling for owning only a fraction of the company. But the decisive argument apparently is due to an "insight" of the brilliant if emotionally volatile Larry Summers: when investors buy something with a lot of borrowed money, a decline in its price can lead to further declines as the investors are forced to keep selling to pay off their debts. At least the New Yorker did not call this an original discovery.

So the Geithner Plan was based on this insight. The banks were not insolvent. Their toxic assets were not toxic, just depressed by everybody's rush to pay off excessive borrowing. Never mind that these non-toxic toxins were securities backed by subprime mortgages that were experiencing predictable large levels of defaults; or that they had been sliced and diced into mortgage backed securities that had been wildly overrated by the corrupted rating agencies, that were understood by almost nobody and that were structured in a way which made it virtually impossible for anyone to renegotiate the underlying loans as lenders would normally do in such circumstances. If it weren't for forced liquidation to pay off the debts of banks and hedge funds, these securities would be worth much more. This was an idea Bush's Secretary of the Treasury, Hank Paulson, had clung to in 2007 and 2008; but he had not been able to make any use of it despite numerous attempts.

Geithner (and presumably Larry Summers, his former boss in the Clinton Treasury and virtual boss in the Obama economic policy regime) came up with the solution. If banks and hedge funds wouldn't lend each other the money to buy these questionable assets, the United States Treasury would do the job, lending "qualified" investors ten times as much money as they themselves invested to purchase packages of floundering mortgages. If financial risk addicts had run out of leverage, the government would be the drug supplier of last resort. Oh, and by the way, just in case nobody else thought these securities were worth as much as Larry Summers did, the government (i.e. we the taxpayers) also guaranteed these qualified (i.e. rich, powerful and experienced in high financial skullduggery) investors against losing even the small part of the investment that they paid for in purchasing these really not toxic assets. Is it any wonder that the depressed prices of distressed assets went up under this policy, which effectively bailed out banks and hedge funds at a cost yet to be known, but did little for the defrauded or unemployed homeowner who could not pay her mortgage? Yet, the New Yorker story implies, oblivious to all of these decisions, that the rebound in toxic asset prices verifies Summers' insight, when in fact it merely shows that the United States government is more credit worthy than Citibank or a sub-prime borrower.

The Federal Reserve and the U.S. government, mostly without any explicit authorization from Congress, have lavished trillions of dollars on buying stocks, bonds and toxic assets, guaranteeing debts and investments and effectively paying off Goldman Sachs and others for unregulated private contracts (read "bets") they had made with AIG, Lehman and Bear Stearns. All of these efforts and some of the tax cuts in the stimulus package are bailouts for the rich and reckless. Not only are they of questionable morality, they also are very inefficient measures for inducing an economic recovery. As a result Wall Street is on its way to an all time record breaking year for revenues and bonuses, while Main Street is left holding the bag with unemployment approaching and likely soon to exceed 10% and houses and stock portfolios worth about 30% less than two or three years ago.

This is because financial bailouts were about $3.5 trillion dollars, while spending on job creation and homeowner assistance was about $500 billion dollars. If another $700 billion dollars, or 20% of that $3.5 trillion bailout, had gone into more direct support for Main Street, unemployment today and a year from today would be much lower. As former International Monetary Fund chief economist, Simon Johnson, has been saying all year, the United States now closely resembles the banana republics it once derided for being governed by oligarchs and bankers.

In the 1950's William McChesney Martin, the very conservative Chairman of the Federal Reserve, summed up the Fed's responsibility as taking away the punch bowl when the party got going. Since then the policy mantra has been steadily transformed so that it can now be expressed as bringing out a fresh punch bowl when the first one is empty and the guests are in danger of sobering up. Although the collapse of leverage is the proximate cause of our problem, the resurrection of leverage -- which will inevitably collapse again -- is proffered as the solution. So here is the answer to the worrier's prayer; but only the far sighted worrier, as we must first have the rebuilding of the tower of leverage and the celebration of yet another new golden age before we can get to the collapse of that tower. There will be another crisis, perhaps as bad or worse than this one; but not for at least another seven or eight years.

Meanwhile, it is nearly certain that developed countries will continue at least a modest recovery for a number of years while most emerging economies resume quite rapid growth. Generally most stocks in the world are still reasonably priced given this positive economic outlook, while the protection that bonds offer against a deflation now seems unnecessary. Accordingly we are close to fully invested in common stocks given the guidelines in different portfolios. A number of specific areas are attractive, including exposure to improving consumption in the developed world and accelerating consumption in emerging markets; new technologies, especially Internet based, that are gaining market share; renewable energy; health care, especially outside of the United States or with high exposure to the consequences of an aging global population; and financial companies that will benefit from an economic recovery or the growth of emerging market consumption not to mention the policies we have excoriated above.

 

Comments

[SewaneeLeftist]

I have a brother who's a University Econ professor, and I understand very little of what he says, about like I understand this article.

From the little I understand, however, I'm not sure how this shows that capitalism has had the last laugh. To me, it looks like the only thing that has saved capitalism -- from itself, as the salvation of capitalism always is -- is that governments set aside capitalist precepts to use quasi-socialist initiatives to save capitalism. That hardly sounds an endorsement of capitalism.

Instead, why not admit that we need real democratic socialism to avoid the various catastrophes that keep on occurring with capitalism and avoid the enormous waste of resources and human creativity and avoid the enormous suffering of the poor and natural resources that come with capitalism, too?

The author is right that there are worriers invested in capitalist calamities occurring. However, no humane socialist wants the suffering to grow just so the system can be exposed for the state religion rather than economic system that it is. The suffering is not worth that to anyone who cares about the wellbeing of humanity.

Furthermore, that's way too close to the old tactic, applied by totalitarian parties from the left and the right of creating so much havoc and so much polarization that no neutrals or compromises exist and either the disrupting party creates so much chaos that the ruling party loses power OR the disrupting power assumes power as an alternative to the status

[Nuyorican21]

Interestingly enough, it was the pressure of the Cold War that enabled politicians to compormise numerous times from the 50's through the 70's, when oil prices fluctuated and fiscal and monetary dicipline was enforced. Each time an economic crisis came about, the executive and legislature were very much more effective from Nixon floating exchange rates and Johnson's Great Society. Now, kneejerk media outlets, downfall of American education, and the vast changes in financial culture brought about by the Reagan administration has brought us to a plutocratic kneejerk law-making process that is heavily corporatized. I don't care if you're conservative or liberal, we all can agree we've practiced corporatism lately, not capitalism.

*4 F-22 Raptors (not active in any warzone currently and in the near future) would pay for Health Care Reform now.

[SewaneeLeftist]

You're exactly right NYrican; I well remember (I expect you weren't even born yet), when Richard Nixon instituted wage and price controls. They didn't come close to working because he announced that they were for the short term, but because Nixon was a conservative who no one would ever suspect of endorsing redistribution of wealth, no outcry arose. Now we have a pragmatic moderate president with close ties to Goldman Sachs, yet who is astonishingly being called a socialist. Much worse world of political discourse.

And I feel nauseous when I think of the money we've wasted on the guns side of the guns and butter argument -- we could have eliminated poverty in this country and still had enough firepower to wipe out the human race at least three times over.

[Energizer2009]

Blaming the crisis on CRA or subprime lending is wrong: there simply were not enough subprime borrowers to cause a catastrophe of this magnitude. For that, you needed greed-induced leverage, a complete lack of ethics, and a set of parasitic financial institutions.

As we noted in April, 2008:

"With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic."

You also need a compliant (non functioning) regulatory apparatus, something we warned about in 1998:

"“The nature of financial market activities is such that significant dislocations can and do occur quickly, with great force. These dislocations strike across institutional lines. That is, they affect both banks and securities firms. The financial institution regulatory structure is not in place to effectively evaluate these risks, however. Given this, the public is at risk.”

See:http://twisri.blogspot.com/2009/07/bernankes-history.html

Why the market failed - http://twisri.blogspot.com/2009/03/why-market-failed.html

Adam Smith on the Current Financial Crisis - http://twisri.blogspot.com/2009/04/adam-smith-on-current-financial-crisis.html

What happened. What now. - http://twisri.blogspot.com/2009/04/commercial-and-investment-banks-used.html

To REALLY see what went wrong, take a look at page 6: http://www.sec.gov/rules/proposed/s71903/wmccir122203.pdf See page 2: http://www.sec.gov/rules/proposed/s71005/wcunningham5867.pdf

Also see: http://www.ethicalmarkets.com//wp-content/uploads/2008/12/financialbailoutcomment1.pdf

[henryberry]

No doubt, the technical factors of the stock market and banking/investment sector have strengthened. However, certain individuals in the financial sector (executives in certain corporations) have benefited wildly disproportionately, just as they did before the recession through the invention of outlandish investment instruments they could reap huge fees for peddling. These individuals are akin to war profiteers. Let's call them recession profiteers. Although as many have seen, with the government handing them vast sums of tax money, they hardly had to do anything at all to profit from the recession.

What is occurring in the improvements Zevin calls attention to is not a reinvigoration or correction of capitalism, but a continuation of the rigged financial system sustained by a similar corporatist mindset of government and the financial sector. Financial risk with the possibility of failure and the raising of capital for genuine economic activity and ventures adding to the country's wealth is the heart of capitalism. The U.S. has strayed from this--and authentic, classical capitalism is not coming back without radical change involving regulation, oversight of the financial sector, and recognition of and respect for real accomplishment rather than a succession of get-rich-quick schemes.

The improvements Levin points to are not signs of the restorative powers of capitalism, but indications that the U.S. isn't prepared or willing to return to capitalism.

[sposton]

This is an illusion of recovery sustained by the "gift" Summers and Co. gave to those who had brought us this disaster. This gift is just added to our grandchildren's tab. We have been engaging in a massive transfer of wealth from many to few but this adds an additional dimension of transferring wealth from the people not yet born to the current and future thieving few.

Basic error of Summer/Gei­thner/Obam­a economic "plan" is the attempt to be bring back the same system which is responsible for this disaster. This system is utterly bankrupt in every sense of the world. Even if we succeed in extending its life with an illusion of recovery the next series of economic tsunamis will surely help self-destruct this system once and for all. Even FDR, who was not a radical, understood that in order to revive our system we had to resort to a large number of innovative programs outside the economic orthodoxies of the time. Obama's economic team lacks such understanding and reminds me of the the people whose only tool is a hammer. To them everything around them begins to look like a nail. Lack of imagination, slavish adherence to outdated economic orthodoxies and the strong pull from the Wall Street to preserve the current thieving system only means a more precipitous decline in the future. It will take a miracle to avoid an economic meltdown within the next five years or so. We are running on faith fumes!

[satyriasis]

We have to revive the old order, at least for now. We need to transition away from it but in a controlled order and at a smooth and steady pace, not through an unexpected shock.

If don't revive the old system what else is there? Massive unemployment that's for sure. We don't have manufacturing here anymore so unlike the depression that is not a route towards recovery.

[sposton]

I would go along with you if this were indeed true. Once we restart the "old order" there will be no impetus for change and we will continue our collective downward march. You work the iron while it is hot.

Additionally, it is does not seem Obama has anyone around him who is actively working on alternatives for the future. It is the same old tired stuff just more eloquently packaged.

[seawolf77]

Growth is over. Cheap energy is gone and depsite the platitudes of the republican hegemony it wasn;t democracy or capitalism that created this "miracle" economy. It was the fact that we discovered fossil fuels and now that they are becoming scarce growth has headed for the exit. What to do what to do? Well for starters we can admit it. Then we can enact the oil depletion protocol among all countries and yes this means a world government becasue the choice is between that and a world war. Once word gets out that we are running out of fossil fuels there will be a mad dash to "grab" what's left. In other words war.

[satyriasis]

Good post. But that war has already begun. We invaded Iraq for that purpose. Now the battle over Africa is occuring. The US is setting up AfriComm to battle European and Chinese influence in the region's fight for fossil fuel.

[unitron]

If we hadn't bailed out the rich and powerful, they would have taken the rest of us and the whole system down when they collpased. So we had to hold our noses and do what was necessary at the moment.

Now that we've bought ourselves a little breathing room, we need to start separating our economy from their economy so that, to use an analogy, the next time the CEO goes to Vegas, they can gamble as much of their paycheck as they like, but not a penny from the company's treasury, and the company's finances remain untouched no matter how the dice tumble, the cards turn up, or the roulette ball bounces in the wheel.

[NoMoFearNoMoHate]

That's not Capitalism laughing, it's having a seizure while still critical on the gurney as Socialism tries to keep it alive with life support.

[BLBass]

Look at the Bush recovery in the beginning of the decade. The "jobs are a lagging indicator" trope got a lot of exercise then as well, but the actual result for which we waited so patiently (because it was unpatriotic to question anything!) was job growth less than that required to cope with population growth. That is not a recovery.

The simple fact is that *some indicators* of economic activity are recovering. That doesn't make a recovery true, it makes it possible. Perhaps we should update our definitions of economic recession/recovery, but more importantly we have to recognize that positive news is not license to halt expansionary spending. We can look toward slowing spending, but we cannot actually take that step until growth has reached "Main Street". I would suggest that job growth equal to labor force growth during the recession is the bare minimum to trigger any reduction in government involvement in supporting the economy.

[Rule Of Law]

Correct. There were not enough new jobs under Bush to overcome the recession he created with his tax cuts and increased military spending.

The fascinating parallel between then and now is that in both instances the Appearance of a recovery of sorts was maintained by--in Bush's case--massive borrowing that was booked on our GDP as growth, not debt, and in the current economy, by the bailouts and stimulus packages that pumped trillions into the market.

Both are unsustainable, and neither administration had an industrialization policy in place that would create the jobs needed for the consumer to do his expected part in the recovery. No jobs equals no money equals no recovery. Period. Claiming that jobs are a lagging indicator and that all is rosy is ostrich thinking.

[satyriasis]

Well said, rule of law.