The last week has witnessed phenomenal political & economic events. Observers, including every pundit under the sun and businesses around the planet, have stood transfixed by a dramatic series of negotiations over a plan that would transform America's economy.
Henry Paulson, the Treasury Secretary and former Wall Street banker, initially proposed squandering even more than $700 billion of taxpayer money -- enough money to fund the Department of Education for the next 115 years -- to buy bad loans from failing banks.
The audacious proposal has inspired rampant criticism from all sides: ideological free market conservatives argue it represents socialism; progressives rail against its offensive distributive implications and its proponents' hypocrisy; the financial sector has argued it places too much power in the hands of the Treasury Secretary; and economists say it won't work. Each of these criticisms is fully justified.
Only one argument meaningfully favors the plan: its reported necessity. But in fact, the scheme can't possibly work without abusing taxpayers. At best, it could help ease the nation's eventual recovery from an increasingly inevitable depression - quite likely, one the likes of which few people alive can remember. But it won't keep our economic chickens from coming home to roost.
And while the bill's many economic injustices have faced criticism, one in particular has largely escaped notice: its complete disregard for, and financial abuse of, 100 million Americans who rent their homes.
Making it Up as They Go Along
In addition to writing his column for The New York Times, Paul Krugman is also a world-renowned economist who has taught at Yale, Stanford, MIT and Princeton, where he specializes in studying financial and currency crises. He noted when Paulson first introduced his plan that, "after having spent a year and a half telling everyone that things were under control, the Bush administration says that the sky is falling, and that to save the world we have to do exactly what it says now," without delay. Dean Baker of the Center for Economic and Policy Research agrees that "Henry Paulson...totally missed [precursors to the current crisis], and has been wrong about almost everything."
Yet, roughly two weeks ago, "the realization...that American capitalism was going through something historic -- and not in a good way," prompted a plan that "may redefine Washington's role in the marketplace for years."
Paulson's initial proposal would have granted him unprecedented authority over a $700 billion revolving pool with which to purchase bad loans from failing banks -- at full price and without any equity for taxpayers.
According to Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, Paulson would have gained the authority to "make any loan he wants under any terms to any entity or individual in America that he thinks is economically justified." Because the plan shielded Paulson's decisions from review by any court or administrative agency, Krugman interpreted it as a "sheer demand for authority: give us total discretion and a blank check....There was no explanation of...why we should believe the proposed intervention would work."
After the original plan was ultimately amended to accommodate various concerns raised by Democrats, a "revolt" by House Republicans on Thursday derailed the compromise between the White House and congressional leaders. In its place, House Minority Leader John A. Boehner (R-OH) proposed an alternative plan based on government insurance for failing mortgage-backed securities, rather than outright state ownership. On Friday, Rep. Eric Cantor (R-VA), the lead author of Boehner's plan, admitted that it was unworkable.
After lawmakers and the President got "back on track," marathon negotiations over the weekend culminated in a consensus that would reportedly find bipartisan support. But it was rejected on Monday by Republicans in the House of Representatives, inspiring a massive stock market crash in which over a trillion dollars evaporated and which continues to "ripple across the globe."
While markets around the world reeled from news of the House's vote, the unfortunate reality is that no economic stimulus plan can shelter the U.S. economy from failure.
A Discredited Administration's Latest Ruse
The $700 billion requested by the Administration for Paulson's bailout plan dwarfs even the cost of the Iraq War, which offers a host of eerie parallels. Back in 2002, the Administration fired Chief Economist Lawrence Lindsey for forecasting that the Iraq conflict would cost as much as $200 billion, instead promising that it would cost only $50 billion. The White House's error attained an order of magnitude, as the war has cost nearly $600 billion so far, not to mention over 4,000 American lives, those of nearly a million Iraqis, and an untold number of physical & psychological wounds suffered by survivors in both the U.S. and Iraq, as well as their families.
Paulson's equally half-baked bailout plan deserves the skepticism it has received.
Like those offered before the invasion of Iraq, the Administration's official cost estimates are unreliable. Some observers, like Daniel Alpert of Westwood Capital, argue that "when you add up all the problems in the residential housing market still to come -- further erosion of housing prices, mortgage foreclosures and so on -- we are going to need another $1 trillion of write-downs."
Uncertainty is even greater on Wall Street today than in Iraq five years ago. Questioning "What's All This Stuff Worth?", The New York Times explained that the bailout involves "troubled investments that even Wall Street is struggling to put a price on." Debt portfolio manager Andrew Feltus suggests the price taxpayers pay "might be 20 cents on the dollar or 60 cents on the dollar, but we won't know for years."
Under these conditions, absurd notions that taxpayers might conceivably profit from the bailout are naive.
Beyond its uncertainty, the Administration also appears as disingenuous as it did on Iraq. Five years ago, officials cried wolf about weapons of mass destruction that were never found. Over the last week, many of the same people raised alarms about an all-too-real financial crisis, but then proposed a plan that would have lined Wall Street pockets, advancing the crony capitalism favored by the Administration elsewhere.
Its very willingness to even recognize the crisis underscores the Administration's lack of credibility: "Compare their dire proclamations with their outright refusal to even entertain the notion of a recession as little as seven months ago." At least one economist has confessed a "sneaking suspicion...that they started [the current crisis] with a determination to throw money at the financial industry, and everything else is just an excuse." Economists concur even across the political spectrum: Allan Meltzer, a monetary policy expert at Carnegie Mellon and former economic adviser to President Reagan, characterized the Administration's rhetoric as "scare tactics to try to do something that's in the private but not the public interest. It's terrible."
Finally, there is the audacious hypocrisy of "people who have spent their careers arguing that government is in the way of progress -- that its role must be pared to allow market forces to flourish -- [now] calling for the biggest government bailout in American history." The "revolt" within the GOP House caucus that blocked the bailout on Monday was prompted by outrage over precisely this double standard. Rep. Ron Paul (R-TX) confessed, "I don't know who the conservatives are and who the liberals are."
Like the occupation of Iraq, the bailout plan forces the American people to pay for the Administration's errors, in order to place a band-aid on a doomed financial system whose failure is now inevitable.
A Drop in a Bucket...
Our nation has already fallen off a financial cliff. According to Roger Kubarych, former chief economist at the New York Stock Exchange, "Historic events over the past two months have fundamentally changed the US financial landscape, and additional shocks to the system are likely....[B]old action didn't calm financial markets, far from it." In fact, "[t]he bailout discussions came on a day when the Federal Reserve poured almost $300 billion into global credit markets and barely put a dent in the level of alarm."
Krugman (the scholar of economic crises) predicts that the Paulson plan would fail to achieve even its core aims, even setting aside the various economic problems that lie well beyond its scope. "[I]t might -- might -- break the vicious circle of deleveraging....[but e]ven that isn't clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure."
Moreover, the plan addresses only one of several structural problems pervading the financial system. "Even if it works, the system will remain badly undercapitalized. ....[T]here will be $800 billion or more of real...losses on home mortgages. Only around $480 billion have been acknowledged by financial institutions so far. So even if the fire-sale discount is removed, we'll still have a crippled system. And Paulson is offering nothing to fix that...."
Finally, Paulson's earlier efforts to limit the crisis may have made it even worse. Describing it as a "Hail Mary pass," business journalist Joe Nocera observes that "[t]he rescue of A.I.G. further undermined confidence because....[it] suggested the Treasury Department was as confused about what to do as the rest of us. So rather than help solve the crisis, the Treasury Department has actually contributed to the biggest problem...an utter lack of confidence." The AIG bailout also reflected conflicts of interest that further undermine Paulson's credibility.
...With a Hole at the Bottom
Recall that the "bad loans" from which Paulson proposed to rescue banks are mortgages on which homeowners will likely default. The bailout plan does nothing to address the underlying reasons why people are having trouble paying their mortgages. It also does nothing to stop banks from pursuing the same -- often predatory -- practices that got the economy into this mess in the first place.
The crisis prompting the bailout remains the tip of an iceberg, as faults pervading the economy stretch well beyond the financial system. Put simply, "[t]he U.S. consumer is under stress. The unemployment rate has climbed above 6% and anxiety about job stability is high....Wage gains are barely keeping up with inflation. Housing prices are still falling...." Even without the current crisis in the credit sector, consumer spending -- the "main engine" for economic growth -- would continue to weaken. At bottom, several fundamental weaknesses threaten the U.S. economy.
Fist, and most important, unemployment is "soaring" across the nation, even in geographic areas and industrial sectors that were recently robust, like Silicon Valley and the tech industry. Moreover, joblessness is even more troubling than it might seem, since official statistics systematically understate the extent of real unemployment by excluding three large groups of workers: part-time workers seeking full-time work; workers employed in jobs that fail to leverage or reward their training; and discouraged applicants who have stopped seeking work.
Household debt has also reached unsustainable levels. The household savings rate dropped from over 10% of disposable income, in the 1980s, to a record low of 1% earlier this decade. At the same time, household debt has risen, from "roughly 65% of disposable income in the early 1980s, to 80% in the early 1990s, to 95% in 2000...." Earlier this year, BusinessWeek exclaimed that household debt has gone "through the roof," amounting to "almost $14 trillion, nearly equal to the annual output of the U.S. economy." The combined debt of households and the federal government now amounts to over $23 trillion, or 168% of GDP, "far higher even than in the brief spike during World War II."
Working families suffer declining purchasing power for other reasons, too. The credit crunch emerging in the wake of the crisis is "further crimping budgets and family spending" by restricting access to capital. Despite various "indirect subsidies," over 40 million Americans lack health insurance, which not only adds further uncertainty and depresses spending, but also the foremost catalyst of bankruptcy. The healthcare and credit crises find further fuel in the rising costs of higher education, as well as worker-management pay differentials that have grown a hundred-fold over the last generation. Put simply, Americans make less money than we used to, yet we (sometimes by necessity, but more often by choice) spend more.
Ultimately, "even if by some miracle the financial meltdown could be resolved tomorrow...powerful forces already at work...will suppress business activity. The failure of several more financial institutions would make things somewhat worse; but saving them would not make economic prospects much better."
Berkeley economist Barry Eichengreen forecasts unavoidable budget deficits, higher taxes to service that debt, higher interest rates and more strictly regulated banks that will lend cautiously. "We've had a decade of relatively successful economic growth and have been living beyond our means," Eichengreen said. "Now we'll have a decade of the opposite. It's payback time."
Protecting the Little Guy?
Democrats called last week for attention to the needs of homeowners, arguing that an effort to save banks should not ignore "the little guy." Speaker of the House Nancy Pelosi was blunt: "We will not simply hand over a $700 billion blank check to Wall Street."
The compromise that eventually emerged from the White House bore few mechanisms to concretely help homeowners facing foreclosure. For instance, a proposed provision to allow bankruptcy judges to alter the terms of troubled loans was rejected. Instead, the bill merely invites banks to consider relaxing loan terms and provides some tax breaks for homeowners facing foreclosure. (At the same time, incidentally, the GOP's latest assault on voting rights has taken the form of seeking to disqualify voters who suffer foreclosure).
Solutions that actually help borrowers secure more favorable terms from their banks would be innocuous. In sharp contrast, the Administration planned to buy loans en masse from the banks themselves, in exchange for equity warrants that could theoretically be exchanged for stock if the banks recover in the future.
However, more robust protections for homeowners can hold troubling implications. On the one hand, individuals & families deserve government support more than banks. But distributive concerns raised by most observers overlook the one-third of Americans who rent our homes.
Renters Take it on the Chin: Moral Hazard & Distributive Injustice
Renters - roughly 100 million of us - pay taxes just like homeowners. In fact, we pay more taxes, since homeowners receive massive government subsidies through tax deductions for mortgage interest. Yet, while proposals for mortgage relief (such as the rejected measure that would relax bankruptcy rules) would help homeowners whose assets are threatened by the downturn, the most renters have been offered is the right to remain in our homes should our landlords suffer foreclosure.
Why should renters bear a disproportionate burden of insulating banks from accountability for making bad investment decisions -- or homeowners, for their's?
According to market principles, banks should bear the responsibility of their poor risk management. Rewarding failure ("moral hazard" in the language of economists) is untenable in a market economy. Outrage at the idea of the government paying banks for failing was one issue prompting the revolt by House Republicans that sank the bailout.
Peter Goodman explains that "[t]he financial system got to its dangerous perch by betting extravagantly on real estate. When housing prices began plummeting and borrowers stopped making payments, financial institutions found themselves with huge inventories of bad loans....These were the investments that Wall Street bought, sold and borrowed against in cooking up the money it poured into housing." Beyond being greedy, banks may stand at even greater fault: the "possibility of fraud" has prompted investigations by the FBI of several firms that have sought government assistance, and federal housing and Treasury authorities have criticized predatory lending techniques such as "deception or fraud, manipulating the borrower through aggressive sales tactics, or taking unfair advantage of a borrower's lack of understanding about loan terms."
Like banks, homeowners accepted "risk, an essential part of capitalism," when choosing to buy their homes. Conventional wisdom may posit that real estate prices never go down, but no rationale suggests government price supports. Like the banks that extended them loans beyond their means, borrowers made decisions about how to allocate their capital that proved to be catastrophically bad.
In contrast, we renters look pretty smart these days. Or at least we did, until the bailout proposed to punish us for correctly opting not to invest in an unsustainably inflated market and foregoing the capital appreciation enjoyed by those who profited (often immensely) from the speculative bubble. Driven by recognition that the "bailout requires responsible Americans to pay for the acts of greedy bankers, mortgage brokers, flippers, and over-extended home-borrowers," some 60,000 have signed the petition at www.angryrenter.com, which decries "whining from reckless home borrowers and their banks."
On the one hand, the blatant unfairness in rescuing corporations that pay lavish salaries to rich executives, while letting working families suffer, has raised predictable outrage. "How is it that the administration and Congress, which have not tried to find huge amounts of money to, say, improve the nation's health insurance system or repair bridges and tunnels, can now be ready to come up with $700 billion to rescue the financial system?"
On the other hand, banks are so deeply embdedded in the economy that their failure will hurt everyone. "[I]naction...could imperil the retirement savings and other investments of Americans who are anything but rich."
That's true. That is also precisely the point that fiscal liberals have been making for years: we live in an interdependent world in which one's collapse inevitably threatens others.
But then why bail out banks -- or for that matter, even homeowners -- to the exclusion of renters also impacted by the economy's collapse? Many kinds of assets are deflating in the current environment, not just home prices. Homeowners may find themselves holding less and less equity in their homes as housing markets erode, but renters also bear costs. We endure losses in our retirement savings and other non-housing investments; compete for housing in an increasingly tight rental market "tough for those looking for housing...[but] great for landlords"; and as the credit crisis deepens, face dim prospects of getting mortgages to purchase homes in the future.
Like some homeowners who suffer foreclosure, renters impacted by the country's economic crisis will face a litany of their own. Some will lose their jobs, others will confront catastrophic medical bills, and some will end up on the streets, where they will face disproportionate risks of mental illness, addiction, crime and sickness - each of which entail economic externalities that affect all of us. For instance, emergency room visits stretch hospital budgets, and crowded jails & prisons force states to pump taxpayer dollars into corrections.
The Economic Emperor Has No Clothes
As American's banking system has visibly crumbled, so has the conservative ideological establishment. First went its principles, as the attachment to free markets was jettisoned by proponents of the Paulson plan. Then went its credibility, as the deregulation long championed by conservative ideologues emerged as a principal cause of the crisis. Then went its political power, as House Republicans who remained ideologically consistent obstructed a consensus (on however ineffective and unfair a solution) between a President of their own party and the bipartisan congressional leadership.
Laissez faire capitalism now appears as bankrupt as Lehman Brothers.
While a lot of Americans hammered by the meltdown will likely join them, the proposed bailout is no solution. It can't stop the crisis, and won't help homeowners. And even if it did, it would still throw 100 million Americans who rent their homes to the economic wolves.
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