In addition to the process of wage globalization, and tax policy favoring the wealthy, there is a 3rd main driver behind the "New Gilded Age" in which American society is increasingly divided between the wealthy and ultra-wealthy on the one hand, and the masses treading water to keep even on the other.
The third prong is how the failure to enforce and upgrade antitrust legislation, together with RW monetary policy by the Federal Reserve Bank under "easy Al" Greenspan have enabled a few large financial players to become "too big to fail," ensuring that while their profits are private, the risks of their collapse causing systemic failure remain socialized.
The issue is timely. With a likely unwinding of a huge "credit bubble", only 2 weeks ago a bond rating agency said that 3 huge banks -- Citibank, JP Morgan Chase, and Wells Fargo -- were "too big to fail" and therefore would be bailed out if they ever became insolvent. The same goes for the 2 giant mortgage agencies, Freddie Mac and Ginnie Mae. Ordinary wage earners and savers may be stuck with the bill. To find out how this happened, and how democrats can confront and change these policies, read below.
Introduction
Wealth inequality in the US is so great that we are becoming more like Brazil and Mexico than like Europe or Japan. There are at least 3 main drivers behind this "New Gilded Age" in which American society is increasingly divided between the wealthy and ultra-wealthy on the one hand, and the masses treading water to keep even on the other. Two of them receive plenty of notice here and elsewhere. Globalization, in which industrial production is shifted from high-wage to low-wage countries, has been the subject of a number of good diaries by BobOak, for example. Similarly, tax rates have shifted from strongly progressive taxation from the 1930s-1960s, to net regressive policies now.
The third driver of this concentration of wealth in the highest echelons is that banks, corporations, and large investors can take enormous risks, knowing that the government or the Federal Reserve Bank (the Fed) will bail them out. This is the "too big to fail" doctrine, meaning that the results of a private failure would be so disastrous that it would be better for them to be rescued by the public (or at least, by a large enough private entity). For example, in 1998 the Fed put together a bailout of the Long Term Capital Management hedge fund to large investement houses and banks, in order to stop an international financial meltdown. The public, however, was stuck with the bill for a $165,000,000,000 bailout of the 1980s S & L crisis.
In the last 6 years, I believe we have witnessed the biggest credit bubble in 75 years. Now the bills are coming due. Just last week Senator Dodd of Connecticut proposed a bailout of subprime mortgage borrowers. And Moody's investment service labeled three large banks as "too big to fail". New Fed Chair Ben Bernanke recently issued a similar warning about Ginne Mae and Freddie Mac. Question: if you were the CEO of any of those banks, would you now feel any constraint at all on the amount of risk you could take?
I. 2 types of "too big to fail" policies
1. Part of this is lax antitrust policy. It used to be there were 8 large accounting firms. Now there are 4. There used to be 7 large oil companies. Now there are 4 "supermajors". The antitrust breakup of AT&T has been almost completely undone. The consequences of any of them going bankrupt are far greater than if a smaller player in a more crowded field (like, a clothing retailer) were to go bankrupt.
2. But another part is the policy of the Greenspan Fed, known generally as the "Greenspan put." Simply put, Greenspan claimed that the Fed could not recognize in advance whether there was an asset bubble, and so therefore should not act prophylacticly. Since inflation in assets but not wages is not recognized as inflationary under the "Taylor Rule", the Fed does not act to stop them. Once a bubble bursts, however, its existence becomes obvious and so the Fed should step into the market and flood it with money (liquidity) to avert danger. Greenspan undertook this policy on at least 4 occasions: first after the 1987 stock market crash, second after the S&L crisis and recession in 1990, third after the 1998 asian currency crisis, and 4th in 2001 after the dot-com crash and terrorist attacks. By now (2007) investors have learned that if there is a whiff of serious trouble, the Fed will come riding to their rescue. Profits are theirs. If there is danger of a meltdown, the Fed will bail them out with liquidity, and they can cut their losses.
II. The Bush/Greenspan asset bubble economy
In the last episode, from 2002 through mid-2004, the Fed did something almost unheard of. It lowered the Fed funds interest rate (the rate at which the Fed makes overnight loans) to 1% -- a rate less than the inflation rate, which was running between 1.7% and 3%. This rate, the Fed funds rate minus inflation rate is called the "real" Fed funds rate. This meant that the Fed was actually paying banks to borrow money! Money that they could, for example, invest in long term treasury bonds yielding about 5% risk free.
While I am not a fan of Austrian economic theory, its analysis of the asset bubble economy that has been created in the United States is spot on. According to that theory, when a central bank lowers rates artificially to stimulate an economy,
the artificial lowering of interest rates by the central bank leads to a misallocation of resources on account of the fact that businesses undertake various capital projects that prior to the lowering of interest rates weren't considered as viable. This misallocation of resources is commonly described as an economic boom. The process, however, is brought to a halt ... once the central bank—that was instrumental in the artificial lowering of interest rates—reverses its stance, which in turn brings to a halt capital expansion and an economic bust ensues.
This creates a division between those like investment houses and banks called "early receivers" and ordinary consumers and workers, called "late (and non-) receivers." As described by blogger Russ Winter:
Now, the expansion in banks' credit, i.e., credit out of "thin air", begins with a particular individual or a group of individuals—in other words there are always first receivers of money out of "thin air".
The first borrowers are the greatest beneficiaries of the new credit since they are the first receivers of the newly created money out of "thin air"—their purchasing power has increased. The early recipients can now purchase a greater amount of goods while the prices of these goods are still unaffected.
.... The increase in purchasing power, while boosting the demand for goods and services of the early recipients of money, also gives rise to demand for goods which, prior to monetary expansion, would not have been considered at all.
This increase in the purchasing power of the early recipients of money however, is at the expense of the late receivers or non-receivers. In short, this increase amounts to a transfer of real funding from the late recipients of money to the early recipients of newly created money.... This means that the late recipients of money will now have less purchasing power at their disposal, all other things being equal.
In the Bush/Greenspan economy, almost 30% of all profits in America have been made by financial companies, which are now the greatest component in the stock market. These financiers were the "early receivers" of the Bush tax giveaways and the Fed's overstimulative rate cuts. In fact, so fat with cash are America's large corporations that they literally cannot find any profitable projects in which to invest their capital, so they engage in stock buybacks instead. Much worse, financial firms in search of ever-decreasing interest yields, have engaged in ever more speculative, leveraged (i.e., financed with debt) financing. Meanwhile, the vast majority of consumers were "late" or "non"-receivers of the liquidity. These are the people who have been treading water during the entire economic expansion.
But now, as predicted by Austrian theory, the central bank has tightened (to 5.25%, about 3% higher than the year-over-year consumer inflation rate), and the proverbial birds are coming home to roost, most recently, the implosion of the subprime mortgage lending industry.
Now that the bust is upon us, a few weeks ago bond traders were evaluating bonds of some very large players like Morgan Stanley and Merrill Lynch as virtually junk. And what are we hearing?
JP Morgan Chase is too big to fail.
Citibank is too big to fail..
Wells Fargo is too big to fail..
Freddie Mac is too big to fail.
Ginnie Mae is too big to fail.
Subprime borrowers are too big to fail.
Just who do you suppose is going to be told to bail out all of these people, if they go belly-up? Responsible taxpaying members of the middle class, that's who.
Conclusion: Strenghten antitrust laws, enjoin the Fed to restrain asset bubbles
A more baldfaced example of RW monetary and economic policy failure could hardly be found. Between the time I drafted this diary, but before I had it in final form, prominent economic blogger Nouriel Roubini has chimed in with an excellent post entitled Who is to Blame for the Mortgage Carnage and Coming Financial Disaster? Unregulated Free Market Fundamentalism Zealotry. Please go over and read it; he makes many of the same points I do, but in much more comprehensive economic detail. Also good is this rejoinder by Mish.
Democrats need to focus on two reforms.
First, antitrust laws need to be strengthened and enforced. For an easy example, Ginnie Mae and Freddie Mac are federally chartered. Congress should order them broken up into 8 separate entities, and spin off 6 of them. That way, none of the entities are "too big to fail." Similarly, automatic antitrust breakups need to take place whenever a financial industry gets too concentrated. If, for example, the large banks were each split into three equal parts, with their investors getting a proportional share in each, any loss would be solely that of the market premium accorded a "too big to fail" entity.
Secondly, the Federal Reserve Act should be amended to mandate that the Fed to consider asset inflation in setting its rate policy. Had the Fed not premitted the dot-com bubble to grow to fruition, there would have been no need for such deep cuts in rates in 2002. If the Fed did not permit the housing bubble to grow to fruition, there would be no concern now for systemic risk due to epidemic foreclosures or financial failures.