A History Lesson for David Brooks & Other Laissez-Faire Opinionators

http://www.internetweekly.org/

Duelling Views of the Economy From Two Voices ~ "Wretched Excess Just an Aberration" v. "We've Been Down This Road Before." Apparently, we have to save their greedy asses again!

First up, from David Brooks, the conservative journalist who's not an economist, but who purports to bring us absolute certitude anyway. He helpfully points out that there are 2 narratives from which to choose regarding the economic pickle we're in & the go-go cannibal capitalists whose behavior has done so much to bring it about: the "greed narrative" & the ecology narrative." (Hint: the latter is pretty much "boys will be boys!")

"There is roughly a 100 percent chance that we’re going to spend much of this year talking about the subprime mortgage crisis, the financial markets and the worsening economy. The only question is which narrative is going to prevail...

"The Greed Narrative goes something like this: The financial markets are dominated by absurdly overpaid zillionaires. They invent complex financial instruments, like globally securitized subprime mortgages that few really understand. They dump these things onto the unsuspecting, sending destabilizing waves of money sloshing around the globe. Economies melt down. Regular people lose jobs and savings. Meanwhile, the financial insiders still get their obscene bonuses, rain or shine.

"The morality of the Greed Narrative is straightforward. A small number of predators destabilize the economy and reap big bonuses. The financial system is fundamentally broken. Government should step in and control the malefactors of great wealth.

"The Ecology Narrative is different. It starts with the premise that investors and borrowers cooperate and compete in a complex ecosystem. Everyone seeks wealth while minimizing risk. As Jim Manzi, a software entrepreneur who specializes in applied artificial intelligence, has noted, the chief tension in this ecosystem is between innovation and uncertainty. We could live in a safer world, but we’d have to forswear creativity.

"The United States has generally opted for financial innovation. This has worked out pretty well. The U.S. has enjoyed 25 years of strong economic growth, in part because capital has been efficiently allocated to companies that can use it well.

"Financial instruments like adjustable-rate and subprime mortgages have allowed millions of people to get homes they could not otherwise purchase, and research shows that most of these tools have been used intelligently.

"Hedge funds have proliferated to help investors manage risk. These things exist precisely because investors want to smooth out volatility. In the old days, a blow to, say, the Texas economy could have dried up lending in Texas, but now funds flow globally, and money from one part of the world can shore up weakness in another.
As Sebastian Mallaby of the Council on Foreign Relations has pointed out, time and again hedge funds have dampened market instability. If a currency, a company or a stock market starts to spiral downward, deep-pocketed funds, smelling bargains, will come in and stabilize its assets. If a company’s price is rising to unsustainable levels, contrarian funds bet against the hype.

"Most of the time, the complex new instruments diversify risk and serve the public good. But life requires trade-offs, and, as we’re being reminded this week, the innovation process involves a painful adolescence.

"When a new instrument enters the market, it takes a while before people understand and institutionalize it. Whether the product is high-yield bonds or mortgage-backed securities, there’s a tendency to get carried away.

"In the first stage of this adolescence, investors look around and see everybody else making money off some new instrument. As Nicholas Bloom of Stanford notes: “They assume they are fine because they see everyone else buying it.” Individual bankers have a special incentive to get in on the ride because their yearly bonus is determined by how they do in the short term.

"Then there’s a moment when people realize how stupid they have been. They’ve bought a pile of subprime mortgages without really knowing what they’ve purchased. The ratings agencies suddenly don’t look so reliable. The cycle of overconfidence becomes a cycle of underconfidence because nobody knows who is holding worthless paper.

"Then, finally, maturity sets in. Those who have lost great gobs of money get fired. People still find the new product useful, but within parameters and with greater safeguards.
The lesson of the Ecology Narrative is that, in most cases, the market corrects itself. Maybe this year banks will change their pay structure so there’s not so much emphasis on short-term results. Maybe companies will change their boards to improve scrutiny over complex new instruments. In short, markets adapt.
People who embrace the Ecology Narrative don’t like the offensive bonuses that get handed out on Wall Street. They just don’t see any way the government can curtail them without rending the fabric of the ecosystem. They don’t like the periodic crises, but don’t see how government can prevent them without clamping down on innovation. The challenge is to give people the means to withstand the perturbations.

"The Ecology Narrative is not morally satisfying. I wouldn’t bet on its popularity as a backlash against Wall Street and finance sweeps across a recession-haunted country. But the Ecology Narrative has one thing going for it. It happens to be true."
http://www.nytimes.com/2008/01/25/opinion/25brooks.html

What happens to be true, actually, is that David & other apologists for the sorry mess we're in fail to mention is that, no, Wall Street is not going through an unfortunate adolescence. They've already been through it, dragged the entire country under, & Republicans have failed to learn from the miserable experience. Ever hear of the Gilded Age of Robber Barons & the Great Depression that followed it, David? ~ Stay tuned as we educate you~

Recent history lessons

For the David Brookses of the world *in denial or blinded by ideology*, here's an informative read from 2002 by Robert Kuttner, educated at the London School of Economics & a co-founder of the American Prospect about the parallels to that era this. Then, it fell to liberals to save capitalism from itself. Kuttner points out that crony capitalism was practiced by Bush himself (according to the article, he benefitted from insider stock sales when he was CEO of Harkin Energy) so neither he, nor any other lasseiz-faire fantasists who profited can be said to be credibly neutral on the topic, having succeeded in disembowelling protections that the New Deal liberals put into place ~ to prevent just what we've been seeing take place before our very eyes ~ following on Enron & other debacles ~ another meltdown that has the potential to grow into a full-fledged crisis.
...
"While the New Deal is commonly remembered for its public-spending and social-insurance legacies, its regulatory changes were at least as important to the stabilization of capitalism. The Roosevelt administration initiated much tougher regulation of banking, securities underwriting, accounting, electric power, civil aviation, telephones, broadcasting and labor relations. It added new teeth to pre-existing regulatory agencies in charge of railroads and trucking, as well as antitrust.

"The rationales for the new spate of regulation were diverse, often ad hoc and even contradictory. One strand of regulation addressed the problem of ruinous competition. In a normal economy, competition is good. But in a depression, if companies keep cutting prices and laying off workers, the result is a general downward spiral. Some of the New Deal's regulation was aimed at stabilizing prices and breaking the cycle of deflation. Other regulations set rates--in order to stabilize emergent industries, such as airlines, power companies and telephones--by assuring profits high enough to stimulate innovation and investment, but not so high as to gouge consumers.

"At its heart, however, New Deal regulation was about the stabilization of finance, for financial markets are both the essence of the market system and its Achilles heel. Congress and the White House wanted to make sure that the conflicts of interest and speculative ruin that characterized the 1920s would never be repeated.

"New Deal regulation, entrusted to the new SEC, imposed standards on corporate governance, on the issuance and sale of stocks and bonds, on the accounting profession and on stock exchanges. New Deal banking regulation put a wall between the operation of commercial banks and the underwriting and sale of securities. It regulated bank interest rates, offered deposit insurance, and imposed new conditions on bank safety and soundness. All of this succeeded in stabilizing capitalism--for about 70 years.

"To infer a consistent theory of the economy from New Deal regulation, one might say: Some sectors of the economy need to be regulated for purposes of financial stability, some to introduce greater income security and equality, and some to provide social goods that markets don't efficiently deliver. But underlying all these kinds of regulation is a distrust of the market's ability to regulate itself, and a reliance on government to keep capitalism efficient and honest. This insight was the centerpiece of the modern Democratic Party.

WHAT ARE THE PARALLELS WITH THE PRESENT ECONOMY?
"One is the vast waste of economic resources in speculative investments. Despite nonsensical tracts such as the book Dow 36,000, it's now clear that much of the stock run-up of the 1990s was an enormous bubble. Until the Enron affair, many analysts thought that the damage was limited to dot-coms and closely related technology companies. But as one corporation after another gets a new auditor and 'restates' its recent profits, it's evident that trillions of dollars of investment in far-flung corners of the economy went to no useful purpose. It remains to be seen how disastrous the assault on the real economy turns out to be, and how much lower the stock market has to fall.

"The second parallel is that much of the speculative excess was the result of conflicts of interests that could and should have been prevented. Bankers, brokers and corporate insiders all enriched themselves by temporarily pumping up stocks and contriving off-the-books deals.

"The whole system of compensation by stock option gave senior executives irresistible incentives to contrive phony profits and merger deals that made no economic sense. Corporate directors, never the arm's-length supervisors promised by market theory, were in fact cronies of the CEO. Auditors were in bed with their clients. All of this reflected the systematic dismantling of financial regulation, causing the economy to revert to the laissez-faire world of the 1920s, with its myriad attendant vulnerabilities. If the regulation of options-trading and electricity had not been undermined, Enron would have had to make its money in the old-fashioned way: selling real products and services and reporting honest earnings. If the Glass-Steagall Act had not been gutted by regulatory indulgence and then formally repealed, banks could not have enriched themselves by making profit-sharing deals with dishonest partners such as Enron. If the Congress and the SEC had not undercut the regulation of accountants, corporate books could not have been cooked to artificially inflate profits. If SEC oversight had held corporate directors personally accountable for their decisions and their lapses, corporate boards would never have approved many rotten deals. If stock options had been more tightly regulated, insiders would not have had an incentive to artificially pump up share prices in order to cash them in. What deregulation has produced is an economy and a culture rooted in conflicts of interest.

"The SEC already had the power to police most of these, but [the Republican] Congress directed it not to. And when Bill Clinton vetoed Newt Gingrich's bill that made it almost impossible for investors to sue for securities fraud, (see also Nice Work if You Can Get It I post re Supreme Court decision & Bush SEC intervention) Congress, with the support of many Democrats, passed it over Clinton's veto.

"Bush's law-and-order rhetoric and his call for longer prison terms for felonious CEOS misses the point utterly. What's needed is tighter scrutiny and clearer barriers to prevent such double-dealing at every step. Moreover, regulation is not a one-time action but an ongoing process. Financial scammers are always coming up with new gimmicks to circumvent existing prohibitions.

"For example, New Deal regulators, mindful that speculative stock investments in the 1920s were made substantially with borrowed money, limited that practice by regulating 'margin'--money lent to customers by brokers to finance direct stock investment. But margin is now archaic. You can speculate with borrowed money by investing in derivatives.

"Many of the abuses of the 1990s were the intended consequences of new inventions. The aggressive use of derivatives was new. The use of huge personal loans to executives to create off-the-books subsidiaries was new. Enron-style trading of futures was new. The ubiquity of options to reward CEOS was new. If the general conceit is that anything invented by markets should be celebrated as innovation and that any excesses will be disciplined by investors, existing regulations won't do the job, and there will be a bias against new regulation to counter new abuse. In the era that began with Reagan, when the market fundamentalism of The Wall Street Journal and the Heritage Foundation spread like an oil slick to the general media and the Democratic Party, markets got a free pass. When new scams were contrived, it took uncommonly courageous regulators such as SEC Chairman Arthur Levitt to call for new forms of regulation.

"That's why the counteroffensive needs to be much broader than a mere crackdown on the current spate of frauds. The mixed economy itself needs to be rehabilitated, and market fundamentalism disgraced.

ASSESSING THE DAMAGE
"The economic commentator George Goodman, who wrote in the 1970s and 1980s under the pen name Adam Smith, liked to say that you don't see the bones until the tide goes out. A lot of the long-term damage to the economy is still hidden, and the tide is still going out.

"For example, it has almost been forgotten that the Federal Reserve has been keeping interest rates at historic lows in order to contain the damage of the first stock-market meltdown, the collapse of the dot-coms.

"Monetary policy to keep the economy afloat is already being used to its practical maximum. As Jeff Faux observes in this issue [See "Falling Dollar, Rising Debt," page 12.], America's chronic trade deficit is a source of hidden weakness that is suddenly far more precarious in a stock market meltdown. We finance the trade deficit by importing capital--about $400 billion a year. Until recently, the United States had no trouble importing that capital, despite our very low interest rates, because of America's reputation as the safest investment haven. But that inflow is now slowing, causing the dollar to lose value, and at some point the Federal Reserve will need to raise rates to keep foreign investors from fleeing--just as the economy is weakening.

"That will only slow economic growth and worsen the stock market slide. The late bull market also provided a lot of economic stimulus, which is now reversing. In the 1990s, institutions as well as individuals became addicted to the premise of a stock market permanently rising at four or five times the rate of economic growth. Pension funds that assumed a l0 percent normal annual return and thus were considered "overfunded" suddenly have far weaker balance sheets. So do many insurance companies. Large nonprofit institutions reliant on endowments--such as foundations, universities and hospitals--are suddenly a lot poorer. They must either curtail their existing operations or raise costs to consumers. So far, banks have not taken a big hit, but consumer and corporate debt are at record levels and bank profit margins are thin. A lot of banks overextended themselves in their own merger binge. As corporate stock prices fall, corporate ratios of equity to debt worsen. As the economy softens, bad loans mount. Banks would be in even worse shape were it not for the fact that some tougher supervision by examiners was restored in the wake of the banking and savings-and-loan scandals of the 1980s. And as the banks' own prices fall, their own debt-equity ratios deteriorate. As the stock market has softened, a lot of money has poured into real estate--the last safe haven. But real estate is built and purchased with borrowed money, and offices and apartments need tenants. If the real economy falters and vacancy rates keep rising, the real-estate boom could be the next bubble, and another key sector would succumb to debt deflation.

"It's hard to think of any large sector of the economy that is immune to what is now unfolding. But aren't rates of productivity growth impressively high? And didn't the economy bounce back smartly from both the dot-com crash and the shock of September 11? Yes on both counts, but productivity is not relevant when the problem is a financial implosion. If retirees lose their stock portfolios and workers their jobs, the money to purchase products--no matter how efficiently produced--dries up.

"The history of capitalism is replete with eras in which new inventions made the real economy highly productive but chaos in the financial sector still dragged it into depression. The 1930s was a time of technological progress, in electronics, automobiles, telephones, electric power generation and basic science. But none of it was sufficient to compensate for the financial hangover and the shortfall of total demand. Japan still makes countless products more efficiently than anybody else, but its financial mess has kept it in a self-perpetuating slump. Although the economy still retains a lot of momentum, at some point all of this corporate unwinding has to translate into a slowdown of growth and a rise in unemployment.

"Ideally, the carnage will be contained--it will be enough to discredit laissez-faire and corporate excess, but not so serious that it produces a prolonged slump. Thanks to the part of the New Deal that the right has not managed to repeal, the economy is far more resilient than it was in 1929. Social Security, welfare checks and unemployment compensation are far from adequate, but they do prevent the bottom from falling out of consumer demand. Despite the efforts of the right to condemn the interference with free markets, bank deposits are still insured. The Federal Reserve, given new powers in the 1930s to be a lender of last resort, is a lot more savvy and effective than it was in 1929. Total public spending is about one-third of GDP, and this provides a lot of ballast.

"The more venturesome Democrats have assembled an adequate package of reforms to deal with the financial abuses now unfolding. Taken together, legislation sponsored by key Democrats would sever auditing from consulting, require a majority of corporate directors to be independent, tighten accounting standards across the board, define new categories of corporate criminal fraud, constrain exorbitant stock-option compensation to insiders, protect ordinary employees' pension plans and hold senior executives criminally liable for fraudulent practices that are now beyond prosecution. Republicans are already backing some of these measures in spite of themselves. (A nice summary is on Rep. Richard Gephardt's Web site, http://democraticleader.house.gov/.)

"None of this is 'anti-business.' It is emphatically pro-business in that it prevents the squandering of capital for personal enrichment and because it is necessary to restore investor confidence. Such measures are only the beginning of a long struggle to wrest back a mixed economy. The unleashing of market forces has been harmful to ordinary people and to the modern liberal project in ways that go far beyond the harm inflicted in the current crisis. Why, for example, don't Americans have decent health care? Because the health-care industry wants it that way, and because the ascendant ideology says that markets can do the job better than government-sponsored insurance. Ordinary experience and scholarly evidence both demonstrate that market provision of health care is a disaster.

"But the ideological conventions of the era blind politicians to what their own constituents know and desire. By the same token, the problem with retirement security isn't just that some 401(k) plans are inadequately regulated and at risk of being looted. Half of America's workers have no pensions at all save Social Security, and they will only get pensions when government policy demands it.

"The free market is supposed to solve this problem, but it doesn't. The voucher craze, lately supported even by some Democrats, is another money-making scheme relying on the spurious claim that markets are superior to public investments. The view that lifesaving drugs are commodities rather than social goods is yet another market conceit.

"Bush's appalling tax cut reflects the belief that personal income is entirely private rather than subject to social claims. And the ultimate manifestation of the laissez-faire's hegemony is the global free market, in which speculative money flows periodically wreck the economies of developing countries, undercut labor and environmental regulation in advanced democracies, and invite the creation of tax havens for the wealthy.

"The market fundamentalists also insist that the deregulation of particular industries, such as airlines and telephones, saves consumers hundreds of billions of dollars by cutting prices. But these calculations leave out the sheer economic waste that occurs when a natural monopoly such as telephone service is fragmented. They ignore the huge financial loss that results from hundreds of billion dollars of duplicative investments and bankruptcies...deteriorating service ... and the lost wages to workers when high-wage industries become hypercompetitive low-wage sectors.
"Can Liberals Save Capitalism Again?" http://goliath.ecnext.com/coms2/gi_0199-1933981/Can-liberals-save-capitalism-again.html
Author Bio: http://www.prospect.org/cs/about_tap/about_the_editors#kuttner

"The entire set of free-market era claims are due for scholarly reappraisal and broad political challenge. Just as the soaring stock market and the cult of the CEO gave prestige to markets and deregulation generally, so the disgrace of corporate capitalism is an opportunity to dethrone the role of the market generally. Only when that occurs will the liberal project regain the momentum that it enjoyed in the mid-20th century. Ordinary people are able to connect the dots, if leaders will only lead. It's a pity that it took this kind of crisis to open the door. Lately it has been the right, not the liberal left, that it is ideologically serious. But ultimately, in this pragmatic country, nothing fails like failure.

And furthermore: Paul Krugman, another economist, on why tax rebates for those already paying taxes (& doing well, presumably,) isn't likely to be an effective stimulus: http://www.nytimes.com/2008/01/25/opinion/25krugman.html