If you've ever wondered why these CEOs make hundreds of millions of dollars even if their companies are laying off thousands, their remaining employees have largely seen their paychecks stagnate and their stocks are circling the drain… If you've ever wondered whether you, or even the office boy, could have done a better job…consider the case of Henry M. Paulson Jr., the Secretary of the Treasury and former chief executive of Goldman Sachs. As is now becoming clear, Paulson has little more clue than the office boy about addressing the financial crisis.
After more than a year of denying the gathering storm, he suddenly rushed to Congress demanding an open-ended bailout of Wall Street, "to save the financial system." First the plan was to buy the "toxic debt" that had brought down much of the system. He was urged to inject capital directly into banks but rejected this advice. When the credit system seized up he changed the bailout to…inject capital directly into the banks. Yet the banks still refuse to do much lending, even as they use the taxpayers' money to buy competitors and pay fat compensation to their executives. Now the bailout has been changed yet again, to help "consumers." Well, not exactly: money would be given to companies dealing in credit cards, car loans and student loans. Don't expect any help personally.
Meanwhile, the real economy keeps spiraling downward as 401(k)s are vaporized, a million people have lost their jobs this year, the retail sector is moving into bankruptcy court and Detroit is facing collapse. This is one last gift of the Bush administration. Paulson's actions aren't incompetence on the level of Brownie — a political hack put in a critical position he for which he was completely unprepared. They may be worse.
To be fair to Paulson, the best economic and business minds of "the old order" of the 1920s were completely flummoxed by the Great Depression. Contrary to myth, Herbert Hoover acted with great vigor to try to stem the disaster, pushing far beyond what previous chief executives had done. Yet all these men were prisoners of fixed thinking: the received knowledge of a body of expertise that came to be seen as "the truth" (unencumbered markets, etc.) and a belief that the future would be a replay of the recent past.
In our time we've seen this mindset on display for the past two years, from Paulson in denial then fighting to save his Wall Street right down to the local economists talking about how there really wasn't a housing bubble, but instead "the market was returning to normal." Does this feel like normal? None of this is normal — it is all discontinuity, the Great Disruption. It's not just retailers that should be declaring bankruptcy, but most of the economists, CEOs and business schools.
This is the perfect event to confound the titans who are expert only in the recent past and their own rationalizations. A key problem, for example, with the original bailout was that the "toxic debt" was not your foreclosed mortgage; it was exotic derivatives, such as "collateralized debt obligations," that have no real value. Imagine someone coming up with a scheme to create a derivative of the cash in your wallet. It's not actually the cash in your wallet; it's value is derived from that cash. Then it's rebundled and repackaged again, so it's several more steps removed from the actual wallet. Then it's sold to wealthy investors, pension plans, mutual funds, etc. by Wall Street, which makes huge fees for each sale. Meanwhile, it's insured from loss by a huge, respected company — let's call it AIG. For several years this succeeds brilliantly. Then you spend what's in your wallet and there's nothing there. Such a contraption used to be called a Ponzi scheme and would land its creators in jail. On Wall Street, it became "value-added innovation" and landed its creators and sellers in lifestyles that would have made a Roman emperor envious.
Only the people who had built this house of cards with its impressive computer modeling and game theory could believe it was real. If even they did…or were just trying to get every last dime of compensation before the deluge.
Unfortunately, something else may be happening: an American version of banana republic kleptocracy, where an outgoing presidency tries to loot as much as it can before it leaves office and hops airplanes to non-extradition countries. Much of the bailout money is already out the door, with nothing to show for it, and apparently little oversight. It's not even clear how much, between Treasury and the Fed, has been pledged to various "facilities": a trillion dollars? More? Bloomberg reports that the Fed is refusing to identify the recipients of some $2 trillion in emergency loans.
Think of what "even" a trillion dollars could have done to fund research and development of real alternative energy and advanced manufacturing; to build a high-speed rail network with jobs that couldn't be sent offshore; to raise teacher pay and help create the best schools in the world; to extend Medicare to all Americans. Instead, it's looking increasingly like it's gone into keeping the Old Order chugging a bit longer and keeping up the handsome paychecks for its captains.
Meanwhile, as many as 3 million people will be in foreclosure by the end of the year, some through their own casino mentality but many because they lost jobs or faced health emergencies. And nothing has been done to prepare for the discontinuity ahead.
How is it that intelligent and rational people became believers in “new paradigms” and other forms of wishful thinking? In Arizona, the main industry – real estate – was a can’t-miss proposition only a few years ago. There were no Cassandras, Talton excluded, sounding the alarms. In fact, as Talton found out, there was a career disincentive for doing so. Even today, you can still catch the certitude on faces who regard the current unpleasantness as a minor deviation from a Roman-candle economy.
Belief, not reason, is our guiding light. Ponzi schemes require nothing more or less. Hucksters and salesmen live a credo founded on cornucopian fantasy. There are no limits, no speculative excess, no unintended consequences. It’s why even in the middle of an equity market meltdown we still regard the price/earning ratio as an outmoded standard of valuation.
The American Right is now preparing itself for a new Holy War. The demonology involves a government no longer our own. When the Good Rs were in control, government was trustworthy. Now, swarthy, possibly Islamic, Ds are taking over. The markets are swooning because of that. Never mind the crazy aunts in the attic who told us that unleashing the markets would solve everything. As it turns out, the market was betrayed because liberals demanded black people be given mortgages. The market didn’t fail. Liberals stabbed it in the back.
One occasionally (very rarely) sees a different kind of commentary. Today’s newspaper contained an Associated Press item which included the following passage:
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Analysts believe consumers — who usually account for about 70 percent of economic activity — will no longer be the key driver of the economy, said Scott Hoyt, senior director of consumer economics at Moody’s Economy.com.
“This is the end of the consumer-based economy,” said Peter Schiff, who runs the investment firm Euro Pacific Capital Inc. in Darien, Conn. “Americans have been buying too much stuff, and now the epic shopping spree is over. It is a permanent change.”
For years, consumers tapped into inflated home equity and use credit cards to finance their spending. Now those spigots are being shut off, and job losses are mounting.
Even when home prices recover and credit becomes more available, Hoyt notes, Americans will have learned something: “They can’t count on asset appreciation to meet their long-term goals.”
https://ap.google.com/article/ALeqM5jHRLUYO20k3uGm7pQIsPZyNcTgPAD94DLVB02
* * *
Considering how revolutionary such statements are, you might have thought they would have received extended, in depth treatment. Instead, nothing. No explanation is given. For example, how does Mr. Schiff know, or more accurately, why does he say, that “it’s permanent”? For that matter, which analysts (cited by Mr. Hoyt) say that consumers will no longer drive the economy, and what is the basis of their analysis?
P.S. That AP item was in the Business section. The part of the item containing that passage was on the back page.
Remember the Maine! – We’ll never forget!
The Great Depression – we’ve learned our lesson and will never repeat it!
World War I & II – never again!
In all of these contexts ‘never’ means it won’t happen until the people who experienced it directly are dead and all of the people who are in charge have no living memory of the past event.
Or 40 to 60 years.
Then, if anyone like Mr. Talton tries to point out the lessons of the past, they can convince themselves that, this time, they won’t make the same old mistakes.
Problem is that scholastic test scores show a steady decline in History comprehension. (ironic humor intended, if not acheived)
However you want to go about structuring your economy (and there are many arguments down that path), there’s a few basic corner stones that must be in place.
Rewards must be somehow linked to performance, and failure must result in some sort of penalty. Once this rule no longer applies, your economic activity is completely out of control. Anything is possible, but bad things are the most likely outcome.
In addition, taking higher risks, deserves a higher reward BUT ONLY if the risk comes good. Taking high risks and screwing it up implies that the person responsible must take the penalty (that is after all what risk is all about).
The current situation does not obey these basic rules. People are being generously rewarded for abject failure. It looks like the Republican party are doing their best to teach citizens the danger of a government gone wild by delivering the worst government possible, for as long as possible, and looting for their own benefit in the meantime. I could seriously imagine Karl Rove in court telling a jury, “Sure I knew what we were doing was wrong, but we did it so blatently that it seemed reasonable to believe someone would stop us a lot sooner.”
Great post!
Love the wallet analogy…
It gets it exactly right.
hmm…i wonder that all the time.
Saying that rewards should be tied to performance is one thing, but trying to blame the current mess exclusively on the Bush administration’s “bailout” misses the broader point.
Would Tel allow the world to descend into economic collapse and another Great Depression merely to teach a few irresponsible individuals a lesson?
Even if you don’t believe that the current situation would have led to that without the “bailout” (and I don’t insist on it), the question remains important because it is reasonable to infer that a point could be reached where risky business practices could result in national or global economic disaster that only wholesale and coordinated intervention by governments could stop (assuming that even this would be enough).
The answer, then, is not (as Tel suggests) to allow a “free market” to teach a few greedy fools a belated lesson at the expense of everyone else; rather, it is to provide an independent and objective regulatory environment, which does not share the motives of financial speculators since it operates outside the market, and which is systematically and diligently enforced, being empowered by legislation and regulatory rules, and being funded adequately to carry out its mission effectively on a consistent basis.
If everyone (or nearly everyone) from both parties could be made to acknowledge the ideological necessity and desirability of this, then half the battle is won — at least as long as institutional memory abides.
Don’t forget that the individuals taking these risks were not gambling with their own money; they were risking the money of others. They borrowed that money, and in being permitted the privilege of doing so, adequate regulation could have been made a condition.
They borrowed this money while acting as managers of financial corporations which exist as legal entities independent of them. They cannot be held personally accountable for the losses and debts of the corporation whose borrowed assets they manage, provided they did not commit an act of fraud or theft while taking these risks.
Many of these managers, who took the risks leading to the current crisis, already made a killing from their sharp practices and left the company with a golden parachute. How can they, the ones who actually made the decisions, be held accountable for what turned out to be bad risks?
The answer is, they can’t. The only solution was to have enforced a regulatory environment which prevented such risk taking to begin with.
The typical household investor, whose borrowed money was being gambled with, had no knowledge of the technical details of the risk models used by the financial managers who took the risks. To expect the ordinary retiree to become a financial expert prior to investing is absurd. Again, the solution is to appoint independent, disinterested, outside expert regulators, and give them the legal backing and the budgetary funding necessary to do their job correctly.
The alternative to a proper regulatory market is a Wild West Market. In a Wild West Market, for every sharp operator whose risks result in failure, there are a thousand more ready to step in and take his place, because if they succeed the rewards are astronomical. No doubt eventually enough suckers would be fleeced to scare the public away from the financial markets in a wholesale fashion; but whereas this would end the sharp operators’ opportunity, it would also end the opportunity of the legitimate credit and equity markets. Again, the solution is a vigorously enforced, properly empowered and funded regulatory environment.
Once you admit this, and do away with doctrinaire ideological positions calling for “free markets”, the practical question becomes one of detail in designing such a system. This requires all responsible parties to give up infantile “government is bad, markets are good” rhetoric once and for all.
Bankers should err on the side of prudence when risking others’ money. So should their regulators. There was a time when bankers were content with a small but steady accumulation of profits. No longer. Individuals tempted by greed and personal gain may be biased in favor of risk and may not be the best judge of what is prudent. Hence the need for outside, disinterested regulators.
Some other points to consider:
“Performance” is judged by how it is defined. One standard of performance is “whatever makes me and my cronies a quick buck and makes the current shareholders happy in the short term”. That’s a definition which has been in vogue at least since the leveraged buyouts / shark-attacks /demolition capitalism of the 1980s. By the time the broader consequences manifest, whether in that company, in the broader business world, or in society at large, those responsible may already have left the company as rich men, and be unaccountable.
Capitalism also has a built in disconnect between performance and rewards. All of the fat profits which make a few owners wealthy beyond the dreams of avarice would not be possible without the labor of those who actually produce that wealth. Yet, far from being rewarded, they are paid a pittance (in many cases not even a living wage capable of supporting a family), denied benefits such as health insurance and vacations, and otherwise abused. They are also the first to go, whenever management decides that it can save money by hiring someone even more desperate overseas. Yet, those who cut labor costs by firing skilled workers in order to hire less skilled workers for severely lower wages, are rewarded, as are the stockholders who, again, have nothing whatsoever to do with the actual productive activity which provides the basis for profit. These are fundamental disconnects between productivity and reward which cannot be solved until workers themselves take ownership of the means of production.
Similarly, while it’s perfectly sensible to call for a proper regulatory environment, it’s naive to expect legislators and political executives to insist on this, when their own political existence depends on campaigns privately funded by wealthy corporations and individuals. Even those who talk a good game are seldom interested in seeing it through in its implementation, because to do so would risk their own source of funding.