Wednesday, August 03, 2011

Kicking the Crisis Can Down the Road

by Gary Berg-Cross

We've all been awash in the recent media coverage of largely ideological arguments over the size of government and its spending , the threat if unfunded “entitlements” and the possible fall out from not increasing the debt ceiling. According to economist Joe Stiglitz much of the discussion has been aimed at the wrong issues:
“Our economic situation is the result of 30 years of unbridled right wing free market ideology. “Unaffordable tax cuts and wars, a major recession, and soaring health-care costs – fueled in part by the commitment of George W Bush’s administration to giving drug companies free rein in setting prices, even with government money at stake – quickly transformed a huge surplus into record peacetime deficits.”

Stiglitz adds, “Regrettably, the financial markets and right-wing economists have gotten the problem exactly backwards: they believe that austerity produces confidence, and that confidence will produce growth. But austerity undermines growth, worsening the government’s fiscal position, or at least yielding less improvement than austerity’s advocates promise. On both counts, confidence is undermined, and a downward spiral is set in motion.”

In a way we seem to have avoided an immediate disaster, unless you count the disastrous impacts to our political system, good government or things like lowering unemployment and an anemic economic recovery. With the economy shrinking we have perhaps kicked the disaster can down an ugly and dangerous road for a few months. Looking down that road economist Michael Hudson put it:

"since the government can’t supply the credit, that means that the economy is going to have to rely on commercial banks. And they’re going to charge interest. And it means that all of the growth that does occur in the economy is basically going to be paid to Wall Street, not to the people who produce the wealth, not to industry or its employees. The economy is going to shrink. Industrial corporations will shrink. Real estate will shrink. And the government isn’t doing anything to prevent this shrinkage into a deeper and deeper recession."

The declared victory is avoiding default, a downgrade from the ratings agencies and resulting higher interests rates that would be paid to borrowers. But this got me thinking about the power of rating agencies and their investment allies. You remember these rating guys - S&P and Moody's. During the run up to the debt ceiling these were the organizations threatened to cut the US's sweet AAA credit rating for sovereign debt for the first time in its history. This is a real threat since countries have to pay a higher rate if they are risky. As a recent WAPO story said:

"Investors drove borrowing costs for Italy & Spain to 14-year highs, fueling sharp stock market drops in London, Frankfurt, Paris, Milan and Madrid. Though Italian and Spanish bonds later rebounded, borrowing rates for both nations remained dangerously high, at more than 6 percent — and closing in on the 7 percent threshold that eventually triggered bailout talks with Greece, Ireland and Portugal."

Rating agencies had a lot to do with framing the debt ceiling debate as a crisis with unsustainable $14.3 trillion U.S. debt. They even provided their view of a credible medium-term plan to reduce the debt. It had to be at least by $4 trillion or they still might consider a downgrade leading to higher interest rates.

To some this seemed sound advice and people follow the bond market's prophecies closely:

"The bond market is, as they say, the smartest market in the world; so they must know what they’re doing when they send yields on the ten year Treasury down to 2.6% and the thirty year bond down below 4%." Don't Get Caught in the Treasury Bond Trap

But to me this is all conditioned by the memory that these forms are the same ones that liberally giving out top ratings to ultimately worthless structured mortgage products in 2005-2007. These are the fiscally irresponsible guys who facilitated the housing and credit bubble inflation. They did not provide sound advice and seemed to put their own interests along with their allies ahead of the ultimate customers and the nation. One reason the debt is soaring now is that incompetent economics involving unsecured loans and irresponsible credit allowed an $8 trillion housing bubble to grow out of control so that when it crashed it melted the larger economy. This drove down our tax base so that governments have to borrow money to meet their budgeted needs.

Following the housing bubble collapse with its resulting financial meltdown, there was widespread agreement on the need for reform both banks and rating agencies. One idea was that the banks, aka securitzers, should be forced to keep some investment “skin in the game,” meaning a stake in the mortgages they issued. If they collapse then the bank loses money directly. The Dodd-Frank included bill required to this effect, but only got a minor piece of skin. Many wanted to require a 10 or even 20 percent stake in mortgages, but the final bill had just 5 percent. Furthermore, the regulators exempted traditional 20-percent-down mortgages that have low risk of the fault. So now banks need keep no skin in the game on those.

Rating companies were the other target. They had to defend themselves in the face of all of this and said, "Well, yes, we gave AAA ratings on junk mortgages, but they’re legally only opinions."

The Dodd-Frank bill was the Feds attempt to correct this saying that rating agencies are liable for their opinions. Seems reasonable and responsible, but the rating agencies and their investment bank allies who have real political clout didn't want any skin in that game either. The responded in effect that they expected a free lunch just like always:

"We want to make money by selling our opinions. We need to. It's what we do and people need an idea about what options might make them money on a reliable basis. But we don’t want to have to take any responsibility for those opinions. That''s too hard. It might get in the way of us making money. Don't ask us to do that. It sounds too much like Social Justice. We live by the phrase, 'let the buyer beware.'
And one more thing. We'll show you what we can do if you upset us. We might have to downgrade the U.S. government rating. Our banker and investment friends will make a good profit from this. Good for then, but you wouldn't want to play the rate that Greece has, would you? "

So now a few organizations sit in judgment of the viability of national finances. If you go into debt an entire nation might be up for sale at fire sale prices. You can read about just such things starting now in Greece, but likely in other parts of the Euro-zone. It looks like one western history's great fire-sales is starting, as Greek officials began appointing advisers for the country's ambitious privatization drive. Last week Europe's banker, Germany, signaled it was interested in snapping up assets in the energy and tourism sectors. The Chinese are already buying up ports and Greece is thinking of selling some islands. Greek finance minister, Evangelos Venizelos announced:

"Our target is clear, and it is to generate €1.7bn from privatizations by the end of September and €5bn by the end of the year,"

By one report Austria is thinking of selling mountains to pay off their national debt and on this side of the Atlantic cities are thinking of privatizing their parking meters. All part of a process that turns historically public assets over to the control of private actors, whose bottom line is less investment than extracting maximum profit in the short run.

This all does reminded me a bit of the warning that Naomi Klein provide in Shock Doctrine: The Rise of Disaster Capitalism. Klein argued that crises are intentionally created to push the free market agenda or fight government actions. You see this whenever a natural, economic, war-related, or other disaster such as a financial meltdown happens. Narrow profit driven folks seize this as an opportunity to quickly impose a brand of economic policy benefits an oligarchic elite at the cost to most everyone else. This may result in increased unemployment, pushing the cost of essential goods up rapidly, and otherwise increasing poverty. All this may happen while the masses of people are still in shock and unable to react within a slow moving Democratic system. In the midst of such crises free marketers are able to destroy social protection, such as union rights, and to install a virulent, mutant version of free market capitalism. An example of profits from financial crisis such is being seen in the Greek fire sale. It could happen it, and is happening across Europe. See America Is Being Raped ... Just Like Greece and Other Countries.

It is perhaps why we are seeing such calmness among some as we slowing move along kicking a mix of crisis and future disasters down the road.

1 comment:

Gary Berg-Cross said...

WAPO's Ezra Klein ( provides a look into the lasting vulnerability caused by financial crises quoting Carmen Reinhart, coauthor of 'This Time is Different,' (the seminal work on financial crises):

"Seven of the 15 post-war crises had broadly defined double-dips," she said, "but often these renewed bouts of slowness were tied to external factors. They weren't always related to post-crisis intrinsic forces. But after a crisis, you're highly leveraged, you're growing slowly, and so you're vulnerable to an adverse external shock that, in normal times, you could handle well."

Ezra also quotes Paul Krugman on a way out of what he sees as a self-fulfilling/self caused crisis based on a trump of fear over reasoning:

"There is a reasonable case that what we’re seeing in Italy is a self-fulfilling crisis trying to happen, in which fear of default is precisely what leads to default. And that’s exactly the kind of case in which intervention could short-circuit the crisis. Let the ECB buy lots of Italian bonds, in effect guaranteeing a low interest rate, and the possibility of default fades – which in turn means that further intervention isn’t needed. It’s certainly worth a try."