Monday, September 14, 2009

One Year Into The Financial Maelstrom

(Today, U.S. President Barack Obama went to Wall Street to make the case for regulatory reform to govern the operations of the U.S. financial system. This post deals with the financial crisis and its role in the general economic malaise. It is an excerpt from my upcoming book, Beyond the Bubble: Imagining a New Canadian Economy, to be published in a few weeks by Between the Lines Publishing.)

In sharp contrast to the Great Depression of the 1930s when the United States was the world’s leading creditor nation, the U.S. is now the greatest debtor in the world. This places enormous constraints on the course the United States can pursue to cope with the economic crisis and with the broader foreign challenges that confront it.

Two forms of debt are particularly important to the external position of the United States: the U.S. government deficit and debt; and the U.S. current account deficit.

First, let’s look at the effects of the U.S. government debt, which presently amounts to $11 trillion and is set to soar much higher. The Obama administration’s economic recovery plan is driving the U.S. government’s annual deficit from $410 billion at the beginning 2008 to well over a trillion dollars a year. The administration projects that trillion dollar deficits will persist for years to come. The U.S. federal debt is financed in part by securities held by U.S. government accounts, among the most important, the Federal Employees Retirement Funds, and the Federal Old-Age and Survivors Insurance Trust Fund. At the beginning of 2008, 55 per cent of the debt was held the “public”, meaning those who purchased U.S. treasury bonds. Forty-five per cent of these “public” purchasers were made by foreigners, two-thirds of that total by foreign central banks. By far the most important of the central banks in making these purchases were those of China and Japan. When to the central banks of China and Japan are added to other purchasers from these two countries, about 47 per cent of the purchases by foreigners is accounted for. In total, foreigners have been financing about 25 per cent of the gigantic U.S. National Debt, a percentage that the Obama agenda could drive much higher.

Between them, the central banks of China and Japan hold over a trillion dollars worth of the U.S. securities used to finance the U.S. national debt They don’t buy them because they regard them as a good investment. Quite the contrary. They buy them to save the United States from the crippling consequences of its own internal weakness. This, they do, not as an act of generosity, but to safeguard their vitally important export markets in the U.S. and to prevent a global economic collapse.

Suppose the Chinese and Japanese central banks, along with about eight or ten other central banks, decided to reduce their purchases of U.S. Treasury bonds. The consequence would be a sharp decline in the value of the U.S. dollar against other currencies. A lower dollar would lead to a very substantial reduction of U.S. imports. Keeping exports flowing into the vast American market is what motivates Asian central bankers to buy trillions of dollars worth of U.S. Treasury bonds.

There is a limit to this willingness to serve as lenders for the deeply indebted Americans, however. The biggest money makers in China are foreign multi nationals that set up shop in that country to avail themselves of a highly productive and relatively inexpensive labour force. Those multi-nationals are earning a far higher return on their invested capital in China than the Chinese central bank makes sustaining the U.S. dollar through its purchases of U.S. Treasury Bonds. In March 2009, the Chinese central bank issued a clear warning that it was tiring of playing such a pivotal role in propping up the U.S. dollar. Zhou Xiaochuan, the governor of the People’s Bank of China, suggested that the time had come to consider replacing the dollar as a global reserve currency with a new currency made up of a basket of currencies to include the Euro, Yen, Pound and Dollar. Zhou proposed that the International Monetary Fund increase the use of “Special Drawing Rights”, a notional currency already used by the IMF. Not surprisingly, both President Barack Obama and U.S. Treasury Secretary Timothy Geithner rejected the Chinese idea and predicted that the dollar would remain the world’s dominant reserve currency for a long time to come.

The Obama administration will need to sell vastly more (the dollar total could more than double) Treasury Bonds to Asian and other central bankers. This will have two effects. First, it will substantially increase the downward pressure on the American dollar against other currencies. A renewed fall in the value of the U.S. dollar will serve as yet another disincentive in the path of central bankers and private investors buying up the bonds. Buying bonds denominated in a falling currency is a money loser, especially if the interest rates on the bonds are low. To sweeten the pot, the interest rates on U.S. Treasury Bonds will have to be substantially raised, both to slow the decline in the U.S. dollar and to increase the return to the buyers of the bonds.

This, of course, creates yet another problem for the United States. Higher interest rates on American bonds make the cost of financing the rapidly expanding U.S. national debt ever more dauntingly stratospheric. Thus, borrowing immensely more from foreigners to finance the administration’s stimulus program is an exercise that can only be described as fraught. The more expensive the cost of borrowing, the less effective will be the U.S. recovery program.

In principle, there is a way to reduce the volume of additional foreign borrowing. This would be to dramatically reduce the income and wealth gaps between the rich and the rest of the American population, in part by imposing much higher income and wealth taxes on the very affluent. While in theory, this could work, in practice this would necessitate such an enormous shift in the American socio-economic system that it is inconceivable under present circumstance. It remains only a theoretical possibility to be noted. The continuing dependence of the United States on foreign borrowing, and thus on the need to tie much of the world into an American centred geo-political system is rooted in the marked inequality that exists in the United States itself.

Adding to the problem is the current account deficit of the United States, which was running at an annual rate of $-673 billion in the spring of 2009. (The current account includes the trade in commodities, tourism, and the trade in services, including profits, dividends, and interest payments between the United States and all other countries over the course of a year.) To finance its gigantic current account deficit, which amounts to just under five per cent of the U.S. Gross Domestic Product of $14.3 trillion, the U.S. is forced to engage in immense foreign borrowing. This can take a number of forms. One of the most important is the inflow of investments by foreigners to acquire assets in the United States. During the 1990s, these inflows were occurring at a time when the U.S. was on the cutting edge of the global technological revolution. It was the age of the boom. Following the crash in 2000, though, much of the flow of new foreign equity into the United States halted. Indeed, over the next few years, if the U.S. dollar should drop significantly against other currencies, foreign investment inflows into the United States would likely be aimed at the acquisition, on the cheap, of American economic assets. This is hardly a prospect that the U.S. government and corporate sector can view with equanimity.

For any country to have a perennial current account deficit that runs at just under five per cent of its GDP is a perilous exercise. For any country other than the United States to do it is unthinkable. The U.S., as those who believe that America can go on doing this indefinitely insist, has a special role in the global system which allows it the privilege of greater indebtedness than other countries. Among other reasons for this is the fact that the U.S. dollar remains the reserve currency of the world. This means that when the U.S. government borrows money abroad it does so in its own currency, so that even if that currency depreciates against other currencies, Washington does not have to assume the additional cost this would impose on other borrowing governments.

The merit of this argument has declined as the prospects for the further depreciation of the U.S. dollar have increased. The burden to be borne by foreign central banks has simply grown dangerously large and it is about to become more enormous still.

The U.S. current account deficit---the extent to which the United States spends more abroad than it earns abroad---creates a paradoxical relationship for the U.S. with other countries. On the one hand, there is the vast American market on which China, Japan and other countries, including Canada, depend so much for the profitability of the enterprises based on their soil. (Manufacturing companies, because of the economies of scale they achieve as their sales and volume of production increase---as the ratio of fixed to variable costs falls---make as much as half of their profits on the last fifteen or twenty per cent of their sales.)

It helps to picture the size of the U.S. market for foreigners this way: each year the U.S. offers to foreign suppliers a market more than half the size of the entire Canadian market as a consequence of its deficit. This additional market exists on top of what the U.S. market could offer foreigners if Americans sold abroad as much as they bought. The paradox is that foreigners have to pay dearly to keep this market open and available to them. The bigger the U.S. current account deficit, the more lucrative it is to foreigners. But the bigger the U.S. current account deficit, the more burdensome is the weight of the unprofitable U.S. Treasury Bonds foreigners must buy to keep that market open.

There is an inherent instability at work here. It is the kind of arrangement that could only exist in the relationship between a declining empire, or hegemon, and its clients. When the United States was a rising empire---as it was even in the dark days of the Great Depression in the 1930s---it creditor status, its superior productive plant and ultimately its unexcelled military potential, ensured its ability to invest abroad on its own terms and to dictate its trade arrangements with other countries. Indeed, in the last days of the Second World War, in 1944, the United States, along with its allies established the rudiments of the post-war economic system at Bretton Woods, New Hampshire, placing itself at the centre.

The United States can be likened to a ballerina. When she is young she makes difficult feats look easy. When she is aging she has to settle for making easy moves look difficult.

At what point will foreigners conclude that the game is not worth the candle, that financing the foundering U.S. is more trouble than it’s worth? Since so many factors are at play, including the stresses so evident in the U.S. effort to sustain its geo-strategic position in the world, no precise answer can be given to this exceptionally important question. What is abundantly clear, however, is that the Asian powers and the Europeans could adopt economic strategies in which the role of the U.S. as a market of necessity (much more for the Asians than the Europeans) becomes far less important than it is today.

Every winter, government and business high-flyers from around the world flock to Davos, Switzerland to pontificate about the state of the world economy. In January 2009, the World Economic Forum at Davos was unusually subdued. Those who ran the global economy were not receiving high kudos from anyone about the job they had been doing.

A major topic at Davos in 2009 was how the Obama administration was going to raise the $819 billion it was seeking to finance its stimulus package. Unprecedented borrowing of capital from foreigners would be needed to fund the program. Experts at Davos warned that American borrowing could push up interest rates, generate inflation, and drive down the value of the American dollar against other currencies. While some might wonder about the risk of inflation in a global setting where the deflation, its opposite, posed the greater peril, the question of where the capital would come from was on many minds. Alan S. Blinder, a Princeton University economist and former vice-chairman of the Federal Reserve in Washington told the New York Times: “At some point, there may be so much Treasury debt that investors may start wondering if they are overloaded in dollar assets.” Another concern raised as Davos, a concern expressed many times about U.S. borrowing in recent years, is that it has the effect of making it extremely difficult for poorer countries to borrow the capital they urgently require. Ernesto Zedillo, the former Mexican president who was in office during his country’s financial crisis in 1994 warned that “the U.S. needs to show some proof they have a plan to get out of the fiscal problem. We, as developing countries, need to know we won’t be crowded out of the capital markets, which is already happening.”

While much of the focus, and rightly so, has been on U.S. public debt and on the gargantuan U.S. current account deficit, the level of American private debt is equally alarming, and has enormous implications for the prospects for economic recovery in the United States. In 1960, the household debt of Americans stood at a level that was equivalent to fifty per cent of the U.S. GDP. By 1980, that level had grown to sixty per cent of U.S. GDP. Since 1980, the level of household debt in the United States has taken off to unprecedented levels. By 2004, the average American was spending $1.04 for every $1.00 he or she earned. By the end of that year consumer debt alone (not all of household debt) had reached an amount equivalent to 85.7 per cent of U.S. GDP.

There are various ways of analyzing the shocking rise of U.S. private debt. Some see it as a cultural phenomenon, the consequence of the inability of contemporary Americans to defer gratification. Others attribute sky high consumer debt to the mass marketing of credit cards and the goods and travel that flow from them. Campaigns to win over young Americans to credit card use have been especially effective. Between 1990 and 2003, the number of Americans holding credit cards jumped from 82 million to 144 million. A fundamental cause of the rising of personal indebtedness has to do with the way the incomes of most Americans have stagnated since 1980, as we have seen. An economy in which the mass of the population enjoys rises in real incomes is one in which the market for goods and service expands rapidly. On the other hand, an economy in which incomes for the majority are stagnant is one in which there are real barriers in the way of market expansion. Just as financial institutions found ways to expand the markets for their activities by promoting mortgages and home purchases to millions of people who could not afford them, these institutions were enormously successful in enticing tens of millions of Americans to spend today, building up massive debts for the future.

But now the time has come to pay the piper.

That is now no easy task. Now that Humpty Dumpty has fallen, even the vigour, intelligence and dedication of Barack Obama may not be enough to put him back together again. The problem is that the crash in the United States occurred when the financial institutions, with the full support of Washington, had used up every method they could think of to grind more profits for themselves out of the system. What they had created was an arrangement with distinct similarities to a gigantic Ponzi scheme. A full-fledged Ponzi scheme exists when a financier like Bernie Madoff takes the money of investors, promises them a high rate of return, and then pays them dividends, not drawn from profits, but from the capital invested by the next group of investors. While U.S. financiers had not created a pyramid scheme along the lines of Madoff, they had erected a system that was constructed on vast layers of debt, as we have seen. If the economy stopped moving forward, a crash, when it came, would create vicious cycles involving all those layers of debt.

That is what happened with the crash of 1929. When the market fell, it forced all those who had made investments on margin to sell off positions they held to pay off the margin calls they had to meet. This pulled the market down much further. The system was running in reverse. The same thing has happened with the crash of 2008. The ways that leverage was exercised in the 21st century were much more arcane and technologically advanced than the old method of stock purchases on margin of the 1920s. But through a slew of derivatives and other financial instruments, the same result was achieved. With the investment of let’s say one million dollars, high rollers, whether individuals or enormous financial firms, were able to achieve the leverage of an investment of as much as thirty million dollars. Such leverages yielded huge profits. But once the crash came, it halted the whole machine. Individuals and enormous companies such as AIG were unable to cover their positions. Left exposed, they plunged into bankruptcy. Too big to fail, Washington rushed in to save the giants, the mastodons. First the Bush administration and then the Obama administration tried desperately to put Humpty Dumpty back together again.

The problem with Humpty Dumpty, the financial sector of the American economy, is that while Washington believed it was too big to be allowed to fail, it had actually grown too big to succeed.

Over the past quarter century, an extraordinary shift has occurred in the make up of the U.S. economy. As late as the early 1980s, manufacturing accounted for close to 20 per cent of the American economy, while the financial sector (commercial banking, investment banking, insurance firms and other financial firms) generated 12 to 14 per cent of GDP. By the eve of the 2008 crash, manufacturing had shrunk to 12 per cent of GDP while finance had swollen to account for 20 to 21 per cent of GDP.

For over one fifth of the economic output of a major nation---we are not talking about the Cayman Islands or even Switzerland---to be accounted for by finance is a shocking phenomenon. Considering the allure finance had acquired in the English speaking countries by the eve of the crash, it is not surprising that analysts rarely step back to consider what this really means. In theory at least, finance is not a benign phenomenon in and of itself. It is a means to an end. The proper and most efficacious raising and investing of capital is supposed to open the way for the production of goods and services that are actually useful to, or desired by, people. Manufactured goods, food, houses, education, medical care, entertainment, a host of other services, and transportation are useful to people.

On its own, finance is not. Only as a means to an end does it have value in any meaningful sense of the word. In a great and powerful country such as the United States, once the world’s leading industrial nation, when manufacturing steadily shrinks and finance expands remorselessly, as a proportion of GDP, we have to ask ourselves what is really going on.

One thing that has been going on is that a few people have been vastly enriched by the immense profits that have been juiced out of the engorged financial sector. These are the people who have now become notorious, in the aftermath of the crash, for their sky-high salaries, advantageous stock options and gargantuan bonuses. As finance has become a huge industry unto itself, more and more of the “best and the brightest” among the young have eschewed engineering, medicine, scientific research and other fields to go into “money”.

On campuses across North America, universities have responded to the rise of “money” as an industry by establishing schools of business whose function is to turn out graduates ready and eager to work in the financial sector. Money has been sexy; manufacturing has been old-hat. At business schools, a very particular school of economics has dominated the curriculum. Students are taught how to apply neo-classical economics in the setting of contemporary globalization. In the world-view as they receive it, free trade is benign, as is the right to invest anywhere in the world, and to shift investments freely from country to country. Protectionism is negative, as are government interference in economic decision making, and militant trade unionism. Other schools of economics get short shrift at business schools, and such schools are not enamored with having their students take courses from departments on campus where neo-classical economics is more thoroughly critiqued. It is not an exaggeration to say that the economics taught to business students in North America fits hand and glove with the economic practices that have been found so wanting in the aftermath of the crash of 2008.

Of more immediate concern is whether the Obama administration remains hooked on a finance-centred conception of the economy. Over the past couple of decades, as finance has grown ever larger as a proportion of the GDP, financial institutions have evolved a plethora of instruments, more or less arcane, whose purpose is to invite investors to heighten the risk, or the pleasure, that flows from their investments. Securitization, credit default swaps and derivatives in many shapes and sizes were the products on the market from which investors were able to choose. Securitization is a process which creates instruments that enable those who have lent money to sell the loans---credit card debts, sub prime mortgages, car loans, etc.---to those who wish to purchase these instruments as investments. The idea, of course, was to spread risk widely, so that investors could assume a portion of the risk, while making a healthy return when times were good. “Banks used securitization to increase their risk,” wrote Paul Krugman in the New York Times “not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption. Sooner or later, things were bound to go wrong, and eventually they did. Bear Stearns failed; Lehman failed; but most of all, securitization failed.” In October 2008, Columbia University economics professor Joseph Stiglitz quipped to a congressional committee in Washington that “securitization was based on the premise that a fool was born every minute.” The problem with securitization, as with other exotic instruments was that while the spreading of risk allowed financial institutions to do yet more lending to increase their risk, when the market plummeted the investments under the securitization label blew up, became toxic, and helped drag their holders toward bankruptcy.

Credit default swaps were another Alice in Wonderland creation that apparently provided protection for investors, but actually vanished into inutility the moment the insurance they supposedly provided was actually needed. As the name suggests, credit default swaps involve a deal between two parties, a swap, in which one party is buying protection and the other party is selling protection. They are betting on whether a particular company will default on its bonds. The first party is buying protection so that if the company does default within a specified period of time, it will collect a large payment from the party selling the protection. The second party, the seller, receives payments for assuming the risk. Thus the purchaser of the credit default swap is acquiring what looks like an insurance policy, protection which covers it so that it can go out and make other risky investments without the appearance of having a balance sheet that involves too much risk. The seller, on the other hand, collects money for selling protection on let’s say a risky bond in the sub prime mortgage market. In recent years, according to some estimates, hundreds of trillions of dollars (yes, that read trillions) of these credit swaps have been made. The numbers involved are absurdly large. For comparison, the U.S. GDP is about $14 trillion.

In the run up to the great crash of 2008, Credit default swaps were traded in the creation of an ever higher fantasy skyscraper. When the sub prime mortgage market, among others, imploded, the entities that had sold credit default swaps suddenly discovered that the assets they held on them were reduced to rubble. In March 2008, when Moody’s downgraded the ratings of Bear Stearns, Bear----the party in $13 billion in credit default swap trades---imploded and was acquired for next to nothing by J.P. Morgan.

No one knows how huge the bill could be for the collapse of the credit default gambit? That’s because with hundreds of trillions of notional dollars gambled in the various forms of exotic financial instruments including credit default swaps, it is next to impossible to calculate the price tag for a potential collapse of all this. The Bank for International Settlements (BIS), an international organization of central banks based in Basel, Switzerland, took a crack at calculating the potential risk making use of 2007 data. The BIS estimated the notional value of the whole at $596 trillion dollars, divided among interest rate derivatives ($393 trillion), credit default swaps ($58 trillion), and currency derivatives ($56 trillion), with the rest allocated to other categories. The BIS calculated that the net risk from all of this was $14.5 trillion, and the gross credit exposure was $3.256 trillion.

The utility of such calculations is questionable. What we learn from this sort of abstract exercise is the vastness of these shadowy transactions, which can and do have implications for the real world. To make sense of this, it is necessary to understand the motivation that underlies the proliferation of exotic financial instruments and more broadly what caused their emergence. This takes us back to the discussion in the previous chapter about the predominance of the neo-liberal Anglo-American model in the world. Holding down the growth in real wages and salaries has limited the expansion of the market for goods and services. In response, the financial sector has proliferated enormously, the motivation being the rapacious quest for new sources of profits. In our time, capitalism has cannibalized itself. The financial sector has grown ever larger as a proportion of U.S. GDP, not to produce useful goods and services, but to squeeze ever more out of the existing economic pie.

Pushing out sub-prime mortgages to people who often could not afford them, and credit cards to millions of people who have maxed out their cards, as well as financial products to heighten the leverage of investors have all been ways for finance to juice out more profits for itself. Most of that has involved various forms of borrowing against the future. Today’s capitalism, swollen with debts that will take many years to reduce or write off, has fouled its own future, ensuring lean years ahead.

As is the case in its most extreme form with a Ponzi scheme, the cannibalizing of the economy by financial institutions has shifted the economic engine into reverse. Now that the time has come to cope with the debts, both the toxic and the more salubrious ones, the impact of the activities of financial institutions has been to put the brakes on the economy for coming years. The same thing happened with the financial meltdown of 1929, when the world of buying on margin imploded. That time the Dow Jones did not reach October 1929 levels until 1954.

Just over two months after Obama was sworn into office, the United States seethed with populist rage. Storm clouds were forming ever since the bailouts of financial firms began in the fall of 2008 while the Bush administration remained in office. What caused the maelstrom to burst were payments of bonuses totaling $165 million to executives of the American International Group (AIG) in March 2009, in the wake of Washington’s massive bailout of AIG which amounted to more than $170 billion. Everywhere across the country, ordinary Americans were furious. With rising anxiety, they had numbly accepted the vast Wall Street bailouts, and the talk of trillions more dollars needed to get the financial sector and the auto industry back in business. But the idea of the people who had presided over the AIG plunge into toxicity receiving handouts of a million dollars each, and in some cases more, blew the lid off.

I was in California when the hurricane hit. On television, on the front pages of papers in small and large cities, in conversations in cafes, the fury was everywhere. CNN covered a busload of working people, some of them political activists, going on a tour of the palatial homes owned by AIG executives, to deliver the message to the doorstep that they were angry. They were met by security guards who halted them and so delivered the message to the Pinkerton police. CNN titled the segment “The Lives of the Rich and Shameless.”

American populism extends from left to right. As has been the case for decades, when it rears its head, populism can be anti-capitalist one moment, then racist the next. It can demand fairness for all one day, and then can recoil in fury against the guy next door who is living on the dole. During the Great Depression of the 1930s, populism showed up under the banner of the Congress of Industrial Organizations (CIO), with its drive to unionize industrial workers, that of Louisiana’s Huey Long, as well as that of the fascistic Father Charles Coughlin. And Coughlin was adept at sounding radical as when he urged his audience to “attack and overpower the enemy of financial slavery.”

In the United Kingdom, when banks crashed in the autumn of 2008, the government of Gordon Brown did not hesitate to nationalize them. Pumping capital into these banks was accompanied by government control and public equity. If the banks returned to profitability while they remained in the hands of the crown, the public would earn a return on its investment. In the United States, the ideological recoil from the very idea of nationalizing banks was much stronger. It amounted to a violation against the very shibboleths on which American capitalism rested, a step that was to be avoided unless there was absolutely no alternative. The Obama administration, as New York Times columnist Paul Krugman observed, appeared “to be tying itself in knots” to avoid having taxpayers take ownership in return for their rescue of banks. The dilemma Krugman noted was that “bank stocks are worth so little these days---Citigroup and Bank of America have a combined market value of only $52 billion---that the ownership wouldn’t be partial: pumping in enough taxpayer money to make the banks sound would, in effect, turn them into publicly owned enterprises.”

The problem for Obama was that many of his top officials were deeply involved with Wall Street. Treasury Secretary Timothy Geithner, to name one prominent case, was a Wall Street enabler for years. Mentored by Clinton era Treasury Secretaries, Robert Rubin and Lawrence Summers, Geithner was named president of the Federal Reserve Bank of New York in 2003. He was critically involved in the sale of Bear Stearns, in the bailout of AIG and the decision to let Lehman Brothers go down. He was the principal architect of the Obama administration’s move to partner up with the private sector to buy up the toxic assets of Wall Street financial firms.

While right-wing populist ranters such as Rush Limbaugh salivate about the evils of big government, there is nothing big financial firms and other top corporations love more than handouts of tax dollars to them. The Obama administration’s policy toward the financial sector, in his first months in office, was to shovel out the money while leaving the private bankers in charge. The president was so afraid of nationalizing the banks that he was willing to run the risk of putting Wall Street back in the driver’s seat while leaving the tax payers stuck with a mountain of bad debts.

As soon as George W. Bush was out of the White House and Barack Obama in, the Republicans turned their guns on the size of the stimulus package being proposed and on the danger of government control of the economy. Even in the last months of the Bush administration, the White House had to rely on the Democrats to push through its bailouts of the financial sector. Out of power in the executive branch and both houses of Congress, the Republicans became the defenders of tax cuts, new tax incentives to lure buyers back into the housing market, smaller government, and warning Americans of the perils of socialism.

In the New York Times, columnist Frank Rich wrote: “The Republicans do have one idea, of course, but it’s hardly fresh: more and bigger tax cuts, particularly for business and the well-off. That’s the sum of their ‘alternative’ stimulus plan. Obama has tried to accommodate this panacea, perhaps to a fault. Mainstream economists in both parties believe that tax cuts in the stimulus package will deliver far less bang for the buck than, say infrastructure spending. The tax-cut stimulus embraced a year ago by the G.O.P. induced next-to-no consumer spending as Americans merely banked the savings or paid down debt.”

Even in opposition, the political right, which speaks for much of American business, has had a very significant impact on the national debate. In a country where socialism is a dirty word and free enterprise is a deity, the Obama administration has bent over backwards to avoid the appearance of promoting a government takeover of the U.S. banking system.

In January 2009 as the Obama administration weighed the idea of an immense new bailout of the banking system, Treasury Secretary Timothy Geithner declared that “we have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system.”

Barack Obama’s much touted promise to transcend the partisan divide forced his administration to cut $80 billion from his economic stimulus package. The cuts came in plans to spend money on school construction, on aid to the unemployed to maintain their health care and in the provision of food stamps, among other things. In return for these cuts to his plan, the president failed to win the support of a single Republican in the House of Representatives, and wound up with the backing of only a handful of Republican Senators.

Potential public backlash against the stimulus package and especially against additional measures to bail out financial institutions posed yet more risks for the administration. The Bush administration’s $700 billion bailout of the financial sector in the autumn of 2008---half of which had been paid out under the Troubled Asset Relief Program (TARP) by the time Obama took office---was deeply unpopular with the American people. As President Barack Obama sought to win public and Congressional support for his stimulus package, he struck out at the practice of handing out huge bonuses to executives at Wall Street firms that were surviving on infusions of public money. The announcement that in 2008, the worst year since the Great Depression for Wall Street, firms handed out over $18 billion in executive bonuses brought the issue to a head. Obama said that at a time when the economy was faltering and Washington was spending billions to keep Wall Street firms afloat, such bonus were “shameful.” In an interview with NBC Nightly News, the president said that “if taxpayers are helping you, then you have certain responsibilities to not be living high on the hog.”

On February 4, President Obama and Treasury Secretary Timothy Geithner announced that at firms receiving significant funds from Washington, executive compensation would be capped at $500,000 a year. To put this sum in perspective, Obama’s annual salary as President of the United States is $400,000. But to top Wall Street CEOs, half a million dollars a year is a chump change. In 2007, the top guns at Wall Street Firms were compensated at a much more stratospheric level. John Thain of Merrill Lynch took home $83 million; Lloyd Blankfein of Goldman Sachs, $54 million; Kenneth Chenault of American Express, $51.7 million; and John Mack of Morgan Stanley, $41.7 million.

To the average American, half a million dollars sounded like a great deal of money. To those used to the lives lived by top corporate executives it was a meager ration. James Reda, the founder and managing director of James F. Reda and Associates, a compensation consulting firm thought the pay cap would not work. “That is pretty draconian---$500,000 is not a lot of money,” he said “particularly if there is no bonus.” Reda said that few large companies pay their top executives such puny salaries and that it would be “really tough to get people to staff” corporations if they have to apply such a cap.

Reda was among those warning that top executive talent would flee to firms not being bailed out by Washington and therefore, not subject to such a miserably low salary cap.

The question of compensation has always been a tricky one in the United States. According to the American Dream, earning an enormous income and acquiring great wealth are among the rewards that are possible for anyone with the drive, the imagination and the luck to make it. Nothing should ever stand in the way of this dream being fulfilled according to the American creed. But with the crash of Wall Street’s titanic firms, CEOs and top executives of the bailed out firms became the butt of the harsh populist humour of Americans.

It is a cardinal error to believe that the United States will sustain its present role at the centre of the global economy and that it can continue the virtually unlimited access to foreign borrowing it has enjoyed in recent decades.

Although this has not been widely acknowledged in public discourse, the United States will have to navigate a wrenching economic transition. One cost that is virtually certain to accompany this is a falling standard of living for the American people.


Garin said...
This comment has been removed by the author.
Garin said...

I found the stat that Americans are spending over one dollar for every dollar earned particularly alarming, but not surprising. Alarming because this is clearly not sustainable. Not surprising because the American government unapologetically borrows trillions so how can they expect their population not to think debt is okay? Some Americans I have talked to embrace debt as a means of economic stimulus.

The intense amount of debt held by the American population makes me think that the American Banks are a good investment right now. This debt of the American people will secure fat profit margins in the financial sector, which should boost the still battered US bank stock prices.

Anonymous said...

Obama is a conservative. He chose not to ride the wave of fury at the pampering of the financial institutions. He had the finance industry at his mercy. He could have ridden popular discontent and put the industry on a short leash. He didn't want to. The people needed distracting. He wondered aloud why people were so upset. After all, there were other players in the US economy who get more money routinely -- the military, for example. So Obama ramped up the GM/Chrysler rescue/bankruptcy plan. With incompetent CEOs and workers making decent salaries, ex-workers collecting decent pensions and receiving medicare, the auto industry was an easy target. It worked. The US masses were distracted. Fury at Wall Street died out. Now, Obama is touting his pallid financial reforms while the industry is fighting them. It makes for good political theatre and it impresses his liberal supporters.
According to observers, the US financial industry is back at it slinging derivatives and other dodgy stuff. And Obama let them. Not because he was gulled by his advisers but because he thinks it's the only way to go. Perhaps, it is. Perhaps the only way to avoid meaningful reform is to goose the US economy with speculative trash and let the good times roll.

Anonymous said...

Obama is a conservative. He chose not to ride the wave of fury at the pampering of the financial institutions. He had the finance industry at this mercy. He could have ridden that discontent and put the industry on a short leash. He didn't want to. The people needed distracting. He wondered aloud why people were so upset. After all, there were other players in the US economy who get more money routinely -- the military, for example. So Obama ramped up the GM/Chrysler rescue/bankruptcy plan. With incompetent CEOs and workers making decent salaries, ex-workers collecting decent pensions and receiving medicare, the auto industry was an easy target. It worked. The US masses were distracted. Fury at the Wall Street died out. Now, Obama is touting his pallid financial reforms while the industry is fighting them. It makes for good political theatre and it impresses his liberal supporters.
According to observers, the US financial industry is back at it slinging derivatives and other dodgy stuff. And Obama let them. Not because he was gulled by his advisers but because he thinks it's the only way to go. Perhaps, it is. Perhaps the only way to avoid meaningful reform is to goose the US economy with speculative trash and let the good times roll.