May 2009
Like most of you out there, I feel bewildered when I listen to the policy makers’ explanation of the economic crisis, or read about their plans to get the economy back on track. I consider myself a person of reasonable intellect. I teach political economy, and write about related subjects. But I had to read Timothy Geithner’s “final plan” for the toxic assets owned by our troubled banks a couple of times before I could say, “OK, I get it.” After all, the plan is not that complex. It works the following way. We beg big hedge funds to kindly take our money—“borrow” the money at low rates—and buy these toxic assets. We will get the money back if the asset values increase. Not a bad deal. Heads, the hedge funds win, and tails, the taxpayers lose, Paul Krugman would say.
A cursory look at the names, and the acronyms of some of the new initiatives and special facilities the government invented to deal with the crisis is enough to make anyone’s head spin. So far, we have managed to spend billions of dollars—and without any results, I mind you—through the Troubled Assets Relief Fund (TARP), the Term Asset-Backed Securities Loan Facility (TALF,) the Term Auction Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (try to say the acronym ABCPMMMFLF), the Money Market Investor Funding Facility, and others.
With all these facilities and expenditures, the crisis continues to destroy jobs, break up families, and push more people under the poverty line. The U.S. continues to shed around 600,000 jobs every month. We are beginning to see tent cities in California and elsewhere in the country. Yes, these are working people who could no longer pay rent.
Elsewhere in the world, the situation is even worse. An estimated 30-50 million more people will be unemployed in 2009 compared to 2007, according to the ILO. Some 200 million people, mostly in developing economies, could be pushed into poverty if rapid action is not taken against the crisis. According to the World Bank estimates, additional 22 children will die per hour in the world throughout all of 2009 because of the crisis.
How did we get to this point?
We are experiencing the final chapter of a postmodern coup d’état against the institutions, laws, norms, and codes of conduct that shaped the American society for years after the Great Depression. The seeds of the crisis were planted a log time before the housing bubble and the sub-prime scandal, and before Bernie Madoff and other Wall Street high rollers ran wild with our money.1
A New Deal, A New America
“When there was despair in the dust bowl and depression across the land,” said Barak Obama in his victory speech in Chicago, the nation conquered “fear itself with a New Deal, new jobs and a new sense of common purpose. Yes we can.”
Roosevelt could not have imagined such lasting legacy when, facing a 25% unemployment rate, mass poverty, and a total collapse of the banking system and the economy, he decided to do the unthinkable, to defy the dominant economic gospel of his time, and violate the laws of the market place. Following the spirit of the unorthodox path advocated by the young English economist John Maynard Keynes, FDR increased the role of the government in the economy through the implementation of an aggressive Public Works Program, regulated banking, passed the social security act, supported progressive labor laws, and helped strengthen labor unions. He broke taboo.
The result was a mounting budget deficit. The opposition attacked. Intimidated, Roosevelt tried to balance the budget during his second term in the White House. The economy collapsed. It was at that time that World War II came to his rescue. It gave FDR an acceptable excuse to increase public spending. War and patriotism helped Roosevelt finally tame America’s gravest economic crisis. Roosevelt became the first war-Keynesian in American history.
While taming the crisis, Roosevelt and his New Deal policies changed America in profound ways. We saw the birth of new norms, institutions, and rules of conduct. Unions were strengthened. The National Labor Relations Act gave American workers the right “to self-organization, to form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in concerted activities for the purpose of collective bargaining or other mutual aid and protection.”
Helped by the new power of unions, a large section of American workers enjoyed a middle class life style. Their pay and other benefits grew, on average, 2.5 to 3% a year, keeping pace with increase in productivity. The real median family income doubled. By the mid 1950s, almost half of American families were considered middle class.
To pay for his policies, Roosevelt had no choice but to radically change the country’s tax system. The top tax rate increased from 24% in the 1920s, to 63% during the first Roosevelt administration, and 79% during the second administration. It reached 91% by the mid 1950s. The average federal tax on corporate profits rose from 14% in 1929, to 45% in 1955.
America was milking the very rich to feed the rest of the country. And, contrary to the prevailing belief today, higher taxes did not stall economic activity. They did not end creativity and technological progress, or impede productivity. The whole nation prospered. Industry grew, and citizen’s standard of living improved. America became a more equal society. By the mid 1950s, the real after-tax incomes of the richest 1% of Americans were 20-30% lower than what they had been in the 1920s. The real incomes of the top 10% had declined by 50%.
The New Deal also created a more democratic society by allowing a larger percentage of the Americans benefit from the fruits of economic activity, and by giving voice to American workers. It made America a more democratic country by creating institutions and norms that changed the balance of power between the large corporations and the rest of the society, and by making the government responsive not only to the demands of the very rich, but also to the needs of other less fortunate citizens.
The New Deal was the culmination of a long battle for the future of this country. Forced to retreat for some years, the losers returned to the foreground in the 1970s. They returned to dismantle the progressive institutions of the New Deal, and replace them with new norms and institutions that would shift the balance of power to a small power elite at the top of the American corporate empire.
The Unholy Alliance
A miracle gave the Anti-New-Deal movement an unexpected boost in the mid 1970s when globalizing American corporations entered the battle for a new era of deregulation. World War II gave legitimacy to the New Deal; globalization helped its destruction.
Organizing to expand across the globe, large corporations fought for the removal of regulations within countries, and lobbied for the freedom of cross border movement of commodities and physical capital. Spending money in campaign finance, and lobbying, they bought new friends in the government, and transformed public policy into an unchallenged instrument of corporate interest. Corporations took over American politics. The Anti-New-Deal movement had found its perfect bedfellows, powerful corporations pushing to dismantle the legacy of the New Deal.
Globalization opened the economic front for an all out fight to reorganize America. Irresistible, tempting, and sexy, it soon became synonymous with progress, the key to heaven on earth. The Americans embraced a fairy tale, a pack of make beliefs wrapped in gold, and sold to them by policy makers, economists, and other “experts” under the name of free market globalization.
The battle for the control of public policy reached its turning point with the election of Ronald Reagan. Having found a generous uncle in the White House, large corporations became more confident, more aggressive. Now it was time to win friends within the Democratic Party. Expanding their net, corporate lobbyist showered Democratic lawmakers with money. Victory came without difficulties. Bill Clinton—the biggest pro business president in U.S. history according to his one time Secretary of labor, Robert Reich—turned the party of the New Deal to one behind some of the most sweeping post-Roosevelt deregulations. By the time Clinton left office, the Democratic Party had totally abandoned its New Deal legacy; it had become a party of free trade, and market “liberalization.”
The result was a shift of power from workers and ordinary citizens, to the power elite in charge of big business, and the gradual destruction of the society that was built on the institutions and norms of the New Deal. By the 1990s, we were all free marketers, champions of unfettered market forces in the quest for universal happiness. America was bathing in the holly waters of free markets.
Large corporations unilaterally broke the social contract between the unions and capital. They pealed off workers benefits, demanded wage cuts, and reduced the number of full time and regular employees. Strong unions, they told us, hindered our national interest, and constrained our ability to beat the hard working, disciplined, and repressed Chinese workers. Fighting to win the battle of international competition became a new form of patriotism. Victory was not possible with strong unions.
“The globalizing corporation made unions an enemy of progress. Bill Clinton championed the creation of a flexible labor market—corporate ability to freely navigate between part time work, temporary work, and non-union work—in America. Labor market flexibility was soon a new orthodoxy, preached by the economist, the media, and policy makers.
Countries such as Japan, with two-tiered work forces in which an army of temporary workers with few protections toil alongside the mollycoddled folk with many, will need to narrow that disparity by making the latter easier to fire. The euphemism for that is “flexibility”. The bare truth is that the more easily jobs can be destroyed, the more easily new ones can be created…Governments will have to switch from policies to support demand to policies to make their labor markets more flexible. That is going to require fancy political footwork; but politicians will have to perform those steps, because if they fail to, they will stifle growth.”2
Anti unionism became a powerful American ideology. The result was devastating for labor. The unionized labor within the manufacturing sector declined from 39% in the 1973, to 13% in 2005. The overall rate of unionization in the economy declined from one-third, to only 8% of the labor force.
The real average hourly wage in the non-agricultural sector decreased from $8.9 in 1972, to $8.3 in 2007. Average family median income increased slightly in these years, mainly because of the entry of women into the labor force, and the additional source of income for many families. Meanwhile, on the average, American worker’s average output per day of work was substantially increased because of the computer revolution and other productivity-enhancing technologies. According to Paul Krugman, the typical worker’s income would be 35% higher than it was in the early 1970, if wages had kept pace with gains in productivity. Workers’ earnings no longer followed productivity growth. It was only after the outburst of the current crisis that the overall damaging effect of these changes came to the fore. We will wait for that.
The rich were having their heyday throughout this period. The progressive tax regime of the New Deal era was repealed, and top corporate executives were rewarded dearly for changing the economic landscape. According to the AFLCIO, a chief executive officer of a Standard & Poor’s 500 company was paid, on average, $10.4 million in total compensation in 2008. The CEOs made 42 times the pay of average factory workers in 1980, and 475 times as much by 1999.
Having made a U-turn, America had become a more unequal, and less democratic society, both with important implications for the impending crisis.
The Great Power Grab by Wall Street
In a world of pervasive financial deregulations, and speculative movement of capital across the world, most people cannot remember that, not long ago, the United States and the Great Britain led the world—the part not under the influence of the Soviet Union—in promoting a regime of strict capital control in order to avoid the very same calamities were are experiencing today. Designing a new world economic order in Bretton Woods, they supported specific regulations to prevent the return of the liberal international financial regime of the 1920s. America then wished to “drive the usurious moneylenders from the temple of international finance.”3
The post-war capital control provided the stability needed for the New Deal regime in the United States (and the social democratic governments across Western Europe). It held together the unwritten social contract between labor unions, large corporations, and the government. Its demise after the 1970s served the final blow to the New Deal.
Unencumbered by government regulation, and helped by new telecommunication technologies, finance capital began chasing the globe for fast profits. All that was needed was a gentle tap on the keyboard. Bondholders and speculators freely moved between markets. From Mexico, to Asia, Russia, Brazil, and Argentina, they caused havoc, and brought these economies to the brink of destruction by their unexpected and mass departure. What the architects of the Bretton Woods had feared was now a reality.
Cozying up with allies in the government, and spending $5 billion (between 1998-2008),Wall Street managed to influence sweeping deregulations.4 Top Wall Street executives, many from Goldman Sachs, took key positions in the government. Retirees from the treasury and commerce departments found lucrative positions on Wall Streets. The influence of Wall Street in the government reached a peak with the appointment of Robert Rubin, a one-time co-chairman of Goldman, and Henry Paulson, a Goldman CEO, to head the U.S. Treasury Department under Bill Clinton, and George W. Bush respectively. Meanwhile, many lower level appointees navigated between Wall Street and the government. The open corridor between Wall Street and the government of the United States became an important feature of the Post-New-Deal era. It played an instrumental role in the crisis we are experiencing now.
When he was the Secretary of Treasury, Robert Rubin opposed the regulation of credit swaps, and pressured rating agencies to delay downgrading Enron, a Citigroup debtor. Joining Senator Phil Gramm, he fought to overturn Glass-Steagall Act, a move that paved the way for the creation the Citigroup. When he left his post at the Treasury Department, Rubin joined the Citigroup as a Director and Senior Counselor. Why not!
Still with Goldman, Henry Paulson fought successfully to end debt restriction for banks. As risky lending activities by top banks mushroomed, the housing bubble, and its eventual burst were only a matter of time. Later, wearing the government hat, Henry Paulson designed TARP, and masterminded the first AIG bailout, $12 million of which was kindly deposited in Gloman’s account.
Wall Street was increasingly calling the shots after the 1990s. It was once again the master of the economy. Coupled with other changes in the late 1970s and the 1980s, we had paved the way for the volcanic eruptions of 2007-2008.
Banks went on a lending frenzy, extending risky loans, repackaging their loans, selling them to new buyers. Facing the stagnation or decline in their earnings—remember the flexible labor markers, and the gap between wages and productivity increases—American families were also on a borrowing binge, some to make the ends meet, and others to catch up with the joneses. Closing their eyes to obvious risk factors, banks pushed new credit cards on their customers, extended the credit limit of the old cards, and gave all sorts of incentives, to all sorts of risky borrowers, to encourage them to simply borrow. And borrowing they did. Without thinking.
Indeed, for a while, the credit expansion unleashed by financial deregulation made many people rich in the real estate, and the asset bubbles. Ordinary Americans, who would have never dreamed of investing in anything, let alone speculating in the market, joined the frenzy. There was money to be made for everyone, we thought.
The euphoria that kept growing year after year finally came to a sharp end last October. The crisis with all its manifestations was upon us. The rest is a familiar story.
President Obama’s Same Old Deal
We are all Keynesians, said one Richard Nixon before he was forced to leave the White House with disgrace. Years after this declaration, Ronald Reagan, a staunch champion of free markets pursued one of the most aggressive Keynesian policies by running the biggest ever peacetime war economy. Some two decades later, George W. Bush made the list of war Keynesians with his three trillion dollar adventure in Iraq.
Fiercely opposed in the academic and policy circles in the past three decades, Keynesianism, once again, became the policy choice of the time after the outburst of the financial crisis. These days, many outside the Obama economic team—Nobel Prize winners Amartya Sen, Joseph Stiglitz, Paul Krigman, and others—call for the regulation of finance and other markets, an aggressive non-military Keynesian demand booster coupled with a platform for social justice, progressive taxation, strong unions and labor laws, and extensive measures income redistribution, to save the U.S. and the world economy from the abyss. But, for the most part, especially in the area of regulating Wall Street, President Obama has been following the old—and as we now know, destructive—Reagan-Clinton-Bush policy. No one blames President Obama for not having ended the decline in his short time in office. The problem in the path he has chosen for this task.
Worrying signals about Obama’s economic direction emerged with the selection of the three musketeers, Robert Rubin, Larry Summers, and Timothy Geithner to key economic positions. At the time that the country needed a substantial change in direction, President Obama hired those who were proven loyalists of the old direction. He put deregulators in charge of fixing the problems caused by deregulation, and sent a clear message to the big players in Wall Street that the administration would not make a radical change in rules of the game.
Many supported the choice on the ground of the trio’s insider’s knowledge of Wall Street. They hoped the connection to the financial sector would be an asset in returning the economy to health. The last few months have shown not only the naiveté of these expectations, but also the inability of these insiders to be the economy’s effective regulators. You don’t hire pirates to protect your ship from piracy.
President Obama has shown a great deal of reluctance in putting in place effective regulations and oversight of finance, while his administration has continued to feed Wall Street with billions of dollars of public funds. The no string attached policy for the money given to banks, and the administration’s reluctance to take over and temporarily nationalize large and failing banks, resulted in an inexcusable waste of public resources. Credit remains frozen despite many expensive bailouts. Jobs continue to be lost, and the economy shows no sign of improvement.
In the G20 meeting in London, the United States presented the right wing perspective, initially resisting the calls for a more stringent global regulation of financial markets, and the creation of a new global regulatory watchdog. In the eyes of many in the world, the new administration has become the new patron of Wall Street and its big players. Not a good place to be for a president who won on the promise of change and hope.
Why is President Obama unwilling to do (a variant of) what Roosevelt carried out with much success in the aftermath of the Great Depression?
Roosevelt was neither exceptionally visionary, nor a progressive, or a friend of labor. He was a realist. What let to his embracing of the New Deal was fear, a different fear than what is haunting President Obama.
While most economist and policy makers were suggesting a continued reliance on market forces to defeat the prolonged economic crisis, Roosevelt was fearfully eyeing the Soviet Union. When America and the rest of the world were caught in the abyss of stagnation, the Soviet economy was growing at an astonishing rate. Socialism, as it was practiced then in the Soviet Union, was far more attractive than the faltering capitalism to millions of people—the unemployed, followers of the Communist Party, intellectuals, and a wide range of other people—in the United States, and elsewhere in the world.
The fear was all too real. Not doing anything was costly. To save capitalism from communism Roosevelt had to act, break taboos, and defy the conventional wisdom. He had to neutralize Uncle Joe, not politically or militarily, but economically. In saving capitalism from communism, Roosevelt managed to also save it from capitalism, the type of capitalism that had brought the “free world” to the brink of extinction.
The fears that moved Roosevelt to launch the New Deal had long disappeared before President Obama took the command of this ailing economy. The Soviet Union is no more. The old communist countries are more catholic than the Pope these days. The unemployed and disenchanted Americans are left with no alternative model in the world. Let’s be serious, no one would want to follow the Communist Monarchy of North Korea.
Labor unions are weaker, and smaller than ever. They are ineffective, and paralyzed, unable to stand for their members’ rights. While unions in England, France, and other countries in Europe have used their democratic rights to publicly voice their grievance, striking, or protesting layoffs and government policies, there has been little to no action on the part of the American workers and their unions.
Not facing a strong and organized movement inside the country, or a respected and credible alternative outside, President Obama’s fears have been channeled to Wall Street. In the absence of workers’ strike, he fears bondholders’ strike.
What is to be done?
Barak Obama’s presidential victory was a historic event. It energized and gave a sense of empowerment to million in the U.S. and the world. There are still many reasons to be excited about Obama. Although significantly better than his predecessor, Obama’s overall economic policies, however, remain too market friendly, and inadequate for the task in hand. President Obama needs to be reminded of the mandate given to him by his supporters among the youth and the working Americans. Today, the fear of negative reaction by Wall Street plays an important role in shaping the administration’s policy. That should be replaced with the fear of the American electorate, this time voting with their feet.
Time is not on our side.
Footnotes:
1- By the way, I never understood why we were so shocked to find Bernie Madoff and others like him among us, or “outraged” at AIG executives for taking fat bonuses out of our bailout money. Madoff and his likes are only clever thieves who entered a house with wide open doors, and emptied it in daylight. Many in their position would have done the same. The doors remain open and unguarded.
2- The Economist, March 14th-20th 2009, page 11.
3 – Henry Morgenthau, U.S. Secretary of Treasury.
4- “Sold Out: How Wall Street and Washington Betrayed America,”