05/06/2011 05:16 pm ET Updated Jul 06, 2011

Unemployment and the Deficit: The Disconnect

A recent Gallup poll shows that Americans view unemployment as the biggest economic problem facing the country. So why are Republicans letting Tea Party zealots put out in their name a draconian plan to cut the deficit that would do nothing to bring joblessness down?

Today's painfully high unemployment -- over 14 million jobless and millions more forced to work part time -- has nothing to do with budget deficits.

The surge in unemployment at the end of the Bush Administration had nothing to do with the budget deficits he ran every year of his administration.

Spending on Medicare, Social Security and aging Baby Boomers that the Tea Party deficit plan in its sights has nothing to do with joblessness.

The "war of choice" that George W. Bush opted for in Iraq has nothing to do with unemployment, although it is adding trillions to the deficit.

The Tea Party's focus on deficits is not about jobs. To the contrary, it is a way to shift attention from the real cause of joblessness -- egregiously greedy behavior by the American financial community and anti-regulation regulators -- to the government.

It burns me that the Tea Party invokes the history of patriots who threw British tea into Boston Harbor and ignores the history of a dozen American financial speculations that led to mass unemployment when they collapsed.

In the late 1980s, a speculation in housing on President Reagan's watch led to the collapse of almost a quarter of U.S. Savings and Loan institutions and required a $90 billion government bailout. The recession and unemployment that followed probably cost George H.W. Bush the presidential election of 1992.

President George W. Bush learned nothing from his father's experience. He and Alan Greenspan, the overrated chairman of the Federal Reserve, stood by and cheered a much larger financial speculation in housing from 2002 to 2007. The Great Recession that followed is the reason the U.S. has 8.8 percent unemployed today.

Tea Party Republicans act as though the 2002-2007 housing speculation and the unemployment that followed had nothing to do with them. They refuse to accept responsibility for cheering on the hucksters, the erstwhile "masters of the universe," whose wealth they would not touch. Like Huck Finn's drunken father, the Tea Party blames the "govment" when the problem is the culture of quick enrichment that they continue to encourage.

It is not the deficit that is causing unemployment. What happened is that private lenders loosened credit standards so that they could make more money. Taking advantage of peoples' trust, they made loans to millions to buy houses knowing that many of them would not be able to pay back the loans. These lenders then packaged the dicey loans into mortgage-backed securities and got rid of them. CEO's at the nation's leading banks, who should have known better or been better supervised had their institutions buy the risky securities because they paid high interest rates.

Many bankers only pretended that they knew what was in the packaged securities they were buying. They did not want to look a gift horse in the mouth. Wiser ones knew what was in the securities but hoped to sell them before others found out. They minimized in their minds, no doubt, the outsized risks they were taking to "earn" returns that would justify bloated compensation. Real students of American history -- although clearly not the Tea Party -- know the same thing happened in almost identical fashion in the late 1920s.

In 2007 and 2008 the gravy train stopped. The ordinary Americans who had been suckered into borrowing at high rates were unable to pay the lenders back. The mortgage-backed securities the banks had bought became unsalable and lost much of their value. The value of the capital in bank vaults, therefore, fell drastically reducing their ability to make loans to solid non-speculative businesses. The government had to step in to keep essential credit flowing to non-speculators. Unemployment soared in the housing industry, spread to raw materials linked to building, and then to manufacturing and the service sector.

Did this soaring joblessness have anything to do with government deficits? Absolutely not!
Alexander Hamilton was the American Founder who understood best what makes an economy work. He built the foundations of America's modern free enterprise system while serving as George Washington's Secretary of the Treasury. Hamilton had a friend, William Duer, who was speculating in government bonds in the early 1790s, and borrowing heavily to do so.

Hamilton had nurtured a market for government bonds because he understood that it would help the young country grow. He knew the difference, however between prudent investment and speculation. He warned his friend Duer repeatedly not to go too far.

Duer, like the "masters of the universe" the Tea Party is hiding behind the deficit smokescreen, did not listen. Duer lost everything when the speculation collapsed: He was not protected by corporate law that today limits liability, allowing modern speculators to stash gains away where the people they fleece can not get them. Duer was sent to debtor's prison where he was almost lynched by other New Yorkers whose money he had lost.

Hamilton, unlike the Tea Party zealots, took care of the country and did not pretend his businessman friend was innocent. He made sure that the banks that the speculators could not repay had enough money in their vaults to continue making worthwhile loans to others. He put customs and other government revenues in their vaults to tide them over until they had made up for the speculative loses. Lending for worthwhile projects continued and no depression followed. As for William Duer, he died in the debtor's prison 7 years later. Hamilton remained his friend but despite Duer's entreaties he would not get him out of jail or absolve him of responsibility.

There are lessons in this history that are lost on today's Tea Party-led Republican Party. They have not learned from Hamilton's behavior toward Duer 220 years ago that belief in free enterprise does not require us to believe that financial markets don't need to be supervised.

Hamilton also could teach them that government debt for real investments --- public works, education --- is worthwhile and is not, as they so foolishly say, just another word for "spending."

Hamilton led American troops in a dangerous assault on British trenches at the climactic Battle of Yorktown when he could have stayed out of harm's way. He had matching political courage that he displayed in building a tax system to fund the government, something a majority of Republicans have not had the political guts to vote for in three decades.

Most important, Hamilton understood that job creation depends on releasing the energies of all the people not on get-rich-quick speculations that benefit only a few sharpies. Sadly in the Tea Party distortion of American history real causes of unemployment --- the sins of financial wheeler-dealers like Duer left unsupervised --- are covered up by rhetoric about government spending, and the government whose vital role Hamilton understood gets smeared.