Bubbles, Bailouts, and Free Money

The dawn of 2008 brought bad news on the economic front. One suspects the administration had seen the signs of a slumping economy long before but held its fire, hoping that consumers would provide a temporary fillip by going on a Christmas shopping spree. The annual Christmas retail binge has by now become so embedded in the national psyche that the news media spend the entire month of December reporting about little else — mainly because it requires very little investigative reporting, and running stock video footage of shoppers is easy to do. But the Christmas miracle failed to arrive as prophesied: the American consumer, up to his ears in debt, was tapped out.

Accordingly, in early January the president began cautiously poor-mouthing the economy (while of course extolling the underlying system's "fundamental soundness"), followed a week later by a speech from Federal Reserve Board chairman Benjamin Bernanke. The Fed chairman gave the usual assurance to his masters on Wall Street that he would drop interests rates through the floor if that was necessary to bail out asset values. [1] This promise, which is no more than a continuation of Alan Greenspan's standard operating procedure, was duly noted by business reporters. But beyond that, merely by the timing and subject matter of the speech, Bernanke was almost certainly signaling that there will be more bad economic news to come.

The president's coat-holders are now floating the trial balloon of a stimulus package (i.e., a legislative casserole full of special-interest tax breaks which could probably get through a Democratically-controlled Congress only if it had spending increases as well). The Democrats, who entered the majority last year vowing to restore fiscal responsibility through pay-as-you-go budgetary mechanisms that would require all new spending legislation to be deficit neutral, quickly forgot their sobriety pledge, and are floating stimulus proposals of their own — unpaid for, of course.

Over the coming months there will be much partisan rancor over competing proposals. If the past is any guide, Republicans will coalesce like iron filings obeying a magnet around schemes to give special interest tax breaks to their rich donor base. (All the while declaring spending to be bad because it increases the deficit — which it does, of course, but this has never prevented Republicans from spending maniacally on Pentagon toys. And tax breaks may be good or bad on their merits — chiefly judged by whether one is a recipient or not — but the GOP insists on clinging to the childish notion that any tax at any rate can be cut by any amount and revenue will increase. If that were true, setting rates at zero would yield infinite revenue).

House Republicans have in fact announced that their starting position for negotiations on a stimulus package is extension of the 2001 and 2003 tax cuts. Given that these rate cuts do not expire until 2010, the effect of this as a nostrum for an immediate downturn in the economy would be analogous to someone with an acute infection scheduling a hospital visit two years after learning that he was sick.

The Democrats, by contrast, have focused their search for a panacea on a combination of tax rebates and spending increases such as an extension of unemployment benefits or an increase in food stamp payments. This menu of fixes is the traditional countercyclical cure-all for recessions. Whether or not it makes any sense in the current situation is another matter.

Naturally, whenever talk of tax breaks or spending worth roughly $100 billion heats up, K Street is sure to notice. Congress Daily, the Racing Form of Capitol Hill, printed an amusing article about Washington lobbyists salivating over the prospect of all that loot. "As talk spreads of a measure in the range of $100 billion that could include a hefty helping for business, a downtown free-for-all has erupted, with various trade groups jawboning the administration and lawmakers to include their favorite provisions in the package ... Even as they promote their pet projects, several veteran lobbyists warned against excessive grabbing..." [2] Alas, K Street restraining its greed is like expecting chastity in a bordello.

Most reporting of the economy in the mainstream media, just like reporting on political campaigns, focuses on short-term, "horse-race" issues, with very little discussion of long-term, underlying factors. Almost completely absent from the debate about recessions and stimulus packages is any recognition that all of the nostrums variously offered by the Federal Reserve System, tax-cutting Republicans, and free-spending Democrats are essentially similar, and may not be suitable to a recession that is less cyclical than structural.

The factor that best characterizes the American economy of the last decade is debt: government debt, consumer debt, leveraged corporate debt. According to the Office of Management and Budget, gross federal debt is just over $9 trillion, a 60-percent increase since 2000. The United States sucks in about two-thirds of the savings generated by the rest of the world to feed its over consumption of goods and services relative to its real wealth. The old saw about how deficits didn't matter because "we owe it to ourselves" is no longer true. Each dollar in new debt is now a foreign claim against future wealth. The growing debt, in turn, sinks the dollar further. There is no need to expatiate on the extent and implications of this growing debt imbalance; der Spiegel has done it for us. [3]

This debt imbalance is a symptom of the long-term financialization of the U.S. economic system, and is closely related to its ongoing deindustrialization. Countercyclical panaceas — be they interest rate cuts, tax cuts, or spending increases — will have about as much efficacy in addressing the fundamental imbalances as an aspirin for a brain hemorrhage. A more appropriate pharmacological analogy might be to say that they resemble an attempt to cure morphine addiction by another dose of morphine.

After all, we already have an enormous stimulus package in place: a three-quarters of a trillion dollar current account deficit, a $200-billion Federal deficit, and a weak dollar. How much more inducement to over consumption and debt do we need?

One of the most pernicious effects of an economy that runs on debt, rather than financing investment and consumption primarily out of savings, is that it resembles a classic Ponzi scheme, where there is a mad scramble at the end to avoid being the last person holding the debt. [4]

As Countrywide brought down the housing market in Samson-like fashion, homeowners were hurt, builders saw their business slump, and banks took multi-billion dollar losses, Countrywide chairman Angelo Mozilo could feel a little more secure: he had already pocketed $410 million in compensation. When Bank of America completes its acquisition of Countrywide, Mozilo will get an additional $112 million. [5]

Mozilo, however, is not alone to blame. He had help from higher up. As we have already written, the free money illusion, in the form of artificially low interest rates, had fueled the housing bubble in the first place. [6] The chief architect of that policy was Alan Greenspan, who in turn was following policies inaugurated at least as long ago as the 1920s, when Andy Mellon at Treasury and Benjamin Strong at the New York Fed fueled the stock bubble with artificially low interest rates. Greenspan even went so far as to recommend that people with fixed mortgages might want to switch to adjustable rate instruments.

And where is Greenspan now? He will advise Paulson & Co., a hedge fund firm that profited from the collapse of the subprime mortgage market that Greenspan helped precipitate. [7]

Government institutions have been at the bottom of one of the biggest debt-leveraged wealth transfers in history. Millions will be hurt directly; the rest of us will be compelled to pay indirectly, through higher taxes or inflation. Only a favored few will reap the dividends. This is the essence of state capitalism or, if you will, fascism.

Many persons wrongly suppose fascism to be a foreign political ideology. Still others regard it as a fashion statement involving black uniforms and Luger pistols. It is neither. Fascism is a business strategy whose simple, consistent, bludgeoning rationale is, privatize the profits and socialize the losses. Friedrich Krupp's inspiration is now Halliburton's modus operandi — or Countrywide's. Where Halliburton's pot of gold is no-bid government contracts with escalation clauses, Countrywide's is an "independent" Federal Reserve System propagandizing for them, and rigging the rates.

* Werther is the pen name of a Northern Virginia-based defense analyst.

[1] "Financial Markets, the Economic Outlook, and Monetary Policy" January 10, 2008, Ben Bernanke, luncheon address.

[2] "K St. Lines Up For Slices Of Stimulus Pie," January 15, 2008, Congress Daily, (subscription required).

[3] "The Dollar Nosedive: Why America's Currency is the World's Problem", November 30, 2007, der Spiegel.

[4] Just as it is said that all movies are reducible to five basic plots, all financial scams are ultimately reducible to two types: the Ponzi scheme or debt pyramid; and the complex transaction, which makes the flow of money so confusing that the innocent victim (or the regulator) cannot hope to know what is going on. The mortgaged-backed securities industry combined these two scams into an elegant package.

[5] "Big Payday Awaits Chairman After Countrywide Sale," January 12, 2008, Frank Ahrens, Washington Post.

[6] "Now He Tells Us!" September 18, 2007, Werther, Electric Politics.

[7] "Alan Greenspan to Join Hedge Fund," January 15, 2008, Reuters.