A fascinating article at New Deal 2.0 details the steps we are taking towards a likely second Great Depression. At a time when economies are teetering on the edge of recovery and a second recession, governments are starting to make noises, particularly in Europe, about reducing deficits as a model for responsible financial health. Unfortunately, this is the exact opposite response governments should be taking as reducing a governmental deficit will naturally result in deflationary pressures on the private sector because the two are necessarily related.
Governments have two main ways to reduce deficits, increase taxes and reduce spending, both of which are deflationary. Doing either at a time when unemployment runs at 10% in most First world countries would result in huge burdens on the private sector. Governments are currently running large deficits because we just came out of one of the worst recessions the world has ever seen. Unfortunately, the bigger problem is that a huge portion of the government spending during those recessions actually resulted not in job creation but in an amazingly brazen transfer of wealth from the middle class to the wealthy through paying bondholders at par value and keeping the oligarchs in the big banks solvent.
Bailing out the banks instead of the common people was a monstrous mistake but not one that needs to be compounded now by cutting spending which will necessarily affect the very same classes of people negatively that the bank bailouts did through reduction of public services and increased unemployment. The fact that our elites are even considering this shows how little they understand of the situation. Or playing more cynical, how little concern they have for the plight of the middle and lower class.
What we need are statesmen and leaders who can clearly explain why the current budgets deficits are necessary and then begin to formulate plans to redirect stimulus not to the oligarchs in power but to the people most affected by the economic disaster. Instead, we have captured men and cronies in power who will continue to rape the middle class until they no longer can, either because there is no middle class left or because they have been deposed. Until the system is reformed and our political leaders once again serve the interests of the many instead of the power of the few, I don’t see how we aren’t in for dark days ahead.
Overreaching headlines aside, the Eurozone is a bit of trouble. Greece has been bailed out in an attempt to avoid a sovereign default. Those in the know think the Greeks are unlikely to be the last country in the Eurozone to require a bailout and the conditions the IMF are expecting Greece to conform with are likely to have unintended far-reaching consequences that we can’t possibly understand at this point. A lot of people I talk to seem to be of the opinion that the Greeks got themselves into this mess and that bailing them out serves little purpose. This is probably true though for reasons far more complicated than that.
A guest post over at Naked Capitalism outlines 11 points supporting the idea that the Eurozone will likely break down over the Greece bailout. One of the key points revolves around a basic accounting principle: if one entity has a deficit, some other entity must have a surplus. Fiscal accounting is essentially a zero sum game and this is very important in the Greek case. When thinking about this, it’s important to realize that Greece, being a member of the EU, does not control its own sovereign currency. Thus, for Greece to run a deficit, there had to have been complicity from within the EU, specifically from Germany. It’s the fiscally conservative Germans benefiting from their strong export driven economy who provide the opportunity for the Greek government to run a deficit.
This part about sovereign currency is important. Historically, countries that control their own currency have been able to inflate their way out of debt, at least to some degree. In Greece’s case, the country is unable to do this because their currency is the euro and is outside their control. Therefore, they essentially have two options: default or bailout and accept the draconian retrenchment terms the IMF is demanding. As the article above mentions, it is unlikely that these terms are created with the considerations necessary regarding the simple accounting fact above, e.g. if Greece successfully imposes financial austerity measures on its people (a HUGE if at this point, one that isn’t getting enough attention), this necessarily means that the export societies of Germany and other Eurozone countries will retract due to the cutbacks in spending in Greece and others.
On top of that, these austerity measures will likely have a deflationary effect on the Eurozone. The bailout of Greece is aimed at government debt and the austerity measures are aimed in the same direction. Based on the same simple accounting concept I talked about above, if Greek government debt obligations are reduced through austerity measures, the Greek private sector will see their debt obligations grow leading to more private defaults and less growth in the Greek economy. Shortsightedly demanding to lower government debt with no consideration of the interconnectedness of the government and private sector spending will lead to further pullbacks and lack of growth in Greece.
In the end, the issues that we are seeing with Greece and the like illustrates several problems with the Eurozone as it is currently existing. If the Eurozone collapses, as the article seems to think possible, the ramifications will spread out over a much bigger area than just Europe. My crystal ball is cloudy when it comes to the results of a Eurozone collapse but I can’t help but think it will be highly detrimental to our country as well. We should watch carefully how things play out in Europe since it’s quite possible we may have to deal with similar circumstances in the near future here at home as profligate states like California begin to encounter the same issues the Greeks are running into.
There is currently a movement underfoot in Congress to recompense investors in the Bernard Madoff and R. Allen Standford Ponzi scheme debacles. It is couched in the terms of people having lost their life’s savings being fairly represented and treated but is actually a disgusting reminder of how those in power control much of our government now, wheeling and dealing in the halls of Congress to enact hidden taxes on the American people. By and large, the investors in these schemes were wealthy individuals and families who enjoyed years of outstanding returns with little or no risk, something that should have immediately raised concerns for any normal investor. Instead, they are now trying to collect money from Wall Street firms based on returns they would have gotten in the schemes had they been above board.
Should this come into law, it will codify protections for imaginary gains in all kinds of investment schemes. These were investors, mostly all rich, who should have known that outlandish returns had to be highly risky. We should also realize that these investors weren’t left out in the cold like so many average Americans who have lost significant portions of their life savings over the last three years. People in these schemes were covered under the Securities Investor Protection Corp up to $500,000 towards legitimate claims. Claims that aren’t legitimate include instances where the individual withdrew more money than they paid in. These people are clamoring for imaginary gains when many of them actually made money on the schemes. This is ridiculous.
What this will turn into is a tax. If it becomes law, the brokerages will have to pay the fines but they will most certainly pass the costs on to the consumers, most of whom are average Americans who just happen to have accounts with them. To think that we have Senators who are gladly sponsoring legislation to defraud the public to reward the rich and connected is sickening. But I suppose that is exactly where we are these days. Millions of people are out of work and our elected representatives are trying to get imaginary returns granted to the already rich and wealthy. Some day, the people of America will get sick of this treatment. I have some fear that the response from them will not be quiet and civilized.
This week, President Obama proposed regulatory changes that would limit big banks, implicitly those that received the guarantee of a government backstop during the crash last year, from investing for profits using their own hedge-funds or proprietary trading desks. This would be an excellent first step in reining in the power that the JP Morgans and Goldman Sachs of the world wield over our economy and political landscape. It is unfortunate that Obama waited 12 months before listening to Paul Volcker, losing precious political capital in the process. 12 months ago, the banks were beholden to the President and the American people. We essentially owned them and should have taken steps then to limit their power.
Instead, we let them pay back TARP and gain monstrously atrocious profits this year, making money by sucking cash from the tit of the Federal Reserve and refusing to then lend it out to the people who actually needed it. The banks are now emboldened to go right back to business as usual as they came through 2008 learning only the lesson that the government will make sure they do not fail no matter what the consequence. They have not been punished, not even reprimanded for behavior that sucked the life out of the American and global economy.
“While the financial system is far stronger today than it was one year ago, it is still operating under the exact same rules that led to its near collapse,” Mr. Obama said. “My resolve to reform the system is only strengthened when I see a return to old practices at some of the very firms fighting reform; and when I see record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rates low, and cannot refund taxpayers for the bailout.”
This is exactly right, something that is a direct result of not reining in the banks 12 months ago. Now, the regulation has little chance of emerging from Congress with any teeth. It will die a death of 536 pricks, bled to death on the floor of the institution created to represent the people.
Of course, proprietary trading wasn’t the cause of the financial collapse, at least not the root one and that is a point many on the right are making now. But this isn’t designed to fix the problem, it’s a first step down the road of reforming the entities that currently have all the power in the American economy. There are those on the right who will moan about frightening the stock market but the market needs to be frightened because it is currently nothing more than a Ponzi game played with our money. Rising from the depths of last year inside of 12 months during the worst economic collapse since 1929 is silly. The stock market gains are largely smoke and mirrors using money that the Federal Reserve has created out of thin air. It cannot continue and the longer it goes on, the worse the responding fall will be.
This regulation will be difficult to implement as Yves at Naked Capitalism details. But it would be a much needed baby step down the road of reform and true recovery. As long as the big banks can find comfort in explicit government backing while remaining unpunished for poor decisions and risky behavior, they will continue to act in exactly the same way they have been acting for 10 years. We cannot have true recovery until the Goldman Sachs of the world, parasites on true creation of wealth, have been reined in.
More reading: Jesse
Perhaps there is some hope
Our financial system is horribly broken, serving only the well-connected and well-monied interests of Wall Street. We, the American Taxpayer, gave billions of our dollars to save people who made stupid bets on gambles designed to make them millions and millions of dollars. We haven’t flinched yet but if the republic has a chance of recovering, we’re going to have to do something about it.
From Bill Moyers Journal January 8th, 2010:
“Thanks to taxpayers like you who generously bailed banking from the financial shipwreck it created for itself and for us, by the end of 2009 the industry’s compensation pool reached nearly $200 billion. And despite windfall profits, the banks will claim almost $80 billion in tax deductions. And nearly $20 billion of those deductions will go to just three institutions — Morgan Stanley, JP Morgan Chase, and Goldman Sachs.
Ah, yes — Goldman Sachs, that paragon of profit and probity — which bet big on the housing bubble and when it popped — presto! — converted itself from an investment firm into a bank so it could get your bailout money. Now consider this: in 2008, Goldman Sachs paid an effective tax rate of just one percent. I’m not making that up — one percent! — while their CEO Lloyd Blankfein pulled down over $40 million. That’s God’s work, if you can get it. And, believe me, Wall Street bankers know how to get it…”
Did you read that? Goldman Sachs paid an effective tax rate of ONE PERCENT. This is the change we have been given. Short change indeed. Why we haven’t risen up and destroyed these people, either figuratively or literally, is beyond me. They are sucking the life blood out of America and calling it God’s work.
They are doing it because we let them. You do have some choice. Let your representatives know that you will not stand for it. Better yet, take any and all money you have in major banks and move them to small community banks as part of the Move Your Money movement. I will be opening an account with American National Bank of Texas today and closing my Chase account as soon as I can. I refuse to continue to support institutions who do anything they can to disadvantage me the customer while lining their pockets with my tax money. If you do not do what is right, you will continue to suffer the painful consequences of what is wrong.
Hat Tip: Jesse. If he isn’t in your daily reading list, you are missing out on commentary exactly describing what is going on in our financial and political system.
I tend to collect a variety of interesting links throughout the week, at least to me. I always think that I’ll post them and write a little about them but in truth, I don’t have that much time and would rather write about things that are more important to me. So I’m going to just start posting 5 or 6 occasionally just to have them out there.
1. The Coming Hyper Inflation. We’re printing money faster than the ink dries. If you think the Fed can handle toning it down when the chain starts to catch on the cog, you’re more optimistic than I am.
2. Why The Left Derided The Tea Parties. It’s on Reason so you have to wade through some of the hyperbole but it has a core of truth that is worth considering.
3. Writing Software is like. . .Writing I have a lot of thoughts on this topic but they haven’t really congealed into any recognizable mass yet. Suffice it to say, the more I think about writing software, the more I think it’s much closer to art than science.
4. Where To Find New Ideas
5. An Introduction To Mindfulness Meditation This is the best intro on the web I’ve seen and the link to A Guided Meditation is a fantastic description of how to begin and end a meditation.
6. Taming Perfectionism I struggle with this a lot, specifically as it concerns writing and developing pet projects at home. Nothing is ever quite good enough. In one of my garden project books, the author was describing how to build an arbor and said “Remember, if you screw up the measurements a little, it’s just a garden project.” I may start applying that to ALL projects.
Quote of the Week
Now that those of us who have been making steady, on-time payments on our mortgages for years will be paying off others’ mortgages through our taxes, can we claim a tax-deduction for our neighbors’ mortgage interest too?
Love it. People are angry over this and they are only getting angrier. This is not going to end happily for our ruling class I don’t think. Remember Newt’s Contract With America? It’s gonna happen again in 2010. Just wait and see.
There are some reasonably serious rumblings about people getting sick of our new President spending all their money. And some of the rumblings are getting loud. If a modern day Boston Tea Party happened to get organized in Chicago, I’d be on the first plane to Chicago I could find. Here’s hoping we still have some heart when it comes to our government and who exactly it is they serve.
UPDATE: Link was broken, fixed now. Sorry!
There’s nothing like having the Europeans tell us how to handle our housing crisis. “But as the housing bubble deflates, it also drags innocent victims into a wave of foreclosures” they crow! Please. What innocent victims are being dragged into a wave of foreclosures? Either you can afford the house you live in or you can’t. If you have a house payment that’s more than 28% or so of your monthly income, you’re probably not so innocent. You bought a house you can’t afford. Just because you now lost your job doesn’t make you any less innocent.
If you don’t have a rainy day fund of around 6 months expenses, you probably aren’t so innocent. You probably spend more than you save. That article makes it seem like thousands of people who are the epitome of financial purity are about to be foreclosed upon and I find that ridiculous. Sure there are some out there who played by the rules and just have had a string of bad luck. But $275 billion worth of mortgages in that category? I seriously doubt it.
This bill plunges $200 billion back into Freddie and Fannie who have already proven to be poor stewards of the public’s trust. They are allowed now to finance up to 105 percent of a home’s value. That sounds like a fantastic idea. Really it does.
“But the plan is well targeted: the administration aims to contain the fallout, not to keep everyone in their home. The plan helps only those with a reasonable chance to retain their house.” How can people who have a debt-to-income ratio of more than 38% realistically have a chance of keeping their house? That’s a full 10% over the accepted norms and doesn’t even begin to take into account the overall debt ratio that includes other debt payments like cars and credit cards. These people don’t have a reasonable chance.
Most crucially, fighting foreclosures is a political imperative. The administration needs a lot more money to save the US banking system – money that will be forthcoming only from voters who feel they, and not just Wall Street, are being rescued. This plan may help win them over. At $275bn, that seems like a bargain.
Finally we get the real meat. Like all government handouts, it’s a way to slip future ones by us without us noticing. For that, the Europeans probably are the ones that ought to be giving us advice.