Egypt’s army vows it will not use force against demonstrators, as the government says it is preparing to open talks with the opposition.
To break the inside-the-Beltway consensus that a robust, government-led effort to lower the unemployment rate this year should not be on the table for legislative debate, the Campaign for America’s Future this week announced that it is convening a Summit on Jobs and America’s Future on March 10 in Washington.
This summit is based on the proposition that it is both economically and politically insane for there not be an alternative to the conservative agenda, misnamed “cut and grow,” which would have the federal government fold its arms and back away as the job market continues to stagnate. Absent a bold, galvanizing jobs plan from either the White House or the Democratic leaders in Congress, it is up to the progressive movement itself to raise up such a plan and use it to change the limits of the unemployment debate.
The jobs summit is intended to be a place where progressive members of Congress, together with activists and the movement’s best thinkers, can forge the elements of political movement for sustainable economic growth, dynamic job creation, and a revival of the American economy. (To register for the day-long conference, which is free, click here
President Obama actually helped set the framework for this in his State of the Union address. His call for a “winning the future” agenda that would include bolstering education, repairing and expanding our transportation networks, supporting universal availability of high-speed broadband and boosting research and development efforts can, done correctly, move us toward a new, greener and more sustainable economy of broadly shared prosperity.
In contrast, conservatives are doubling down on their blind faith, discredited by the slow decline of the middle class during the past decade and the climactic crash of the economy in 2007 and 2008, that cutting taxes and regulations alone will create an overflowing fountain of jobs from the private sector. Add to this the deficit mania that is fueling Republican plans to go beyond President Obama’s unprecedented pledge of a five-year freeze on federal spending to call for cuts of as much as $100 billion in domestic discretionary spending.
Of course, the conservative agenda is couched as being faithful to the message voters sent in the 2010 elections: focus on jobs and take actions that will reduce the federal deficit. But these cuts would truly be job-killing, not job-creating. On the chopping block would be a variety of aid programs that help fund state and local governments, which would force the layoffs of hundreds of thousands of public workers. More layoffs in private and nonprofit agencies would result from cuts in a broad swath of other services. Right-wing rejection of plans to build high-speed rail and bolster the rest of our transportation network has already killed thousands of jobs in the New York City area, and hundreds of thousands more jobs will be stillborn if the rejection is allowed to prevail.
The budget plans currently being embraced by congressional Republicans will deprive the nation of the basic building blocks the private sector needs to fuel long-term job growth: an educated workforce, a transportation network that moves people and goods effectively, a universally accessible Internet that is a platform for innovation and efficiency, research that can lead to the creation of the industries of tomorrow.
These policies are guaranteed to prevail, with disastrous consequences to our short-term and long-term economic future, if the only choices on the table are conservative and a “conservative lite” that accepts the basic premise that working-class Americans have to accept an era of austerity that includes unemployment above 8 percent for years into the future (while increasing shares of wealth continue to flow to the top) but is willing to offer an aspirin to dull the pain.
One way progressives must counter this is with an economic program that spends federal dollars today to put people to work today on the jobs that must be done today. That is a program that we should rally behind regardless of whether the political establishment deems it practical. The truth is, it is the right thing to do. It makes no sense that while we have close to 15 million people unemployed–6.4 million out of work for more than six months–we’re not funding jobs that would support the needs of thousands of communities. That would be especially true in the eight states–California, Florida, Georgia, Michigan, Nevada, Oregon, Rhode Island and South Carolina–where unemployment last month exceeded 10 percent.
Progressives must also frame a long-term jobs agenda that adds meaningful substance to President Obama’s vision of “winning the future” through investment in education, research and infrastructure. The president’s past speeches have made the case that we cannot afford to drift into a re-creation of the old economy, with its cycles of bubbles and bursts, its stagnant middle-class income growth and its decaying public assets. And yet, yielding to the austerity crowd threatens to lead us down that very road. The result will be a nonexistent recovery for a broad swath of American workers and no progress on addressing the federal deficit. We can, and must, make the case that public investment in the essentials of economic growth now is the only way we can make progress toward bringing our budget deficit down to a sustainable level.
Getting this message into the center of the political discussion will require taking a page from the Tea Party playbook. On the right, a group of renegades embraced a platform based on a narrative that blamed the nation’s economic woes on the size of government–and mobilized voters in ways that shook the Republican political apparatus. If the Tea Party can do that with a fundamentally flawed analysis of our economic ills and the role of government, imagine what progressives can do with a sound analysis of where America is, where America must be and policies that can get us there that will inspire hope and confidence in the future.
Read more: Jobs, Economic Recovery, Industrial Policy, State of the Union, Economy, Economic Crisis, White House, Summit on Jobs and Americas Future, Winning the Future, Campaign for Americas Future, Conservative Lite, Politics News
In common with other accounts of the financial crisis, the Financial Crisis Inquiry Commission report notes that mortgage underwriting standards were abandoned, allowing many more loans to be made. It blames the regulators for not standing pat while this occurred. However, the report fails to ask, let alone answer, why standards were abandoned.
In our view, blaming the regulators is a weak argument.
A much more sensible explanation can be found by asking: what were the financial incentives for such poorly underwritten loans? Why would “the market” want bad loans?
All the report offers as explanation is that the “machine” drove it or “investors” wanted these loans. This is lazy and fails to illuminate anything, particularly when there are other red flags in the report, such as numerous mortgage market participants pointing to growing problems starting as early as 2003. Signs of recklessness were more visible in 2004 and 2005, to the point were Sabeth Siddique of the Federal Reserve Board, who conducted a survey of mortgage loan quality in late 2005, found the results to be “very alarming”.
So why, with the trouble obvious in the 2005 time frame, did the market create even worse loans in late 2005 through the beginning of the meltdown, in mid 2007, even as demand for better mortgage loans was waning? It’s critical to recognize that this is an unheard of pattern. Normally, when interest rates rise (and the Fed had begun tightening), appetite for the weakest loans falls first; the highest quality credits continue to be sought by lenders, albeit on somewhat less favorable terms to the borrowers than before.
In other words: who wanted bad loans?
The dissents’ explanation is that the GSEs drove demand for affordable housing, which was what weakened underwriting standards. This might explain why the GSEs bought bad loans (which, oddly did default at lower rates than private market crappy mortgages, and thus didn’t contribute significantly to the GSE losses), but it fails utterly to explain why “the market” outside of the GSEs BOUGHT bad loans.
In the market for private loans, who wanted bad loans?
Had the FCIC report bothered to connect the dots raised by this simple question, it could have actually contributed something.
By blaming regulators (and the rating agencies), the report makes it seem as if it was just about what the lenders could get away with. But that same argument could be applied to any credit market, yet the US mortgage market was rife with remarkably crappy loans. And lenders still would suffer negative consequences for selling a bad product, even if they could get away with it for a while, such as loss of reputation due to inferior deal performance, losses on retained interests, and poor pricing for the drecky mortgages.
Along a similar line, the report notes that bonuses skyrocketed for the industry during the bubble years. Where did this money come from? Why had the mortgage industry never before generated such high compensation?
The obvious answer is that good loans did not generate hugely excessive bonuses, but bad loans did.
What happened is that the benefits for originating bad loans exceeded the cost of these negative consequences — someone was paying enough more for bad loans to overwhelm the normal economic incentives to resist such bad underwriting.
The best example of this is John Paulson, who earned nearly $20 billion for his fund shorting subprime. This amount of money was not ever possible or conceivable in the mortgage business prior to that point. The only way it could occur was through the creation of a tremendous number of bad loans, followed by a bet against them. Betting on good loans could never generate this much gain.
Given the massive amount of money earned by betting on bad loans, the logical next step is to ask, how did such incentives affect and distort the market?
Remarkably, the report never asks such a question. Yet the FCIC learned from Gregg Lippman of Deutsche Bank, who was arguably the single most important individual in developing the market for credit default swaps on asset backed securities (which allowed short bets to be placed on specific tranches of mortgage bonds) and related “innovations”, such as the synthetic CDO (a collateralized debt obligation consisting solely of CDS, nearly all of which were on mortgage bonds) that he helped over 50-100 hedge funds bet against bad mortgages. Didn’t it seem obvious to anyone at the commission that this information meant that a tremendous amount of money was invested in the market failing? What was the impact of this pile of money?
The report also fails to connect the dots about how Lippman and these funds accomplished their investment objective. Doing so would have allowed the report to draw conclusions about how the next crisis could be avoided.
The introduction of a standardized contract on credit default swaps in the mortgage related market (which took place in June 2005… notice the timing relative to when the really bad mortgage issuance took off?) allowed interested parties to bet against the mortgage market in a remarkably efficient manner — through the use of CDOs. CDOs allowed investors to bet on the weakest mortgage bonds, the BBB tranches, which were a teeny but critical portion of the original deal (note it was cheaper to place these bets via CDOs than the ABX index, although some of the short sellers did that also). If the dealers couldn’t place these dodgy pieces, the entire mortgage bond factory would have ground to a halt. The last thing the dealers would want to be stuck with is the least desirable portion of a bond offering.
But conversely, this normally hard to place portion, precisely because it was the worst rated piece, suddenly became prized. Speculators could put a very small amount of money down and, if right, reap previously unheard of returns. For just a small investment in a CDO or CDS, an investor could create huge incentives for mortgage lenders to seek out unqualified borrowers and lend them far too much money (for reasons explained at greater length in ECONNED as well as in older posts on this blog, heavily synthetic CDOs pioneered by the hedge fund Magnetar were a particularly destructive way to execute this strategy. Those deals stoked the mortgage market directly, by using some actual BBB bonds, and indirectly, though their impact on spreads and the fact that pipeline players and other longs used some of the CDS not taken down by the shorts to lay off their risk, which encouraged them to stay in the game longer).
The report notes that many people saw the weakened standards and thought it was insanity and a serious problem. In fact, contrary to popular perceptions, many people in the securitization market thought the same thing. Some believed the problem would eventually cure itself, others thought there needed to be tighter controls. Virtually no one understood why the loans continued to be created, even after alarms were sounded. Almost no one recognized that there was a tremendous financial incentive for bad, rather than good, loans and that the alarms just made such bad loans more valuable. In fact, the alarms created a frenzy of more CDO creation as more hedge funds became aware of the opportunity to short the deals, which created demand for more bad loans.
The normal expectation was that warnings and threats about bad lending would have some impact on curtailing the bad loans, but it had the opposite effect: it led to more CDOs and demand for more “product” to short.
Dozens of warning signs, at every step of the process, should have created negative feedback. Instead, the financial incentives for bad lending and bad securitizing were so great that they overwhelmed normal caution. Lenders were being paid more for bad loans than good, securitizers were paid to generate deals as fast as possible even though normal controls were breaking down, CDO managers were paid huge fees despite have little skill or expertise, rating agencies were paid multiples of their normal MBS fees to create CDOs, and bond insurers were paid large amounts of money to insure deals that “had no risk” and virtually no capital requirements. All of this was created by ridiculously small investments by hedge funds shorting MBS mezzanine bonds through CDO structures.
Let us step through some simple math. If a hedge fund invested $50 million in shorting MBS via an equity investment in a CDO, it would lead to the creation of a $1 billion mezzanine ABS CDO (note this 5% assumption is conservative). In 2006, 80% of that CDO would consist of BBB or BBB-tranches of subprime bonds; remarkably, as much as 10% of that CDO could (and often did) consist of the lower-rated tranches of OTHER unsold CDOs, which would make the picture even worse, so for simplicity’s sake, let’s stick with the 80% figure.
So of that $1 billion deal, $800 million is composed of BBB rated bonds. $800 million also happens to be a not-bad number for the size of a typical residential mortgage backed security, meaning from the AAA tranches down to the so called equity layer of that first generation securitization. The CDO, the second generation, would be composed of about 100 BBB MBS bonds created out of these securitizations, and the deals in aggregate would reference about $84 billion worth of mortgages (note that in this example, the $1 billion CDO would take down or if it was synthetic, “reference” $800 million of BBB bonds out of total RMBS issuance of $80 billion. The reason the total amount of bonds issued was $80 billion while the mortgage amount was $84 billion was that the bonds were “overcollateralized” as a form of protection to investors. But as we have seen, this “overcollateralization” fell vastly short of actual losses).
Now even though that ratio is eyepopping, a $50 million investment versus $84 billion of mortgage loans ultimately referenced, it is hard at this level to ascertain the impact in any tidy way. The BBB tranche was hardest to sell and only 3% of the total value of the RMBS. It had served to constrain demand. But the dynamic flipped. In tail wag the dog manner, the pipeline started demanding crappy loans to get that BBB slice. There was a chronic perceived shortage of AAA paper, so the bulk of the subprime could be sold, and the other less prized parts could be dumped into other CDOs, which were also big fee earners to the banks.
But we can assess the market impact for a particular CDO shorting strategy, the one used by the hedge fund Magnetar, which used heavily synthetic CDOs, with roughly 20% actual BBB bonds, the rest credit default swaps.
A back of the envelope calculation, which leaves out the complicating and intensifying factor of the inclusion of lower CDO tranches in supposed first gen CDOs (put more simply, regular “mezzanine” or CDOs composed largely of BBB rated subprime bonds could be and were often 10% CDO squared; the so-called high grade CDOs, made mainly of A and AA bond tranches, could be as much as 30% CDO squared) shows that every dollar of equity in “mezz” (largely BBB) asset backed securities CDOs that funded cash bond purchases generated $533 of subprime bond demand [(1/3% BBB tranche in original RMBS x 5% equity tranche in the CDO) x 80% BBB bonds in the CDO].
You then gross that up for how many dollars of actual loans that represented, since it took roughly $100 of loans to make $95 of bonds, so the impact on the loan market was $560. The Magnetar structure was roughly 20% cash bonds, 80% synthetics, so $560 x 20% is $112. In other words, the impact on the loan market of the Magnetar structure was over $100 for every dollar they invested. And looking across its entire program, we’ve estimated, when making allowance for the effect of lower tranche CDOs in their deals, that their program alone drove the demand for at least 35% of subprime bond issuance in 2006. Industry sources have argued the total impact was considerably greater, both due to the effects of the synthetic component and the fact the structure was imitated by other hedge funds and dealers.
It is remarkable that the FCIC, with its access to industry figures and its subpoena powers, was unable to refine this sort of analysis together to give a clear picture of what was happening in the CDO market. The public deserves to know why Goldman, Paulson, Magnetar, Phil Falcone, Kyle Bass, George Soros, Deutsche Bank and 50 or more others were so eager to make these investments, why they wanted to keep the bad lending machine going, why they wanted to keep their strategies secret (even now), and how they made so much money so quickly. After all, it’s the rest of us wound up holding the bag.
Thirteen years ago, the economists Sara Solnick and David Hemenway conducted a study that revealed a great deal about how Americans define happiness. Subjects, all of whom were middle class or lower, were asked which they wanted more: to earn $50,000 while everyone else got only half as much, or to earn $100,000 while everyone else earned $200,000. The increase in the subject’s earnings from the first scenario to the second was, of course, dramatic. But that didn’t matter to most. What mattered was how rich they were compared to others: 56 percent said they would take $50,000 less as long as they were richer than everyone else.
This study has important implications when assessing the growing divide between America’s rich and poor. What it suggests is that it’s extremely important for us to feel successful next to our peers. In fact, when our peers are significantly wealthier, we become unhappy and anxious. Other studies show increased rates of crime, depression, divorce and stress-related illnesses in regions where income inequality is the most gaping.
And it’s gaping in a lot of places. In case you haven’t heard, the gap between the rich and poor in the U.S. is currently wider than it’s been since the Great Depression. It’s even worse here than in Egypt or Tunisia, where the income gap helped ignite the unrest. In the last thirty years, the richest one percent of Americans has seen its share of wealth jump from under nine percent of the total pie to approximately 25 percent. Many fiscal Conservatives argue that this is good because of the trickle-down theory that says increased riches for the wealthy eventually find their way to everyone else. But this simply hasn’t happened. Over the past three decades — the period when the rich have become superrich — real wages for the middle class have declined and the poor have only gotten poorer. The truth is that the dramatic increase in the wealth of our richest citizens has had devastating consequences for our middle and lower classes.
Because while wealth hasn’t trickled down, something else has. As pointed out by Robert H. Frank, an economics professor at Cornell, increased inequality has spawned “expenditure cascades” that have wreaked havoc with those at the lower half of the economic ladder. These cascades occur when the superrich begin spending more simply because they have so much more. The group just below them, which often travels in the same social circles, starts spending more to keep up with the superrich. This continues down the income ladder until a situation is created where everybody believes they should be significantly wealthier — or at least, look like they are. This has resulted in a huge rise in Americans spending above their means.
Take the housing crisis. While there were certainly a slew of causes of the housing collapse — predatory lending, Wall Street’s partnering with mortgage lenders, financial deregulation, among others — expenditure cascades played a significant role. As supported by Solnick and Hemenway’s study, when people with modest homes saw McMansions constructed up and down their blocks, or saw their neighbors suddenly installing new additions, granite countertops, stainless steel appliances and the like, the social pressure to do the same became, for many, overwhelming. The result was hoards of people pilfering their equity and buying houses they couldn’t afford. Moreover, this social pressure to spend was compounded by powerful political and corporate pressures.
What political and corporate pressures? Congresswoman Marcy Kaptur, the longest serving woman in the U.S. House of Representatives, told me in an interview that when Republicans took control of Congress in 1994, one of the first things they did was to impose fees on savings accounts to encourage spending. At about the same time, as a recent book about the 2008 financial crisis reveals, the large banks and mortgage companies undertook an advertising campaign to de-stigmatize second mortgages and home equity loans. These efforts went far in changing American thinking that had previously held saving money and fiscal responsibility in high regard. Suddenly being in debt wasn’t frowned upon. In fact, it became the norm — for the middle and lower classes, that is.
So why aren’t Americans more alarmed by the growing gap between the rich and poor? And in light of how enormous it’s become, why isn’t there more support for attempting to alleviate it by taxing the rich? Polls show that a large proportion of Americans still want and expect to become rich, and so presumably they’d rather not be saddled with high taxes when they do. But the truth is that it’s more difficult than ever for poor Americans to climb the income ladder. According to a 2007 study, the likelihood that a poor American will attain even upper middle class status has become extremely slim, having steadily plummeted since the 1940s.
A healthy society depends upon a large and vibrant middle class. While virtually every American politician would agree with this, governmental policies over the past three decades have resulted in a smaller and indebted middle class, alarming divide between our richest and poorest, and made upward mobility more difficult. It’s time to admit that these policies have failed and try new ones. Obama made a huge mistake when he agreed to extend the Bush tax cuts for the wealthiest Americans for another two years. Let’s make sure he doesn’t do it again.
This has been cross-posted at GuernicaMag.com
Read more: Poor, The Great Depression, Trickle Down, Income Inequality, Economy, Great Recession, Middle Class, Great Depression, Sara Solnick, Robert Frank, Mary Kaptur, David Hemenway, Politics News
U.S. consumer spending rose in December for the sixth straight month — a sign of an improving economy, but still short of the rate of growth needed for to significantly transform the economy.
Personal incomes rose 0.4 percent in December while nominal spending — which doesn’t account for inflation — was up 0.7 percent. Real spending rose by only 0.4 percent, government data showed on Monday.
“The numbers were okay,” said Cary Leahey, senior economist at Decision Economics. “They showed an okay economy with the potential to do better. The real question is when will firms stop sitting on their kitty of cash and actually hire people. Right now things are sluggish and hiring is expensive. Companies don’t feel a big desire to hire and it’s a problem.”
Leahey thought December’s 0.7 percent growth in nominal spending was strong, but unlikely to be repeated in following months.
“The spending was quite strong,” Bank of America economist Michelle Meyer told Reuters. “To me, the question is what is spending is going do in the beginning of the year. It is probably going to slow down. The year-end increase was not off fundamentals because the jobs market while improving is not great; retailers were offering a lot of discounts and credit conditions are still relatively tight.”
These numbers follow last week’s Commerce Department report which showed the GDP growing at a 3.2 percent annual in the last three months of 2010. The growth was certainly welcome, but, as with consumer spending, not nearly strong enough to fix the jobs crisis.
“The headline number — the 3.2 percent growth — if we sustain that rate of growth throughout 2011 that would do very little to push down the unemployment rate,” economist Josh Biven said last week, noting that the GDP would need to be growing at a rate of at least 5 percent, month-over-month, for an entire year, for the unemployment rate to be lowered by one percentage point.