Kid Gloves for Banks: the Opposite of a Stimulus

A central issue of the current financial period is whether the financial sector will manage to transfer all of its liabilities to the public sector and keep them there.  Many people have tied this issue to the Ireland crisis.  The Irish public sector is getting slashed not because it ran deficits before the crash, and then saw them become unsustainable, but because the Irish government became the guarantor of 100% of the liabilities of Irish banks. These liabilities far exceeded Irish gross domestic product, and they still do.

The Financial Times ran a good overview on November 17th about the growing isolation of Angela Merkel among European leaders on the debt question. Most commentary presents the German position as hostile austerity: force the Greek public to pay for their debt crimes with austerity and poverty for years to come. There's something to that - much of the German public seems to feel that they sacrificed themselves (with few if any wage increases and service cuts throughout the past ten years) while other countries like Greece did not.  But in fact the current German government is also trying to force private investors to share some of the cost.  This has been an enormous problem for Western societies, as the financial sector gets governments to pass on the cost of their mistakes to citizens, who pay several times over - actual money and guarantees, zero-cost access to funds for banks that prop restored profits, public service cuts, austerity-induced low growth, and reduced investment in innovation for the future.

Wall Street Off-World

A piece by one of my Capitalist Pals denounces High Frequency Trading as a form of insider trading, and calls for the government to "tax the hell out of it."  In addition to offering the pleasure of seeing a former investment banker going well beyond the Tobin Tax into HFT profit confiscation, this short piece offers a nice example of the total disconnect between Wall Street activities and those available to the rest of us.  20-30x leverage on funds borrowed at the fed window belongs to a small group of institutions. The huge money in U.S. society is being made by people who, institutionally speaking, have absolutely nothing to do with the overall economy - with the working world of everyone else. Marx's capitalists took a disproportionate share of the value created by labor in the industrial enterprises in which they invested.  The most lucrative financial transactions that our author describes are not actually capitalist anymore, but constitute a kind of bizarre toll or rent or tax on activities in which none of the rest of us even engage.

The equally bizarre and unpleasant wage effects are chronicled in David Cay Johnston's "Scary New Wage Data."  Employment is down ("The number of Americans with any wages in 2009 fell by more than 4.5 million compared with the previous year"), median wages are down 0.6%, and yet the people who earned more than $50 million per year saw their average wage increase "from $91.2 million in 2008 to an astonishing $518.8 million in 2009."   "These 74 people made as much as the 19 million lowest-paid people in America, who constitute one in every eight workers."

The growth of inequality is neofeudal,  and the psychological aberrations required to claim that people "earn" this kind of money belong to the shadow philosophies of authoritarian eras.

Why Is Economic Policy so Dumb?

To understand what is going on in England, the U.S., and France, one has to get past the politicians' self-serving mythology that the popular majority is childishly refusing to face economic reality.

The French national daily Libération published a poll conducted October 14-15 that showed an incredible 79% in favor of the Sarkozy government reopening negotiations with the unions about raising the retirement age. (Sarkozy administration intends to raise the age for minimal retirement eligibility from 60 to 62, while also raising the age for full retirement benefits from 65 to 67.)   Nearly 2/3rds opposed Sarkozy's policy of "firmness" in refusing to negotiate, a policy which led to the passage of Sarkozy's changes "by force" on Friday night (by a vote of 177 to 153).  At the same time, only 43% supported the withdrawal of reforms, and only 36% favored its suspension and future resubmission.  In short, the majority does not in fact oppose change, even change that means a lower standard of living. But a 4/5s majority does opposed change imposed  by oligarchic decree. 

A hallmark of the French protests has been extraordinary participation of young people, who have  marched and shut down may high schools and unversities around the country.  What were the students’ doing out there with the middle-aged truckers and office workers?  Part of it was that the young want to retire older people so their jobs can be handed down in the normal manner - there was some self-interest (and economic rationality in the classic sense).  But like nearly all French people, the young oppose government by decree. They are also sick and tired of the general deterioration in the public sector that includes educational systems under constant, brainless pressure.  Victor Colombani, the president of the Union nationale Lycéenne (UNL), age 16, told Libération that high schools, the universities, public transport, the refineries, are all in the same mess.  The Sarkozy government, like most others in the West, is taking excellent care of its banks, major corporations, and high net worth individuals who dislike paying taxes, and doing as little as possible for everyone else.  French students marched about retirement because they don’t want what their elders are dishing out, which is a second-class deal for them.

One of the crucial facts of the post-2007 era is that market capitalism's social narrative now leads down instead of up.  The Reagan-Thatcher era, and its Giscard-Chiracian echo in France, promised wealth and health to regular people in exchange for abandoning the social democracy that had built their middle class societies and their own security within them.  When Thatcher sold Council housing to ordinary buyers, she was handing out public resources for the personal enrichment of les petits gens who had been given a decent life but never personal wealth by state-sponsored social development from the 1930s through the 1970s.  That would now change, in the Reagan-Thatcher narrative, as they borrowed against the rising value of their now-private home to buy a vacation condo in Spain, trips to Greece and Morocco on new low-cost nonunionized airlines, and grew their financial wealth through investment instruments like mutual funds that had barely existed in LBJ's Great Society.  But since 2007, Reagan and Thatcher's conservative (and centrist) descendants invoked market needs to continue to lower the standard of living of a majority already hammered by the loss of jobs, health insurance, and homes - nearly 3 million lost to foreclosure in the U.S. in 2009, and at least that many again in 2010.  We are looking at the ongoing shrinkage of the US middle class, typified by the continuing increase in home losses even during the "recovery" - up 25% from August 2009 to August of this year. Republicans are continuing to respond to asset deflation by wanting more cutting of taxes at the top.   Hello new dark pools of financial toxins, and ongoing non-punishment for banking fakery of various kinds.

Since they are now dishing out decline and decay, leaders in all three countries are struggling to muster approval ratings that stay above 33%, never mind achieving actual majority support.  Obama is still the strongest at 45%, though on a steady drift downward, according to Gallup.  Cameron's conservatives have a one-point vote advantage over Labour (at 41%) in a forced-choice party face-to-face that artificially inflates approval.  When people are asked about specific policies, he does worse. After he announced his massive cuts, Cameron's ratings fell 11% in one day;  Lord Browne's closely-aligned proposal to eliminate public funding for all non-science teaching in British universities got only 37% (still suprisingly high, since cheap higher ed is still the only reliable foundation of a majority middle-class society). France's Sarkozy fell below 30% for his  "firmness" in opposition to weeks of blockages and marches that brought millions of people into the streets. In California, Gov. Arnold Schwarzenegger held the state budget hostage -- furloughing tens of thousands of state workers and stopping payments to state vendors -- for 3 months late in order to force huge public pension concessions on top of his all-cuts budget policy, and earned himself record popularity lows - 23%, 17%, then 15% in mid September.

Major leaders are imposing economic policies that are frankly unpopular, and which don't actually work.   Dean Baker, Paul Krugman, Yves Smith, Simon Johnson - one can find a host of center-liberal economists denouncing the austerity "fad," as Krugman put it, as having "no basis in reality."  I used to liken Arnold Schwarzenegger to Herbert Hoover, but Hoover has now become the national metaphor for the death-trip financial policies the population is subjected to in Greece Spain, the U.K, the U.S., and elsewhere - or his Treasury Secretary Andrew "liquidate everything" Mellon, or the U.K's Snowden budget of 1931, which Krugman invokes.  And yet these leaders carry on - socialist governments in Greece and Spain alongside conservative governments in the U.K., Italy, Germany and France.

Why do leaders persist with these stupid, self-destructive economic policies? Here's my list, prompted in part by reading a good piece by the not-so-capitalist conservative political economist John Gray.

1.  frozen market ideology.  Gray identifies two ideas ruling the Cameron-Clegg coalition.  First, government reduces freedom while market increase it ("Both Cameron and Clegg have insisted that moving away from state provision is not just a matter of saving money: the result, they say, will be services that are more responsive to personal choice.) Second and more importantly, "there is no standard of fairness independent of the market."  Bailing out banks while firing hundreds of thousands of state workers isn't what it seems to be at first -- running society for the benefit of the economic top 1% or 0.1% of it -- but means stabilizing the market forces that liberate people to create new value, rather than helping the public employees who impede it.  Ideology is never undermined simply by its surreal irrelevance to  economic outcomes past and present.
2. Small elites in mass societies.  Gray observes, "As in the 18th-century elite politics analysed by Lewis Namier, British politics today is shaped by a handful of closely related people."   Political parties in the US, France, the UK, and most other Western democracies have become duocracies of center-left/center-right parties controlled by fairly small circles of people. Note the history of the Democrat party under Clinton or New Labour under Blair.  As modern societies have become larger and radically more diverse, their ruling groups have paradoxically become more self-regarding and self-contained.  (See Blair's accounts of his oddly isolating rituals of political reflection at the link above).
3. The God that Failed.  Political leaders have a natural investment in believing that they have healed market capitalism, but it remains in crisis.  It continues to rest on government life support - nearly-free money for guaranteed loan spreads, fictional "mark-to-mythology" accounting on toxic instruments that pospones lossses, and endless forgiveness for the most basic corrupt errors like the failure to verify forceclosure documents that has called the whole mortgage industry into question in the US - if anyone in government cared to question, which in Obama's case it does not.  It is to be expected that in the midst of confusion, leaders cling to familiar ideas, even as they continue to fail.
4. A Radioactive Media.  The major media routinely bombards any heterodoxic interpretation with fata doses of scorn when it mentions them at all.  The result is that novel accounts are defined in advance for the viewer as marginal, biased, and self-interested, the view of someone who has a particular ax to grind.  Even orthodox views that counter the conventional wisdom, like those of the NYU business school professor Nouriel Roubini before the crash, based on intelligent pro-market skepticism about the valuations of complex securities, were shunned until it was too late, and now identified with Roubini as an individual celebrity, a kind of novelty show.  Regular coverage remains captured by a combination of economic orthodoxy and panic politics. The latter is instanced by the apparent influence of the clearly incoherent and unstable rantings of Glenn Beck.   Much has been written about the tight  grip of the boardroom over major media, largely owned or controlled by billionaire friends of Nicholas Sarkozy in France and by Fortune 500 corporations in America, to say nothing of Rupert Murdoch's global empire, who likened  the Tories's 20% one-year cuts in government to adults administering medicine to children.  The main point here is that the flourishing of diverse opinions on the Internet does not counter the narrowness of the major media, for  the Internet is cast in the role of the permanent opposition, always outside looking in, an accumulation of minority voices easily branded in any given case as extreme. The media famously does not support the kind of public sphere that allows ruling opinions to be debated and changed.  Change is possible, and there is no shortage of good ideas, but in this system, change may be delayed indefinitely, and to the point where it comes too late - as for millions of owners of overpriced homes.
5. Military Dominance.  During the Bush Jr. Administration, the War on Terror successfully replaced the Cold War as the justification for both continuous international intervention and unlimited military spending.  Military spending doubled in the U.S. in constant dollars in the 2000s.  The economist Joseph Stiglitz has revised his estimates of the costs of the Iraq and Afghanistan wars from $3 trillion to something like $4-6 trillion.  This spending on the control of perpetual threats is making social spending impossible, including the basic infrastructural renewal on which U.S. market capitalism in fact depends.  One of Obama's central failures has been his continuation of the instruments, the goals, and the spending that goes with the War on Terror. Under these irrational conditions, scial stagnation is the best case scenario. 
6. Adherence to Minority Rule.  For me, this is the key ingredient of the whole paralytic system.  Reagan and Thatcher were appalled by the challenges to traditional rule posed by antiwar protests, civil rights movements, and the rise of visible cultural minorities be they punk rockers in Birmingham or Jamaician construction workers in East London.  They and their descendents have worked tirelessly to insure that the political majority would never again have the economic independence to support such widespread dissent. They noticed that many of the protesters came from prosperous families, were in good universities, and were forming alliances with the less fortunate, as with for example the college "Freedom Riders" who went to help Black churches and other groups with voting rights and desegregation in the US South. Ronald Reagan kicked off his 1980 presidential campaign in Philadelphia, Mississippi, the county seat near where three of these Northern civil rights workers -- one black, two white -- were murdered in 1964.  Reagan praised "states rights," which was a synonym not only for racial segregation but for minority rule. Desegregation ended this most famous version of minority rule. The Right has been working steadily to replace it ever since.  
7. Upward Redistribution of Wealth.  The inequality boom has expressed minority rule on the level of economics.  There are numerous studies that show the same shift of wealth from bottom and middle to the top - especially the very top (0.1%, 0.01%). Wolff has one good paper, Saez, often working with Piketty, has another, and the Associated Press had a nice overview a while back.  A Pew-Brookings study in 2008 found that the wages of males are now about 12% lower than they were for their fathers a generation earlier, taking an obvious bite out of ordinary people's economic independence.  The Supreme Court decision taking limits off political spending has forged a direct short circuit between extraordinary wealth and political control. 

In short, the economic decline were are facing is a sign of ideological disarray in a political world controlled by conservative ideology for two generations, but it is also programmed within modern conservatism.  Cameron and Osborne inherent this from Reagan and Thatcher.  Governments have no idea how to stimulate innovation and growth.  That would require two things -- some kind of industrial policy if not actually state capitalism Chinese style (the model that did best during the crisis), and a redistribution of wealth back downward, in the name of efficiency, to the people who largely created it in the first place.

The slow impoverishing of the economic majority has been going on for thirty years, and it has become cultural common sense even for its victims.  It has now reached the turning point, a moment of acceleration in which a return to prosperity becomes increasingly difficult.  The only bright spot is that an increasing number of commentators are starting  to trace the unjust and also grotesquely inefficient boom in inequality to a deliberate strateg (e.g. James Kwak at the Baseline Scenario's  good recent entry on the 1970s. But given what I believe to be the profound ambivalence of political and business leaders towards mass prosperity, I see little in established opinion that will convince them to work consistently towards a broad-based recovery. Where is the great economic majority, demanding that politics serve majoritarian economic interests?

This is really too bad for Obama personally, since he hitched his fortunes to that Democratic assumption of the greater good, so often honored in the breach.  This is what Republicans are calling "socialist" in this fairly conservative pro-bank president: the very idea of mass benefit, one so broad as to only be possible through government-led development.

Obama's only chance to succeed is to give a major speech in the next two weeks.  The speech would have to take on the charge of socialism, and say yes, social democracy built our prosperous Western societies (along with much less savory forces), and now my opponents have come to take all that away from you.   He would have to point out that the Right  replaced prosperity rooted in general provision -- low fees in publicly-funded universities, for example -- with prosperity rooted in private property ownership -- that they replaced a grounding in government with a grounding in market-based exchange values. As a result, he would point out, asset inflation and personal debt have become the two pillars of middle-class living after broad improvement in wages ended, coincidentally enough, around 1980.  In addition, the ground rules of this prosperity are now controlled not by elected leaders but by an opaque labyrinth of banking and quasi-banking institutions, from mutual funds to mainline banks to hedge funds. Obama would have to say that even specialists know little about the condition of this system at any given moment, for its essential nature is to be proprietary, to hoard information, and to create losers in every transaction by selling at an advantage.  He would have to say that political leaders have no independence from this system, that his own failure to stimulate anything except banking has abundantly shown this.

Obama would have to make an updated class argument - and a plain argument for democracy-based intervention in the economy.  That is the sole means through which he can save the U.S. from a Republican 2010-12 that will accelerate the disaster, reach out to desperate Tea Partiers, and help people believe that their ideas about a better economic system might actually matter. It is the U.S.'s only chance for short-term public economic intelligence. 

But what, short of a sudden meltdown in the markets, would get Obama to do this?  What would get him to call out his own economic majority?

Woes of the French Government

Here's the best English-language potboiler version of the scandal plaguing the Sarkozy presidency in France.  An equally important story are the ongoing existence of actual independent journalism - in this case, the web-based paper Mediapart - amidst the profession's clientalist servility to the powerful ones who grant it access (witness the anger of the Washington press core at the revelations of Gen. McCrystal's contempt for the civilian government that came from a relative outsider working for the Rolling Stone).

The other big story is of course the extent to which the Sarkozy government works mainly for the rich and connected.  Huge majorities are already upset enough by the absence of real economic accomplishments among contemporary governments -- Sarkozy's approval ratings have been below 50% for a year or two. They are even more infuriated by the prospect of the minister of finance, whose wife handles financial matters for Mme. Bettancourt, working to help the richest woman in France with a fortune of $17-20 billion reduce her tax burden. 

Governments look increasingly like court servants of the each country's elite, in a throwback to the medieval period. The passivity of the middle-classes in effect supports the forces that jeapordize these classes's survival.

Brooks Upset By How Wrong He is, Blames Krugman

As if. You won't want to read the excruciating full-length version of David Schoolboy Brooks complaining about how the pro-stimulus prog economists are wrong even though they are turning out to be right as the recovery dies on the vine.  So cut to the commentary and various retorts. 

The only interesting thing about this is the development of the term "demand-siders" to describe Krugman, Dean Baker, and other neo-Keynesians who think that people's incomes are an important part of economies and that they should be higher rather than lower.  (This is in contrast to the "supply-siders" who came to power with Ronald Reagan, and who used the needs of suppliers, i.e. company owners and investors, as a reason to cut taxes for the high brackets.)  It suggests that the Right is no longer able to pretend that the center-left in the US has no coherent economic strategy.  This was the core of their "one church" approach to capitalism -they pretended there were no actual arguments against small government, no taxes, no public investment, etc. that needed a fair hearing. They taught a couple of generations of conservatives that all the "liberal" arguments had already been refuted, and they could be safely ignored.

That defense line has crumbled, and the next round of arguments is going to be quite different.

Another Dismal Overview

This one pulls together a lot of stats around employment.  Brace yourself.

Or just read this  summary:

Let's recap. Unemployment is high and is in reality going higher if you count those who would take a job if they could get one. Incomes are weak. Plans to purchase discretionary items are falling. Housing is likely in for a further drop in prices. The stock market is not exactly booming. Treasury yields are falling, not from a credit crisis or a flight to quality, but because of economic conditions (deflation). Money supply is flat or falling. Prices are under pressure. The list goes on, and all factors are indicative of deflation.

Fret Index Climbs

More of my capitalist pals are really starting to worry about Great Recession 2 - and I mean the investment advisors that have optimism thrust upon them by the need to find good new deals for their clients.  John Hussmann is predicting that equity markets will fall below their March 2009 lows, and Markos Kaminis is now a believer in the often-heralded double-dip recession. 

Among folks not selling products, Simon Johnson points out that the banks' push into emerging markets repeats past mistakes of the 1970s and 1990s, making me wonder how we can get out of this with such a complete lack of new ideas at the top.  He also notes yet again how impossible it is to imagine Goldman Sachs et al. supporting reforms of their own system, as opposed to supporting their own maximum freedom of movement.  I still don't know why there isn't a massive middle class outcry about this.

The New York Times had a good piece on Ireland sinking under the weight of its austerity regime, with premonitions of long-term decline.  “Ireland isn’t going to spend on infrastructure probably for another 10 to 15 years,” said one observer. Another, her business caught in the middle of a new yet dying housing development, said, “It’s so destroying.  We all live day by day, and we don’t know when it will ever pick up.”

The Crash Was the Best Thing for Finance Ever

Simon Johnson quantifies the benefit of the crash to the ones who caused it:

the purely fiscal damage wrecked by big banks – apparent in 2008 but building for longer – will end up increasing our net government debt held by the private sector by around 40 percentage points of GDP.  . . . Around half of our existing government debt burden and much of our continuing fiscal vulnerability is due to the dangers posed by unreformed big banks.

There's the direct benefit to private financial interest of the bailout with public money.  There's the indirect benefit of crippling the public sector and lowering its tax costs to corporations and wealthy individuals.  This is the only agenda of the California Republican party, whose social vision consists in its entirety of blocking tax increases on large incomes, this year by gutting the pensions of public employees.

This has already happened in Illinois, and click here to hear Arnold Schwarzenegger's spokesperson repeatedly saying that the state budget deficit makes public pensions unaffordable. In America, saying something again and again makes it true.  Another guest pointed out that state employees get 2% of their salary as a pension for every year worked, so after 30 years they get 60% of their final few years averaged salary, and the average is $24,000 a year.  Apparently this is too much money for someone who worked for the public for 30 years, compared to the enormous piles both needed and deserved by wealthy investors.

The banks are continuing on much as they were: too big to fail will survive the reforms,  along with the banks' first lien on all national wealth.  Derivatives trading will carry on with small changes.  The only tools at ordinary folks' disposal - disclosure, data, discussion- will remain unavailable (see Morgenson's summary).   The economic leadership's silent passion for impoverishment means that people are still losing their houses even with loan modification programs. In the California counties of the new middle class of the 2000s -- around 1 in 100 houses received a forelosure notice just in the month of May 2010.

This system is grossly unjust and inefficient - inefficient like baronial 18th century French agriculture. Inefficient like Greece agreeing to austerity and paying even more for credit than before. Inefficient like families having no place to live. Inefficient like a third depression.   Inefficient like today's college-age adults being less well educated than their parents.

What amount of decline is going to upset the middle classes enough to fight for their jobs and their homes?

Sometimes Goliath Loses Even Today

California had its primary elections this week, and the Republicans nominated a billionaire and a megamillionare to be their candidates against Jerry Brown for governor (yes, as is typical of our sclerotic political system, 1970s Jerry Brown is California's only hope for avoiding another four years of oligarchic politics by giving us four years of paralytic centrist politics). In the midst of this was a nice story of Pacific Gas & Electric getting beaten in its attempt to require a 2/3rd vote before a municipality could offer its residents a public alternative to the existing power monopoly - even though PG&E outspent its opponents 1000-1.

Perfect Storm

Here's interesting death-trip summary of Friday's economic activity by Bo Peng

Friday's US equities market strikes me as being highly unusual.

1. S&P 500 followed a perfect straight channel down through out the day.
2. VIX only touched 36.

In other words, there's never any sign of panic or crash, which is quite remarkable when the broad market is down 3-4% across the board; the Dow broke the symbolic 10,000 level, EURUSD broke the symbolic 1.2 level, interbank funding and corporate/muni bond markets have all but dried up, next housing sales are bound to be bad as predicted by the latest mortgage application number, a number of government bond auctions (Brazil, Hungary, Romania, Spain -- almost) have failed, CDS on French sovereign shot up. For the weekend: US bank seizures and Spanish bank mergers/failures, Bilderberg Club to decide on dismantling the Euro, BP (BP) oil washing up Florida beaches, etc

I doubt there's ever been a day like Friday before.

Panic is usually followed by quick reversals. But calculated, organized retreat means gone for good. This is well-controlled retreat. The calm is scary. A perfect storm is brewing.

Global Hoovermania 2

Scarecrow adds fuel to yesterday's post, starting his comment on the G20 by saying, "Unless I misunderstand these stories, it appears the world’s biggest economies just decided, over US objections, to resurrect Herbert Hoover, rebury Keynes and pursue another Great Recession, tanking their economies and putting millions more out of work."

Democracy vs. Finance, Governments vs. Progress

Markets are supposed to create rigor and discipline, to reflect economic reality.  In this standard view,  the public is seen as self-serving and self-deluded about economic reality.  Governments that reflect the wishes of their majorities are almost by definition going to impose inefficient, nostalgic policies suited to a bygone age that discourage their population from adapting to the economic needs of today.  Democratic governments are seen as dangerous for the economy.  This is why "central bank independence," which is seen as the prerequisite to central bank reliability, means independence from both popular desires and from democratic representatives like the U.S. Congress.

Is this how things really work?  The economist Mark Weisbrot has a nice summary of the European crisis that suggests not.  First on markets:

"the markets" can't seem to decide what they want from these governments in order to love them again. Two weeks ago the euro was plummeting because the financial markets wanted more blood: they wanted Greece, Spain, Portugal, and the other currently victimised countries of Europe (Italy and Ireland) to commit to more spending cuts and tax increases. Then they got what they wanted, and within a day or two, the euro started crashing again because "the markets" discovered that these pro-cyclical policies would actually make things worse in the countries that adopted them, and reduce growth in the whole eurozone.

Markets are pushed by investing institutions, which are fairly close to a global monoculture of neoclassical economic orthodoxy.  So austerity is always job 1.  But orthodoxy recognizes contraction and that austerity policies can make contraction worse.  Markets are ruled by an economic orthodoxy that is contradictory and pushes investors in different directions.

Similarly, here's Weisbrot on governments:

Unfortunately the European authorities – especially the European Central Bank – are even worse than the markets. They are less ambivalent and more committed to punishing the weaker economies by having them cut spending even if it causes or deepens recession and mass unemployment (over 20% in Spain).  . . .

There is a class dimension to all of this, with the EU authorities and the bankers united in wanting to balance the books on the backs of the workers – and adopt "labour market reforms" that will weaken labour and redistribute income upward for generations to come. The EU authorities and financiers believe that real wages must fall quite sharply in these countries in order to make them internationally competitive – but the protesters are responding with a fiscal version of "No justice, no peace".

In short, "markets"  change their minds every few days about the necessary medicine because they really have no idea how to develop economies.  Governments are now devoted to de-developing their populations: lower wages is a euphemism for increased poverty.

Economists aren't doing much better, for the most part.  Writing in the Financial Times on June 1, the prescient critic of finance Nouriel Roubini contradictorily calls  for "radical reform of finance" and for Europe to "deregulate" and "liberalise."  And Weisbrot calls for an end to the Euro so that countries like Greece can rebalance by deflating a national currency, rather than calling for EU-based economic re-development.

The only way out is to start by recognizing that markets seek to make money for the people who invest in markets, and do not seek to develop economies. This will help keep governments from catering to them, and impoverishing their populations in the process.  It will also relegitimize popular economic demands, which are in fact closer to developmental wisdom than are the self-serving calculations of investors and the central banks who set things up for them.

Democratic theory presumes the long-term wisdom of the deliberative majority. Finance -- via its economic theorists -- has declared itself to be the great exception to democracy, and remains the area in public life where frankly anti-democratic, elitist  theory flourishes.  It drags public policy in its wake, and in spite of lucid mass hostility to banks, has intimidated and paralyzed the popular reimagination of economics.  This has set up a kind of ancien regime within democracy as such. In the arena of financial capitalism, democracy has been effectively canceled.

Either we democratize finance with a basis in a coordinated retheorization of it or Europe and the US will keeping heading straight the poorhouse.

New Elite at War with Everyone

This past month has seen the final shoving of Germany towards supporting a Greek bailout, the condition being an imposed austerity whose terms will lower Greek living standards for years to come.  Most of the Greek public is opposed, having never seen most of the money their financial and political sectors managed not to invest in rebuilding a modern Greek economy.  They are getting their wages and pensions cut anyway, and are regularly in the streets.

The media largely still tells the story as between past and future, meaning labor and finance, or unions, who seek self-protection that looks backward to a vanished era, and responsible, enlightened business opinion, which seeks austerity.  For example, a leading proponent of serious financial reregulation in the U.S., Simon Johnson, calls for austerity in Greece.  Economists who point out that this is a recipe for poverty and financial depression - which in turn endangers loan repayment - are in a minority.

The "capital vs. labor" paradigm suggests that there is a large, forward-looking majority -- wealthy business elites, of course, but also a large affluent middle-class with BAs, MBAs, JDs and MDs -- and that this combined majority sides with enlightened business interests who create new wealth and the future's new industries.  They oppose the dwindling, outmoded blue-collar folks represented by unions and the public sector in general, who fight a rear-guard action for privileges that the marketplace, reflecting the real economy, no longer supports.

There was a time during the post-war "golden age" when the very top of the financial pyramid cemented the loyalty of a large middle class with generous benefits, delivered largely through a well-funded public sector.  Great public universities were one major example, but so were cheap freeways and subsidized suburban developments, hospitals and schools, the whole panoply of the "American way of life" for what was actually a fairly ordinary bunch of people, judged by global standards.  This time has come and gone. I've written at length about the deliberate downsizing of the middle class through attacks on its central institution, the public university, and we now have abundant evidence of the result: a splitting of a tiny elite -- an upper 0.1% or so -- from the rest of the top, which it opposes.

We're actually seeing a return of the Three Estates of the profoundly pre-democratic French 18th century social system: well-educated brainworkers are falling into a huge Third Estate of unprotected, insecure workers of vastly different educational qualifications. One example of the tendency is the ongoing effort to eliminate public pensions in California, which provide compensation for the relatively lower wages of public service workers many of whom are as well educated as $800,000 / year attorneys (nurses, college professors, financial analysts, etc.)

A good example of our "post-democratic" class structure appears in a nice paper by Mike Konczal.
He finds a way to distinguish the views on financial reform of Certified Finanacial Analysts, whose median incomes of around $250,000 put them in the top 1.5%, in contrast to the people who hire them, in the top 0.1%.

Studies of the distribution of the financial gains of the past decade show much the same thing - the lion's share not to the top 10% or even the top 1% but to the top 0.1% and 0.01% of the population.  The result is an unsustainable economy - as the crisis has shown - and a fractured polity that even the apparently skillful Barack Obama is blatantly unable to glue together again in the absence of meaningful 'reform."

The only cure is moving ahead into a new egalitarian phase of whole-society development.  But this depends entirely on a push from the great majority that is currently losing ground.  And where is that push?  Konczal's paper went up on HuffPo on May 3rd.  Almost three weeks later, it has zero comments. Meanwhile, a clip of Rand Paul's dumb, obviously right-wing stuff about the Civil Rights Act has over 16 thousand. Great, we've figured out that Paul is Tea Partying right-winger, like he hadn't already said that everyday in his campaign.  Meanwhile, the middle-class seems completely unable to define the reforms on which depends for its survival.

Falling Ideology?

In addition to running good steady commentary on the banking reform legislation (e.g here), Simon Johnson remarks on the Baseline Scenario that "the ideology of unfettered finance is crumbling."  Clearly top Obama economics advisor Larry Summers hasn't heard. It's worth watching the clip to see the weird blasé attitude towards "things that happen on Wall Street" - the tone is more important than the words.  I'm not feeling the shift yet but he's there and I'm not so here's hoping.

Finance as Fraud Itself

This morning the Vulcan cloud of cinders is as good a commentary as we're going to get on the fragility of an economy that depends on unsustainble long range transport. 

Krugman is a bit late but still lucid defining the crisis as issuing from deliberate fraud. He mentions a good ProPublica piece on the same kind of toxic stuffing at a hedge fund with one of the stupid fake names bankers love - Magnetar, which immediately dissolves into several variants composed of amputated partwords stitched together by Dr. Frankenstein - Mangy-tar, eat-tar (from the French manger- to eat), eat nectar, magnet-star . . .)

A commentary on Goldman Sachs by Will Hutton gets at two other core issues in the rise of finance over the past 30 years in the Anglo-American version of capitalism (beyond the use of complexity to defraud one group of clients for the benefit of another).  The first is the abuse of independent professionals as fronts of legitimacy: clients couldn't see under the hood of the instruments they were buying, so they took the word of analysts on the basis of their professional stature and institutional affiliation.  "A court-appointed examiner found that collapsed investment bank Lehman knowingly manipulated its balance sheet to make it look stronger than it was – accounts originally audited by the British firm Ernst and Young and given the legal green light by the British firm Linklaters."

And in the Goldman Sachs case,

Goldman allegedly went one step further, according to the SEC actively creating a financial instrument that transferred wealth to one favoured client from others less favoured. If the Securities and Exchange Commission's case is proved – and it is aggressively rebutted by Goldman – the charge is that Goldman's vice-president Fabrice Tourre created a dud financial instrument packed with valueless sub- prime mortgages at the instruction of hedge fund client Paulson, sold it to investors knowing it was valueless, and then allowed Paulson to profit from the dud financial instrument. Goldman says the buyers were "among the most sophisticated mortgage investors" in the world. But this is a used car salesman flogging a broken car he's got from some wide-boy pal to some driver who can't get access to the log-book. Except it was lionised as financial innovation.

The investors who bought the collateralised debt obligation (CDO) were not complete innocents. They had asked for the bond to be validated by an independent expert into residential mortgage-backed securities – a company called ACA management. ACA gave the bond the thumbs-up on the understanding from Fabrice Tourre that the hedge fund Paulson were investing in it.

 Whether or not Goldman Sachs' Tourre lied to his investors and said that Paulson was investing in the CDO when in reality he seems to have made it as toxic as possible so he could bet it would collapse, as it did, the deeper point is that these transactions were confidence games, literally speaking.

The further issue is that the transactions had no value except in the confidence game that constructed them. Outside of that, they had no value, certainly not for society.  Hutton writes,

It is time to reframe the question. Banks and financial institutions should do what economy and society want them to do – support enterprise, direct credit to where it is needed and be part of the system that generates investment and innovation. Andrew Haldane – and the governor of the Bank of England – are right. We need to break up our banks, limit their capacity to speculate and bring them back to earth.

That would be to end high finance as we know it, because that does not invest in enterprise or places where credit is socially needed.  The returns there are lower than what it can get elsewhere.

In a similar spirit, see the Stiglitz presentation on financial reform at a large economics conference at Cambridge University a couple of weeks ago.  It comes from a world that doesn't yet exist.  Perhaps it will be revealed by the passing of the Vulcan cloud of ash.

The Goldman Sachs Complaint

Joe Nocera has a good summary of the issues involved in its Goldman Sachs complaint, and the SEC has a condensed description of it. Here are the two key paragraphs:

According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.

The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

These are our financial geniuses at work on a straight con. The CDO lost 83 percent of its value in the first six months.  Nice.

James Kwak at Baseline has a helpful exegesis on the "type of transaction involved — in which a hedge fund makes a CDO as toxic as possible in order to then short it."  He notes:

It seems like the key will be proving that Paulson influenced the selection of securities enough that it should have been in the marketing documents. Paragraphs 25-35 include quotations from emails showing that Paulson was effectively negotiating with ACA over the composition of the CDO, so it’s pretty clear he had influence. The defense will presumably be that ACA had final signoff on the securities, and Paulson was just providing advice, so Paulson’s role did not need to be disclosed. (I don’t know what kind of standard will be applied here.)

Kwak adds, "no doubt to the annoyance of many, I don’t blame Paulson. It’s Goldman that had the duty to its investors, not Paulson."

Michael Lewis is more explicit about all this in an interview that Kwak quotes elsewhere:

all of the people you mentioned all swallowed a general view of Wall Street, which was that it was a useful and worthy master class, that these people basically knew what they were doing and should be left to do whatever they wanted to do. And they were totally wrong about that. Not only did they not know what they were doing, but the consequences of not knowing what they were doing were catastrophic for the rest of us. It was not just not useful; it was destructive. We live in a society where the people who have squandered the most wealth have been paying themselves the most, and failure has been rewarded in the most spectacular ways, and instead of saying we really should just wipe out the system and start fresh in some way, there is a sort of instinct to just tinker with what exists and not fiddle with the structure.

Lewis also hits this blog's humble theme, the intellectual limits of the mass middle class that continues to prevent it from overcoming its humiliating defeat by financial forces it never bothers to understand:

The question is how does Washington move away from those institutions and make decisions that are in the public interest without regard for the welfare of these institutions. It’s a hard question because . . . this is the problem. Essentially the public and their representatives have been buffaloed into thinking that this subject — financial regulation, structure of Wall Street — is too complicated for amateurs. That the only people who are qualified to pronounce on this are people who are in it. And there are very very few people who aren’t in it in some way who have the nerve to stand up and fight it. . . .

The reporter as much on this beat as anyone in the U.S. Gretchen Morgenson, discusses why John A. Paulson who set this up was not indicted. Paulson's firm released a statement that said in part,

There’s no question we made money in these transactions. However, all our dealings were through arm’s-length transactions with experienced counterparties who had opposing views based on all available information at the time. We were straightforward in our dislike of these securities, but the vast majority of people in the market thought we were dead wrong and openly and aggressively purchased the securities we were selling.

Morgenson (and Louise Story) continue:

After analyzing risky mortgages made on homes in Arizona, California, Florida and Nevada, where the housing markets had overheated, Mr. Paulson went to Goldman to talk about how he could bet against those loans. He focused his analysis on adjustable-rate loans taken out by borrowers with relatively low credit scores and turned up more than 100 loan pools that he considered vulnerable, the S.E.C. said.

Mr. Paulson then asked Goldman to put together a portfolio of these pools, or others like them that he could wager against. He paid $15 million to Goldman for creating and marketing the Abacus deal, the complaint says.

One of a small cohort of money managers who saw the mortgage market in late 2006 as a bubble waiting to burst, Mr. Paulson capitalized on the opacity of mortgage-related securities that Wall Street cobbled together and sold to its clients.

 In a video clip, Story points out that the case seems to be proof that Goldman does bet against instruments it markets to its own clients, contrary to its repeated denials.  In another clip, the SEC's Robert Khuzami answers questions about the compliant.

The complaints are finally getting under way.

Long Slide in the Post-Crisis

Some good books on the financial crisis have come out in the past month, including two I've bought but am still waiting to get time to read. One is 13 Bankers, by Simon Johnson and James Kwak (who also run the blog Baseline Scenario, an excellent source for blow-by-blow commentary on the ongoing struggle for a soupçon of financial reform. Another is Econed, by the author of the blog Naked Capitalism, which details the intellectual failures of doctrinal US economics and their real world impact.

Kwak has a good review of another of the good recent books, The Big Short by Michael Lewis.  Kwak gets at the crucial problem with the financial system in general, which is that the supposedly iron logic of objective market forces to which financial players are all subject in fact masks rules made up by a fairly small number of insiders to maximize their take.  Here's just a taste:

The problem was that the banks, as the swap dealers, got to decide what the swaps were worth. So, for example, Charlie Ledley bought an illiquid CDS on a particular CDO from Morgan Stanley. Five days later, in February 2007, the banks started trading an index of CDOs that promptly lost half its value. But, as Lewis writes, “With one hand the Wall Street firms were selling low interest rate-bearing double-A-rated CDOs at par, or 100; with the other they were trading this index composed of those very same bonds for 49 cents on the dollar” (p. 162).* That is, the market price of the already-issued CDOs didn’t affect the sale price of new CDOs. And what’s more, Ledley’s broker insisted that the price of his CDS (which should have soared as the index of CDOs fell) had not changed. Here you see the banks simultaneously ignoring a market price in two separate ways: once so they can continue selling new assets that are extremely similar — worse, if anything — to assets that they are trading as garbage; and again so they can avoid sending collateral to their hedge fund client.

Got that?  It's people making stuff up, and making a pile of dough as a result. This is finance that has nothing to do with investment, productive or otherwise. Its only impact on society is to damage it.  The rest of us are supposed to believe in its objectivity and defer to the outcome.  How far along are we in knowing enough to think otherwise?

We're looking as usual at a huge gap between the insight of experts and that of the general public.  A sign of where the public discussion is can be found in Jane Hamsher's comment on the its basic non-existence.

The social damage continues to spread. People are looking at Portugal next, and even the best financial commentators, like Simon Johnson, counsel cuts and austerity till the end of financial time.

For example, just to keep its debt stock constant and pay annual interest on debt at an optimistic 5 percent interest rate, the country would need to run a primary surplus of 5.4 percent of G.D.P. by 2012.  With a planned primary deficit of 5.2 percent of G.D.P. this year (i.e., a budget surplus, excluding interest payments), it needs roughly 10 percent of G.D.P. in fiscal tightening.

It is nearly impossible to do this in a fixed exchange-rate regime — i.e., the euro zone — without vast unemployment.  The government can expect several years of high unemployment and tough politics, even if it is to extract itself from this mess.

Neither Greek nor Portuguese political leaders are prepared to make the needed cuts.

Greece's crisis has settled into semi-permanence in the style that is becoming typical of our new post-crisis era: permanent low-level anxiety, permanent austerity, and permanent stagnation in wages. All of this is imposed with a financial logic of inevitability. The continuous message is that there is no escape.  Greece is looking at a lost decade for its society. The West is dealing with a crisis caused by its small, arrogant, uncaring, incredibly rich financial sector by downgrading the resources and the vision of its societies.  After ten more years of this, what visions and aspirations will be left?