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Five years ago I heard Dean Baker, one of the main economists at the Progressive think tank, the Center for Economic Policy Research (CEPR) speak at SUNY Albany.

While the main focus of the talk was how the IMF was about to become irrelevant in Latin America, he did spend some time on the housing bubble.

Why? He was basically telling anyone who would listen that the housing market was in a bubble and that it would have dire consequences for the economy when it burst. I've never forgotten how emphatic he was about the housing bubble and its ramifications.

So, considering that CEPR predicted this mess years ago, I think it's important to take Dean Baker seriously when he says that Wall Street basically put a gun to our heads.....

Baker basically thinks that this "crisis" is the big banks' attempt to blackmail us so they don't get taken over by the Fed.

In Wall St Held a Gun to Our Heads, Baker tells us the real purpose of the bailout, as engineered by those with a stake in the system. For those of us who agree with Markos that we need a better bill, this is the economic analysis we need to hear.

In the most general way:

The bail-out is a big victory for those who want to redistribute income upward. It takes money from school teachers and cab drivers and gives it to incredibly rich Wall Street bankers. These bankers have in turn distinguished themselves by their incompetence, having driven their banks into the ground.

This upward redistribution was done under the cover of crisis, just like the war in Iraq. But there is no serious crisis story. Yes the economy is in a recession that is getting worse, but the bail-out will not get us out of the recession, or even be much help in alleviating it.

Here's where it gets interesting.

The best argument that the bail-out proponents had was that the failure to do the bail-out could lead to a collapse of the financial system, leaving us unable to use credit cards or ATMs, or otherwise conduct normal financial transactions. This would indeed be scary, since it would imply a complete economic collapse. (I had actually accepted this line.)

Actually this was entirely an idle threat. In the event the banking system really did freeze up, then the Federal Reserve would step in and take over the major banks

I bolded the key point, because according to Baker, this is the underlying reason why we've been talked into the bailout. Looks like blackmail, doesn't it?  Baker goes on:

The banks would not be happy about a Fed takeover. The top executives would be out of their jobs, and the shareholders would likely lose their full investment. However, the rest of us would be able to carry on with our lives as we did before. After maybe a few hours of disruption, we would be able to cash checks and use credit cards and ATMs just as we did before the crisis.

In effect, the big banks had a gun pointed at their heads. The banks told Congress that if they didn't get $700bn, then they would pull the trigger. Given this choice, Congress coughed [assuming the bill passed] up the cash.

Baker also thinks there is evidence the bill isn't that serious because it lacks "hard commitments" and detail on important things, including which executives will have their pay limited and by how much, how much equity the government will get when it buys the bad debts, and how many mortgages will be renegotiated. It also doesn't change bankruptcy rules so more people don't lose their homes.  

Importantly, Baker adds:

Nor does it provide for any real stimulus. Undoubtedly, the spending on the bail-out will be used in future months as an argument against real stimulus.

It seems to me, then, that people like Markos and others of us calling on Congress to reject the current bill are totally within reason. Yes, something needs to be done, but this bill is sorely lacking. As it stands, Wall Street investment bankers have screwed up and because they don't want to be taken over, so they scream fire. Lets take a while to consider other options.

First, it's important to start with Baker's analysis of the root of the problem: the housing bubble. This next section is from a subsequent article in TPM Cafe

The main cause of the economy's weakness is not insolvent banks and lack of credit; it's the loss of $4 trillion to $5 trillion in housing equity as a result of the bubble's partial deflation.


With much of this equity now eliminated by the collapse of the bubble, many families can no longer sustain their levels of consumption. The main reason that banks won't lend to these families is that they no longer have home equity to serve as collateral. It wouldn't matter how much money the banks had, they are not going to make mortgage loans to people who have no equity.

And house prices are not going to come back. This is like We are not going to get the price of $200,000 homes in central California back up to $500,000.

The main problem in recovering from the recession will be finding ways to boost demand other than household consumption.

Fiscal stimulus must be central to any serious effort to boost the economy.

The weakness of the banks contributes to the downturn, but they are not the core of the problem. We would still be facing a recession even if all our banks are flush with cash. Hence the hype about the urgency of the bailout was an invention.


How do we go about getting the banks in order? Almost every economist I know rejects the Paulson approach and argues instead for directly injecting capital into the banks. The taxpayers give them the money and then we own some, or all, of the bank. (That's what Warren Buffet did with Goldman Sachs.)

This isn't about begging for a sliver of equity as a concession for a $700 billion bailout, this is about constructing a bank rescue the way that business people would do it. We have an interest in a well-operating financial system. There is zero public interest in giving away taxpayer dollars to the Wall Street banks and their executives.

If Secretary Paulson constructed a package that was centered around buying direct equity stakes in the banks, he could quickly garner large majority support in both houses. Better yet, Congress could just construct its own package centered on buying equity stakes and send it to President Bush. If he balks, we can just threaten him with stories about the Great Depression.

What should Progressives advocate? See Baker's Progressive Conditions for a Bailout for some productive ideas.

I know I quoted a lot of that article, but I feel this is vital to arguments for a different bailout bill.

Now, you can finish reading here, but I want to also give some of CEPR's analysis of this crisis from a paper from another CEPR economist, Mark Weisbrot, which he presented in Brazil the other day. Much of it is about Latin America, his specialty, but I think it presents good information for us non-economists to consider when we are thinking about fiscal policy. The paper was entitled The United States and the World: Where Are We Headed?

It's the economy, stupid! (not just a financial crisis)

There is a confusion in most of the public discussion of the state of the U.S. economy. The current economic problems are seen as overwhelmingly a financial crisis, when in fact there are major problems in the real economy that are dragging the economy into a serious recession.  In other words, even if the problems in the financial sector are resolved, it would not prevent this recession from deepening. We are currently experiencing a recession that was brought on by the bursting of a massive housing bubble, one that created some $8 trillion of illusory wealth before it began to burst in mid-2006.

This bubble is only about 60 percent deflated, and that assumes that there is no overshoot in the other direction at the bottom. The arithmetic is fairly straightforward: from 1996 to 2006, U.S. home prices rose by about 70 percent above the rate of inflation. Prior to this, home prices over the long term did not rise faster than inflation. This means that home prices would have to fall about 40 percent to reach trend levels; in real terms (including inflation), they have so far fallen about 25 percent.

There remains a large oversupply of housing in the United States, and homeowners are currently receiving foreclosure notices at the rate of about 3.6 million a year. In addition to the impact of the shrinking of construction and housing-related sectors, an even more important impact of the bursting housing bubble on the economy is through the wealth effect.


Over the last four quarters of data, the main contributor to economic growth has been an improvement in the trade balance, as a result of the steep slide of the dollar (about 25 percent against a trade-weighted basket of currencies) that began in 2002.4  But trade is only about 26 percent of the U.S. economy; consumer spending is 70 percent. And the labor market has weakened to recession levels: unemployment, at 6.1 percent, is almost at its September 2003 peak from the last recession, and employment as a percentage of population is near its trough from the last recession. The economy has shed jobs at a rate of 81,000 per month over the last quarter, and real wages are falling. All of this will feed back into the housing market and also weaken consumer spending.


In other words, the U.S. downturn is just beginning, and will accelerate even if the problems in the financial sector were to be resolved in the most efficient manner possible. More likely, problems in the financial sector as it rids itself of insolvent institutions and bad debt will contribute to the downturn through restricting the availability of credit and undermining investor confidence generally.

I hope this info can contribute to reducing some of the hysteria around this bailout. We are in deep doo doo no matter what we do, so lets take time to get a new bill that addresses problems in a more comprehensive way. Also, lets realize that Obama could be set up to be blamed for some of the crap he'll inherit as president, and get our responses ready ahead of time.

Obama could safely go back to the 1990s Clinton campaign slogan: "It's the economy, stupid!" How anyone could think of voting for someone as irresponsible as John McCain in the current environment is beyond me

Originally posted to on Tue Sep 30, 2008 at 01:00 PM PDT.


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