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What Recovery!?!!

We are hearing, particularly from traditional media outlets and economists, of an economic recovery.  This talk about a “recovery” is more academic and technical than real.  Sure, most of the economic indicators are turning positive but how much of this is the result of huge amounts of federal government supports and money from the Federal Reserve Bank.  The one true economic indicator that matters the most to an economy driven by consumer spending is EMPLOYMENT and those economic indicators are still very BAD.

A good place to start this discussion is with a few definition.  Let’s start with a “Recession”.  There is no set definition of a “Recession” but the following are pretty descriptive:

1)  GDP (Gross Domestic Product) growth is negative for a period of two or more consecutive quarters.

or

2) The National Bureau of Economic Research (NBER) defines a recession as a “significant decline in economic activity lasting more than a few months.”

NBER determined that our current Great Recession began on December 2007 - this was when our economy began to contract (not grow).  Some economist believe that this Great Recession will be the longest since World War II.  Technically, we won’t know for sure for about a year when this current Great Recession will “officially” end.

The next definition is “Recovery” as in Economic Recovery.  Broadly defined, an economic recovery is the period in a business cycle after a recession which is measured by positive growth in GDP.  Again, we won’t know for sure when an economic recovery “officially” started for at least a year after the start.  But who really cares because other thing truly matter.

Another term that we hear quite often in the media is “jobless recovery”.  This term is an oxymoron - particularly in our current economic condition which includes high household debt levels.  A better term may be “Economic Purgatory”.

This Purgatory is much different than in past (jobless) recoveries because of the level of destruction created by this Great Recession and what still remains of people’s personal finances.  Here are just some of the effects of the Great Recession:

• Total Jobs Lost during Great Recession: 6.9 million
• Unemployment Rate: 9.7%
• SHARE OF PEOPLE NEAR RETIREMENT AGE WITH A 401(K) BALANCE UNDER $40,000 IN 2007: 50%
• 5.8 million mortgage loans delinquent or in foreclosure process

These are just a few factors that show that we are FAR from an economic recovery that will be felt by MOST people. 

Good luck.

Privatizing Gains and Socializing Losses

This is what is happening with the bailouts of the financial sector.  Investors and executives get to keep their gains but any losses are assumed by us.  We are stupid!  We’ve been punked! Punked by the financial oligarchy. Punked by financial conglomerates. And yes, punked by the Obama Administration.

Currently, there is a story on Economic Populist about private equity firms feeding at the trough.  It talks about FDIC’s loss share agreements.  These are very generous sweetheart agreements whereby the FDIC, and more directly taxpayers, assume losses of assets sold to private equity firms and other acquirers of failed bank assets.  Here is a little taste of these loss share agreements:

“The FDIC, assuming its traditional role, brokered a sale of the bank’s deposits to BB&T Corp., ensuring that customers wouldn’t see any interruption. It also agreed to help BB&T buy a $15 billion portfolio of Colonial’s loans and other assets by agreeing to absorb more than 80% of future losses. Under the deal, the most BB&T can lose is $500 million, the bank says, and that is only in the unlikely event that the entire portfolio becomes worthless. The FDIC is on the hook to cover the rest.”

That’s right, BB&T can only lose $500 million on a $15 billion investment.

Or how about this one as it relates to private equity firms’ purchase of IndyMac:

As part of the deal, the FDIC entered into a loss-sharing agreement with IMB HoldCo. IndyMac will assume the first 20 percent of losses on a portfolio of “qualifying loans,” after which the FDIC will assume 80 percent on the next 10 percent of losses, and 95 percent on losses thereafter.

Nice deal. 

Private equity firms are salivating at these types of deals.  Who can blame them - the rules allow it and after all, this is American Capitalism at its finest - socialize the losses.

But wait.  Hedge funds are getting in on this action.  These funds see a great deal:

At least 20 top hedge funds boosted their positions in financial institutions in the latest quarter in a sign that Wall Street is ready to bet on more risky sectors in the hope of longer-term rewards.

This is “smart money”.  They see it.  Private equity funds and hedge funds know that our government has guaranteed that “TOO BIG TO FAIL” Institutions will be supported at any cost particularly any cost to the tax payer.  These investors know that their downside is protected by the government and the taxpayers while their upside is unhindered.  That is “smart money”. 

Look at this money quote:

“It’s a fundamental bet that they won’t go to zero, and that liquidity will come into the system” over time, said McGlynn, whose fund owns shares in Bank of America(BAC.N) and JPMorgan (JPM.N). Big banks have “breathing room,” he said.

Big banks won’t go to zero because there is value to a government/taxpayer guarantee (bailout).

Oh, but it is not just private equity firms and hedge funds that love these socialized losses.  The executives at these financial conglomerates love it as well:

As shares of bailed-out banks bottomed out earlier this year, stock options were awarded to their top executives, setting them up for millions of dollars in profit as prices rebounded, according to a report released on Wednesday.

The top five executives at 10 financial institutions that took some of the biggest taxpayer bailouts have seen a combined increase in the value of their stock options of nearly $90 million, the report by the Washington-based Institute for Policy Studies said.

Who is to blame?  The blame falls squarely on the Obama Administration.  It has done nothing to stop this feeding frenzy.  Its proposals for financial regulatory reform are weak at best.

Lord Adair Turner, chairman of UK’s Financial Services Authority, had the courage to say what everyone already knew but were to scared to say it:  That the financial sector is too big and much of what it does is “socially useless”.  But this is what he said to Prospect Magazine (UK):

“If you want to stop excessive pay in a swollen financial sector you have to reduce the size of that sector or apply special taxes to its pre-remuneration profit. Higher capital requirements against trading activities will be our most powerful tool to eliminate excessive activity and profits.

“And if increased capital requirements are insufficient I am happy to consider taxes on financial transactions – Tobin taxes

While I appreciate his courage in telling the truth and proposing a Tobin-like tax.  What he proposes overall doesn’t go far enough.  It still embraces “too big to fail”.

The Obama Administration and the Fed are talking about macro-prudential policies.  I say bullshit.  Any new capital requirements will have loopholes and financial conglomerates who can afford to hire the best and the brightest will find a way around any new capital requirements.

The answer is something that the financial oligarchy and the Obama Administration don’t want to hear: BREAK THEM UP!  I absolutely agree with Lord Turner assessment that much of what financial conglomerates do is “socially useless”.  Their size only helps their shareholders, debt holders and executives not society as a whole.  BREAK THEM UP!

Cross posted @ Economic Populist

Income Inequality + Financialization + Globalization = Destruction of Middle Class

This is a continuation of this Story (here) but with a lot of updates.  This equation was derived from reading a debate between Professors Branko Milanovic and Ashok Bardhan: Two Views on the Cause of Global Crisis (Here and Here).  These two professors debated the causes of the global financial crisis.  Milanovic argued that income inequality was the root cause of the financial crisis while Bardhan argued that globalization and financialization were the causes of the financial crisis.  I argue they are both right.  But they highlight a much bigger problem.

Most arguments about what caused the global financial crisis ignore a more insidious problem that is being overlooked in all the discussion and policy proposals: the destruction of the Middle Class.  This global financial crisis has negatively impacted the Middle Class more than any other income group.  A report by Bank of American/Merrill Lynch shows that (via LA Times).  Tom Petruno summarizes the BoA Merrill report this way:

The report hammers home what you might already suspect: The consumer debt problem in the economy really is a debt problem for the middle class. The need to work off a chunk of that debt will sap middle-class families’ spending power for perhaps years to come.

It estimates that middle-class families’ debt as a percentage of disposable income was 205% in 2007, a function of the level of trading-up during the housing boom and of the cash people pulled from their houses via home-equity loans.

By contrast, lower-income families’ debt-to-disposable-income ratio was a much less onerous 133%. And for the wealthy the percentage was lower still, at 116%.

What’s more, on the asset side, BofA Merrill says the middle-class has suffered more than the wealthy from the housing crash because middle-class families tended to rely more on their homes to build savings through rising equity. Also, the wealthy naturally had a much larger and more diverse portfolio of assets—stocks, bonds, etc.—which have mostly bounced back significantly this year.

I strongly encourage people to click the LA Times link above to read Tom Petruno’s story because he raises a very important policy question. 

The negative impact of this financial crisis on the Middle Class is a symptom a more larger problem or disease.  As, Dr. Thomas Palley points out in his report: “American’s Exhausted Paradigm” our economic growth model (which calls a Neo-liberal growth model) is terrible flawed.  The equation Income Inequality + Financialization + Globalization = Destruction of Middle Class is meant to symbolize the flawed model.  It is this flawed neo-liberal model that needs to be corrected if the Middle Class is to survive. 

All this talk and policy proposals of re-regulating the financial sector are just treating the symptoms and not the disease.

Income Inequality

The first part of the equation.  This is no surprise that there is income inequality in the U.S: a small number of people earn a lot more money than the rest of us.  What is surprising is the magnitude of the inequality.  This magnitude of inequality is not a good thing.

Branko Milanovic summarized income inequality in the U.S. this way:

In the United States, the top 1 percent of the population doubled its share in national income from around 8 percent in the mid-1970s to almost 16 percent in the early 2000s. That eerily replicated the situation that existed just prior to the crash of 1929, when the top 1 percent share reached its previous high watermark American income inequality over the last hundred years thus basically charted a gigantic U, going down from its 1929 peak all the way to the late 1970s, and then rising again for thirty years.

Notice his comparison to current income inequality to that of the pre-Great Depression.  Very interesting. 

Then we got this stunning graph from Professor Emmanuel Saez’s updated report on income inequality in the U.S.:

Click to Enlarge

Notice how income distribution really starts to change right around the early 1980’s.  That is the time which Dr. Palley rightfully claims that the neo-liberal economic growth model - our current growth model - began.  And another thing, this graph only shows incomes as low as $109,600 which means that a very large group of Americans making less money have a very small share of total income.  That is why this graph is so startling. 

Some people may say that income inequality is not a big deal.  Oh yeah. Well income inequality creates huge inefficiencies in the economy in terms of allocation of resources.  It also creates the potential for an aristocracy (or financial oligarchy) that will do whatever it can to protect its dominate position in society.  A better description would be the creation of a two-tiered economy - kind of like many Latin American countries.

Professor Emmauel Saez in his report “Striking it Richer” offers this suggestion for the huge income inequality:

The labor market has been creating much more inequality over the last thirty years, with the very top earners capturing a large fraction of macroeconomic productivity gains. A number of factors may help explain this increase in inequality, not only underlying technological changes but also the retreat of institutions developed during the New Deal and World War II - such as progressive tax policies, powerful unions, corporate provision of health and retirement benefits, and changing social norms regarding pay inequality.

Emphasis is mine.

Interesting, that bold phrase is what Dr. Palley is railing about in his report regarding our flawed neo-liberal economic growth model.

Financialization

Financialization means the increasing position/size of financial assets and the financial sector in the economy.  This financialization was facilitated by de-regulation of the financial sector.  Professor Ashok Bardhan explains financialization:

Over-financialization could be seen in rise in the size of financial assets relative to the real economy as indicated by gross domestic product. Globally, the holdings of financial assets, comprising equities, government and private bonds and bank deposits ballooned way out of proportion to global GDP, the primary underlying measure of real economic activity (see Figure 1). Similarly, the gross market value of outstanding derivative contracts more than doubled between mid-2006 and mid-2008. The share of financial services in GDP has increased dramatically in the US and UK in recent years; in the latter it has doubled in the last decade alone. In many countries, the financial sector grew to a size disproportionate to its primary raison d’etre - to efficiently bring savers and borrowers together, allocate savings to viable investments, and manage diversification of risk. Liquid and deep financial markets are necessary; indeed, they are the lifeblood of economic activity, but to extend the analogy, not if they cause high blood pressure to the economy!

This Financialization was indicative of a much larger problem.  What replaced wage growth was asset price inflation and rising indebtedness.  For example, as the BoA Merrill report points out above, Middle Class families relied heavily on the equity in their homes - this was an important savings vehicle.  Consider this from Dr. Palley’s report:

1. Since 1980, each U.S. business cycle has seen successively higher debt/income ratios at end of expansions, and the economy has become increasingly dependent on asset price inflation to spur the growth of aggregate demand.
2. Over the last 20 years, the economy has tended to expand when house price inflation has exceeded CPI (consumer price index) inflation. This was true for the last three years of the Reagan expansion. It was true for the Clinton expansion. And it was true for the Bush-Cheney expansion. The one period of sustained house price stagnation was 1990–95, which was a period of recession and extended jobless recovery.

Financialization is a symptom to the disease that is destroying the Middle Class.

Globalization

Globalization can be defined by the free flow of trade and capital from country to country.  The policies implemented since 1980 have precipitated globalization which has forced American workers to compete with much lower-paid foreign workers.  But there is more to it.  Our current, neo-liberal, incredibly flawed, economic growth model depends on CHEAP IMPORTS.  The impact from wage stagnation is covered up by cheap imports - it is a way to pacify Middle Class families.  What better way to make us feel like we have a lot of purchasing power by having access to incredibly cheap consumer goods from a big retailer. 

Dr. Palley describes it this way:

The reality is that the structure of U.S. international engagement, with its lack of attention to the trade deficit and manufacturing, contributed to a disastrous acceleration of the contradictions inherent in the neo-liberal growth model. That model always had a problem regarding sustainable generation of demand because of its imposition of wage stagnation and high income inequality. Flawed international economic engagement aggravated this problem by creating a triple hemorrhage that drained consumer spending, manufacturing jobs, and investment and industrial capacity. This in turn compelled even deeper reliance on the unsustainable stopgaps of borrowing and asset price inflation to compensate.

The Equation

Income Inequality + Financialization + Globalization = Destruction of Middle Class

Together these factors have contributed to the destruction of the Middle Class.  Some economists, like Dr. Palley, argue that our current, neo-liberal, economic growth model is not sustainable.  I would argue that it is not so much that this economic model is not sustainable, because I am sure that the financial oligarchy and corporate aristocracy would keep it going, but it will destroy the most important aspect to any stable economy - the Middle Class. 

It is not too late to reverse course but based on current affairs I have little faith that it will happen soon.  Time is running out. 

Health Care Reform is a Moral and Economic Issue.

There are two aspects that are being drowned out by all the noise surrounding the discussion health care reform.  Opponents to health care reform (particularly private insurance industry) are raising lies, misinformation and fear about the proposals in Congress.  But health care reform is needed for two very important reasons: one moral and one economic.

Moral Argument

As one of the richest industrialized countries in the world how can we allow 46 million Americans and climbing to not have health care coverage.  People are filing bankruptcy because they can’t afford to pay medical bills.  People are losing their homes to foreclosure because of medical bills.  People are postponing necessary treatments or preventative care because they can’t afford it.  How is this OK?

Economic Argument

In 2008, health care spending in the U.S. was $2.4 trillion and it is projected to jump to $3.1 trillion by 2012 - that is 17% of GDP (gross domestic product).  This is the highest percent of GDP of any industrial country including those with “socialize” medicine.  We can’t afford to continue spending that much on health care and expect to provide economic growth.

Majority of Americans obtain health insurance coverage through an employer sponsored insurance policy.  This is an extremely unstable source of health insurance coverage.  More and more employers are dropping coverage because of the increasing premiums.  And what happens if employer who provided health insurance to its workers ceases operations - well those workers are SOL. 

What are the choices?

I would prefer a single-payer system but there are serious questions whether Americans are ready for such a system.  A single-payer system would have a severe impact on private insurance companies (which isn’t a bad thing).  It would be very similar to what Canada and France have.  No system is perfect but Canada’s and France’s health care systems are not as bad as opponents to health care reform say and they are much better than what we have.

Right (8/16/09) now in Congress we have several proposals floating around with one proposal grabbing all the attention.  H.R. 3200, America’s Affordable Health Choices Act of 2009, is the main proposal in the House of Representatives.  This is the proposal that is being called “Obamacare”.  BTW, it doesn’t have ‘death panels’ that conservatives have lied about.

It creates a national insurance exchange for individuals and small employers to comparison shop among private and public insurers.  It creates a “Public Insurance Option” that will compete with private insurance companies.  It does have a mandate that requires people to have health insurance coverage and employers play or pay, that is, either sponsor and contribute to insurance for their employees or pay into a trust fund that would be used to help finance expanded coverage.  A summary of the details can be found HERE [PDF File].

H.R. 3200 is far from “socialized medicine” or even a government take over of the health care industry.  It is just providing another option which may be more affordable than private insurance companies.  It doesn’t require anyone to join the “public insurance OPTION”.  If you are currently insured and happy with your coverage - nothing will change provided that your insurance coverage meets certain national standards that will be phased in over time.  Besides, a little competition never hurt. 

In the Senate, the leading proposal is from the Senate Finance Committee that calls for state cooperatives instead a “public insurance option”.  The Senate proposal doesn’t have the mandates of H.R. 3200.  It is a very different structure than H.R. 3200.

If we want to cover 43 million+ uninsured people and lower the costs of health care spending mandates are a must.  The Senate version will not provide the market power of H.R. 3200 because the lack of mandates and the size of the pools of insured people.  H.R 3200 is a serious proposal that addresses health care reform. 

Last time I checked I haven’t heard of any proposals from Republicans.

A few words on cost.  Congressional Budget Office scored a preliminary version of H.R. 3200 and said it would cost $1 trillion OVER TEN YEARS.  I stress ten years.  This is less money than we have spent in Iraq and Afghanistan in a shorter period of time.  CBO stresses that this is preliminary and will change as negotiations continue. 

Sources:
National Coalition on Health Care
Physicians for a National Health Program

The Great De-Leveraging Continues

We keep shedding more debt.  Federal Reserve reported today that consumer credit decreased at an annual rate 5.25% in the second quarter.  This is good news because we are still highly leveraged/in debt.  But there are consequences to this good news.

The flip side is that we are not increasing our spending.  This lack of spending will mean slower economic growth.  But this is the consequence of substituting wage/salary growth for more debt/leverage.  This is another example of why we need a new economic growth model.

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