Last week, Senator Chris Dodd’s campaign put up a web page highlighting Senator Dodd’s proposed policy responses to the subprime mortgage crisis, and the general sense of economic unease felt by most Americans. Unfortunately, Dodd’s proposed policies serve has a case study of what’s wrong with economic thinking in this country, including even the Democratic Party.
According to the Dodd campaign’s web page, "The current foreclosure crisis is rooted in shameful predatory lending practices on the part of unscrupulous lenders."
False.
more below the fold
The current foreclosure crises is rooted in the stagnation of wages and earnings the past 30 years. If, since Reagan took office, average weekly earnings had continued to grow at the same rate they had grown from 1964 to 1980, the typical household in the U.S. would have had around $30,000 more in income than it does now. That's right, nearly twice the income. There would not have been a "market" for sub-prime mortgages in those circumstances, and the opportunities for predatory lending would have been almost non-existent.
To blame predatory lending is merely focusing on the symptom. The rescue plan announced by Treasury Secretary Paulson last week only delays the inevitable, because the illness that needs to be treated is the decline of wages and earnings. To get a cure, we need to address the problem of the stagnation of earnings for the middle two fifths of the population, and real declines in earnings for the bottom two fifths.
(The above graph comes from Wikipedia, which notes the data source is DeNavas-Walt, Carmen; Bernadette D. Proctor, Robert J. Mills (08 2004). Table A-3: Selected Measures of Household Income Dispersion: 1967 to 2003).
On February 1, 2007, The Center on Budget and Policy Priorities reported that the most recent study by the Congressional Budget Office showed that
income inequality continued to widen in 2004. The average after-tax income of the richest one percent of households rose from $722,000 in 2003 to $868,000 in 2004, after adjusting for inflation, a one-year increase of nearly $146,000, or 20 percent. This increase was the largest increase in 15 years, measured both in percentage terms and in real dollars. . . .
I recall very clearly that when I bought a house in 1999, I was urged to get an low initial rate with a series of resets down the road, rather than a fixed rate, with the argument that when time came for the interest rates to increase, I would be earning more money and thus have higher capacity to pay. Well, it didn’t work out that way for me, and it hasn’t worked out that way for around 240 million of my fellow citizens.
So, where did the missing wages go?
Management guru Tom Peters picked up on a New York Times story in by Bob Herbert on January 8, 2007:
There are 93 million production and nonsupervisory workers (exclusive of farmworkers) in the U.S. Their combined real annual earnings from 2000 to 2006 rose by $15.4 billion, which is less than half of the combined bonuses awarded by the five Wall Street firms for just one year.
"Just these bonuses — for one year — overwhelmingly exceed all the pay increases received by these workers over the entire six-year period," said Mr. Sum.
Last week here on DailyKos, Geekesque called for a boycott of Burger King
Telling Burger King to pay an extra penny for tomatoes and provide a decent wage to migrant workers would hardly bankrupt the company. Indeed, it would cost Burger King only $250,000 a year. At Goldman Sachs, that sort of money shouldn’t be too hard to find. In 2006, the bonuses of the top 12 Goldman Sachs executives exceeded $200 million — more than twice as much money as all of the roughly 10,000 tomato pickers in southern Florida earned that year. Now Mr. Blankfein should find a way to share some of his company’s good fortune with the workers at the bottom of the food chain.
Of course, under the Bush / Cheney regime, certain other sectors are doing quite well, also.
The Sub-Prime Crisis spreads
Last week, The Florida State Board of Administration was forced to freeze withdrawals from the state’s government investment fund after local municipalities and school districts, worried about the fund’s exposure to mortgage-backed financial derivatives, pulled over $10 billion out of the $27.3 billion fund in two weeks.
How important does the financial oligarchy consider this development? The London Financial Times carried the story on the front page on November 30, carried a second story exploring the details of exactly how it occurred, including interviews with the county clerk and the budget director of Leon County on page 8, and further discussed the story in its "Lex Column" on page 14, fretting that it "is a reminder of the potential for contagion" and worrying that "it shows how problems are still spreading slowly through the financial system."
(Contrary to premature reports of the death of the British empire, London remains the largest financial center in the world. According to MarketWatch on December 7, 2006,
The global foreign exchange market, easily the largest financial market, is dominated by London. More than half of the trades in the derivatives market are handled in London, which straddles the time zones between Asia and the U.S. And the trading rooms in the Square Mile, as the City of London financial district is known, are responsible for almost three-quarters of the trades in the secondary fixed-income markets.
So, they watch these things very closely in London.)
The Wall Street Journal reported on page B3 of its weekend edition yesterday (Dec. 1-2, 2007) that a similar run hit the Montana Short Term Investment Pool, with $247 million withdrawn from the $2.5 billion fund after news of Florida spread.
John Mauldin is a best selling author of those "how to get rich" and "how to preserve your wealth" books, who appears regularly CNBC, Bloomberg and many radio shows across the country. Last week, his free weekly economic and investment e-letter that goes to over 1 million subscribers was entitled, The Financial Fire Trucks Are Gathering
Jan Hatzius of Goldman Sachs forecasts a recession and that the growing credit crunch will reduce lending by about $2 trillion (that's with a t, thank you).
SNIP
Home equity, credit cards, auto loans are all seeing a serious rise in delinquencies and foreclosures. Banks are having to eat into their capital base in order to reserve for growing losses. And that means they have less money to lend. And indeed, every survey I have seen for the past few months points to ever-tightening credit conditions for both business and consumers.
SNIP
The structured security market is in a freeze, which is the funding source for much of the credit in the US and the world for such everyday things as car loans, credit cards, student loans, commercial bank loans, commercial mortgages, and construction. The CLO (mostly bank loans) market is reeling. There is no effective subprime mortgage market.
SNIP
This current credit crunch has the potential for growing into a full-blown credit crisis, the likes of which we have not seen in the modern world. It is not altogether clear that cutting rates at 25 basis points per meeting is going to do anything to help, if the cost of borrowing does not come down. We are in an entirely different type of crisis than we have ever seen.
Well, actually, we have seen this before - I'll discuss that at the end.
The Real Economy Starting to Get Slammed
But how does all this high finance affect you?
In its front page story on the Florida fund run, the London Financial Times reported that Florida School Boards Association executive director Wayne Blanton said,
Jefferson County school district is having to negotiate a short-term loan to make their payroll. It is unprecedented to freeze an account like this.
Oh, I hope you’re saying.
What about home sales and home construction? According to the National Association of Realtors
Total existing-home sales – including single-family, townhomes, condominiums and co-ops – eased by 1.2 percent to a seasonally adjusted annual rate1 of 4.97 million units in October from a downwardly revised level of 5.03 million in September, and are 20.7 percent below the 6.27 million-unit pace in September 2006.
Lawrence Yun, NAR chief economist, expected the sluggish performance. "As noted last month, temporary mortgage problems were peaking back in August when many of the sales closed in October were being negotiated. We continue to see the biggest impact in high-cost markets that rely on jumbo loans," he said. "Mortgage availability has improved as evidenced by much lower mortgage interest rates and a sharp jump in FHA endorsements for home purchases.
"A trend away from subprime mortgages to FHA loans, which often carry much lower interest rates, is a positive development for consumers and the housing market going forward. Still, it will take some time for the change to yield a measurably higher closed sales volume in the aftermath of the subprime collapse. In the near term, we expect home sales to remain fairly stable."
I have to make a few comments here. First of all, I don’t think mortgage availability has improved. We listed our home in mid-August, and had had all of five lookers in a market (northern Virginia suburbs of Washington D.C.) that two years ago saw homes sell literally within hours after being listed. I’ve read anecdotal evidence that the same is happening in many other parts of the U.S. What aren’t people even looking? I suspect it is because people simply are not getting mortgages any more. Afterall, the sub-prime mortgage markets has disappeared. But try to find statistics for mortgage approvals. They don’t exist in the U.S. When I googled "rate of mortgage approvals" I got story after story about how mortgage approvals are down by a third from last year in Britain, but nothing on what’s happening in the U.S. In the U.S., mortgage applications are up significantly from last year. But that could be a sign of the increasing distress of home owners who find themselves upside down (living in a home now with less market value than what they owe for the mortgage). People who want to get out of a bad mortgage situation by selling their house will need to buy somewhere else, which means they will have to apply for a mortgage. So, more mortgage applications may actually be a signal of how bad things are, not that the housing market is coming back to an even keel.
My second comment is that if "subprime mortgages to FHA loans, which often carry much lower interest rates, is a positive development for consumers", then what the hell were we doing with all these subprime mortgages in the first place? Could it be that they were simply the means for mortgage bankers and brokers to make more money than they could off of plain, old-fashioned FHA fixed rate mortgages? And brings into question the whole game of financial derivatives. If all these banks apparently were not hedging their risk with these derivatives -- which is the major reason they were created and sold -- than just what the hell was their purpose?
But, back to the effects on the real economy. Ken Simonson, chief economist for The Associated General Contractors of America (AGC), noted in an Oct. 5, 2007 news release:
Seasonally adjusted total construction employment fell 14,000 in September and was down 112,000 or 1.5 percent compared to September 2006," Simonson remarked. "But that masks divergent trends in nonresidential and residential construction.
"The BLS numbers show that over the past 12 months, employment in the three nonresidential categories—nonresidential building, specialty trades, plus heavy and civil engineering—climbed 42,000 or 1 percent," Simonson commented. "Meanwhile, residential building and specialty trades employment supposedly shed 154,000 jobs or 4.5 percent.
"That gap, while large, vastly understates the actual difference," Simonson asserted. "Census Bureau figures for August show residential construction spending was down 16 percent from a year before and nonresidential was up almost 15 percent. With all signs pointing to still less homebuilding ahead, it’s likely that residential employment is also down roughly 16 percent. That means about 400,000 ‘residential’ specialty trade contractors are now doing nonresidential electrical, plumbing and other work.
Now, look at that last number: "400,000 ‘residential’ specialty trade contractors are now doing nonresidential electrical, plumbing and other work." That means these people would be out of work if they had not been pulled into nonresidential construction. So, what happens now that the economy is heading into recession? Will nonresidential construction continue to pick up the slack? I wouldn’t count on it, not without some big government program for infrastructure building or a new Civilian Construction Corps.
Look, for example, at what the auto industry is expecting. The Wall Street Journal reported on the second page of its weekend edition yesterday (Dec. 1-2, 2007) that auto makers expect 2008 to be the worst year for new auto sales in 10 years. A survey by Wachovia Capital Markets found that 34% of dealers now plan to cut back on new vehicle orders, a very worrying jump from the 19% the same survey found in September. General Motors’ ten-months of sales through October of are already down 5.7% from last year.
Construction accounts for 5.5% of the U.S. labor force of 135.371 million, and the auto industry accounts for 7.6%. During the 1930s Great Depression, almost one third of the jobless were unemployed construction workers.
A Second Great Depression
Which brings me, finally, to the title of this diary. John Mauldin, whom I quoted above, is dead wrong when he writes that "We are in an entirely different type of crisis than we have ever seen." Mauldin was not really considering the underlying cause of income and wealth inequalities. So, let me introduce you to Marriner S. Eccles, a millionaire Mormon businessman, just like Mitt Romney. That's where the similarities end.
Eccles came from a leading Mormon business family in Utah, and took up the career of banking. In the late 1920s, Eccles was one of the few bankers in the United States to successfully meet, contain, and end a run on his bank without having to resort to outside assistance, such as turning to the government or to Wall Street. The first day of the run, Eccles instructed his cashiers to give everyone their money that demanded it -- but to serve each customer as slowly as courtesy and patience would permit. With huge lines in his banks’ lobby and out on the street, Eccles quietly brought in a few truckloads of money from his branch operations, from large business depositors, and one carload from the Federal Reserve Bank of Salt Lake City. It was just enough to meet the demand for cash the first day.
Eccles explained what he did next in his memoirs, Beckoning Frontiers (New York, Alfred A. Knopf, 1951):
At the close of the day I called together the personnel of the banks for another conference.
"Now listen," I said. "A lot of people who've been at work will only hear about this run for the first time when they get home tonight. Tomorrow there will be the makings of another crush, and we are going to meet it by doing the opposite of what we did today. Instead of opening at ten, we are going to open at eight. Nobody is going to have to wait outside of the bank to start any sort of line. When people come in here, pay them very fast. Don't dawdle over signatures. Pay out the accounts in big bills. Above all, don't let any line form. It will mean a continuation of the panic."
This tactic was a homely application of how a compensatory economy worked. On Tuesday the amount we paid out exceeded that of the first day, but the important objective was reached. No lines formed to inspire a hysterical belief that the bank was in trouble. On Tuesday customers came into the doorway of the bank, looked furtively around the lobby, and, seeing that things were peaceful and serene, walked away. And that was the end of that run.
Eccles gave a lot of thought to what had happened, and was happening in the national economy as the Great Depression unfolded. He concluded that the underlying problem was the widening disparity in income and wealth. And he was not shy about expressing his views to his fellow bankers. Eccles recalled the reception given his remarks before the Utah State Bankers Convention in June 1932:
Spoken by anyone else, remarks of this sort might have been followed by a riot. But the bankers could not very well throw me out. They could not surmount the fact that though I talked like a dangerous radical, and though I defied all the canons taught by our fathers, the banking organization I headed successfully overcame a series of crises caused, in some instances, by the failures of other banks.
Some of the bankers nodded their heads in agreement when one among them said: "Eccles is like a poker-player. He plays tight and talks loose." Others shook their heads sadly and repeated what a president of a Western railroad said. "Poor Eccles," he confided to a friend, "he must have had so terrible a time with his banks that he is losing his mind."
From within my own organization there were similar reactions. One day even my close associate E. G. Bennett came to me and said: "All of us know you are overwrought by the general economic situation. But you should also know that some of the members of the board of directors are disturbed by the views you are expressing, They think you are hurting business.
In November, 1934, Eccles was summoned to Washington D.C. and was asked by President Franklin Roosevelt to serve as the Chairman of the Federal Reserve. This was the position from which Eccles helped lead the country out of the Depression and through the industrial mobilization for World War Two. Eccles served as Fed Chairman from November, 1934 to February, 1948.
In his 1951 memoirs, Beckoniong Frontiers, Eccles discussed what he concluded had caused the Great Depression. Read it, and see if anything strikes you as vaguely familiar:
As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation s economic machinery. (emphasis in original) Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.
This then, was my reading of what brought on the depression.
END of quote from Eccles, pages 76 to 78
Not enough consumption?! If this makes your had spin, then you’re too much of an environmentalist to be of much use in the approaching financial strom. But think about it. For example: there is not a large enough market for electric cars. Why? Because an electric car is too expensive? Or because the average worker does not make enough to afford an electric car and is forced to make the socially poorer choice of sticking with an internal combustion engine?
See, the thing is to provide incentives for those things we want to have consumed – electric cars, buildings and houses that are hyper energy-efficient, solar energy – and penalties for those things we want to discourage – Hummers, energy-inefficient McMansions, coal- and gas-fired power plants. But first we have to whack the financial system back into line, and get wages and earnings growing again.
I know that this whole wealth inequality / consumption angle is going to go down hard with a lot of progressives who have rejected our overly materialistic culture. But I don't hear them talking about saving the working class and the middle class from the economic disaster we are falling into. It's not those 120 million American with an income under $20,000 that are driving those Hummers. And if this credit crisis unfolds the way it did in the 1920s and 1930s, I suspect most Americans are going to have little tolerance for considering anything other than solutions to the Second Great Depression. Please don't make the same mistake the Dodd campaign is making, and try to treat the symptom rather than the disease.
