posted October 12, 2008
America’s Failing Economy at Historic Juncture

During the month of September the U.S. economy experienced an intensification of its ongoing financial crisis. Many now call the events of the month the worst since the Great Depression of the 1930s and have been dubbing the period ‘Black September’. Indeed, there are emerging many similarities between developments of the past year, and the past month in particular, and the banking panics of 1930-31. A more accurate phrase might therefore be ‘the banking panic of 2008’.

From the beginning of this past month financial institution after institution collapsed. Fannie Mae and Freddie Mac, the two giant quasi-government residential mortgage institutions with $5.4 trillion in mortgage liabilities. Lehman Brothers and Merrill Lynch, two of the top half dozen or so banks. American International Group (AIG), the largest insurance company in the U.S. Washington Mutual (WaMu), the largest savings and loan. And numerous smaller local banks (IndyMac and others). Other major banks and institutions continue to hover on the brink of bankruptcy as well: Wachovia Bank, First National City, Morgan Stanley, scores of unregulated Hedge Funds and Private Equity Funds, and major European banks like Fortis, UBS, and others.

All have disappeared virtually overnight in the course of the past several weeks. Some had their assets seized by the U.S. Treasury or other government agencies like the Federal Deposit Insurance Corp., the FDIC (Fannie/Freddie, AIG). Others were forced into merger with other institutions by the government (WaMu). Some rushed voluntarily and prematurely into merger, selling themselves at ‘firesale’ prices to their once primary competitors in order to avoid collapse (Merrill Lynch). Others were simply allowed to go bankrupt (Lehman Brothers).

As of late September the process of collapse-bankruptcy-merger and/or government outright bailout is still ongoing and will likely accelerate. More than 800 banks are now on the government’s unstable ‘watch list’ and are thus prime candidates for failure and consequently either bankruptcy or bailout. Seizure of these institutions and payment of depositors for losses as they go bankrupt will cost at minimum hundreds of billions of dollars. The U.S. government agency responsible for compensating depositors, up to $100,000 each, is the FDIC. However, the FDIC only has $35 billion on hand to do so and has requested the U.S. Treasury allocate it at least another $150 billion.

To fund the recent, and future likely, collapse of banks and financial institutions, the U.S. Secretary of the Treasury, Hank Paulson, in mid-September proposed to Congress the creation of a $700 billion bailout fund. The fund, called the ‘Temporary Asset Relief Program’ or TARP, will be used by the government to buy up the ‘bad’ bonds and debt now held by private banks and financial institutions of all kinds. Some economists and analysts estimate the total bad debt requiring eventual bailout between $4-$5 trillion. Thus $700 billion may be only a start.

But even the $700 billion is not the entire picture of how much banks and financial institutions have been ‘aided’ financially thus far. The Congress in July authorized an earlier $300 billion to specifically bail out the quasi-government mortgage agencies, Fannie Mae and Freddie Mac (they are ‘quasi’ because they are government institutions in which private investors have been allowed to purchase stock). And the U.S. Federal Reserve Bank (FED) has provided banks since December 2007 an additional $600 billion in below market emergency loans, including a most recent $180 billion injection to European as well as U.S. banks. The Treasury in September also announced it had found a ‘secret pot’ of available funds worth another $50 billion it had not reported previously. That too will now be committed to bailouts.

So the total provided to or earmarked for the financial sector to date has easily been more than $1.6 trillion if one includes not only the pending TARP $700 billion but all other sources.

Despite that massive, historically unprecedented injection of $1.6 trillion in ‘liquidity’ (money) into the banks and financial institutions, the general financial crisis is still deteriorating rapidly. Except for a few economic voices in the wilderness, this writer included, no one is raising the question whether transferring trillions of dollars to the banks—at least a trillion of which is a direct transfer from the taxpayer (which means largely the working and middle classes in America)—is actually the solution to the crisis!

It doesn’t take a financial genius to see that as more and more liquidity has been pumped into the system, that financial system has become increasingly fragile and unstable. That does not mean the injecting of $trillions in liquidity is causing the instability. It does mean that doing so is not resolving the more fundamental causes of the financial crisis and the emerging global ‘Epic’ recession that the financial crisis has begun to generate. It means government authorities are more concerned about taking care of their big bank and investor friends in the short term, as the latter’s losses mount, than in resolving the fundamental long term causes of the crisis itself. That would require a focus on the victims of the crisis—i.e. the homeowner, the consumer, and the American worker.

During the first phase of the current financial crisis, from August 2007 to July 2008, the transfer of hundreds of billions of dollars to banks in trouble was led by the U.S. central bank, the Federal Reserve (FED). After the Bear Stearns Investment Bank bailout in March 2008 and the FED’s extension of low cost loans to other banks in trouble via special ‘auctions’, the FED’s total resources of around $800-$900 billion were effectively halved. In September that remaining half was again at least halved. The FED therefore has only around $200 billion left and has thus asked the Treasury to ‘print’ it some more money. The FED has therefore shot off its cannon to no avail. Monetary policy is thus now clearly a spent force in terms of resolving the financial crisis. It has clearly failed.

The second phase of the current financial crisis therefore represents a shift of the burden of bank bailouts from the FED to the U.S. Treasury and U.S. Congress, and to fiscal solutions to the crisis. That shift commenced with the announcement of bailouts of Fannie Mae and Freddie Mac agencies in July, which were concluded in early September 2008. With the Fannie/Freddie bailout a new pot of $300 billion was created by Congress for the Treasury to use specifically for covering the two agencies’ losses. Since July the crisis has thus entered a new, second phase. The second phase represents the direct transfer of income from the U.S. taxpayer to the financial sector, instead of money shifted from the FED to the banks.

The $300 for Fannie/Freddie bailouts was only the start of the fiscal strategy. To that $300 billion should also be added Treasury Secretary Paulson’s $50 billion ‘slush fund’ discovery, and soon the TARP proposal moving through Congress of another $700 billion. That’s more than $1 trillion earmarked for bank bailouts so far during the second phase.

Splits Emerge On What To Do

The TARP proposal to use $700 billion of the U.S. taxpayers money to bailout out banks and financial institutions that between 2003-2007 made $ trillions in profitshas not been an easy sell. Splits within the capitalist class, reflected in Congress, the media, and elsewhere, show that even the capitalists are not unanimous in supporting that kind of massive income transfer from wealthy banks and investors to the taxpayer.

Taxpayers—at least the 91 million households that represent the working class in the U.S.—have seen their real incomes decline over the past decades dramatically. Income inequality in America is a serious problem that the public is increasingly aware and resentful of. They see the transfer of more hundreds of billions of $ to banks and financial institutions that have awarded their CEOs and senior executives hundreds of millions of dollars a year in pay typically, and in some cases in the range of $1-2$ billions a year! And they received these huge salaries even when their companies have had losses and gone bankrupt. In 1980 the typical American EO made 35 times the pay of the average worker in his company. By 2006 he made more than 400 times the average workers’ pay. Meanwhile, the typical American worker’s family since 1982 has experienced actual declines in their take home pay after inflation. Workers are making less today than they did a quarter century ago. That’s why many are working two and three jobs and have taken on enormous amounts of credit card and other debt just to maintain an increasingly doubtful standard of living. That all poses a tactical difficulty in getting another $700 billion passed in Congress to cover the banks’ financial losses. Politicians are caught between responding to the demands of their campaign contributing banker friends to deliver for them in the current crisis, and the American homeowner-worker footing the bill just months before a general election.

The class splits emerging are, of course, not due to ‘ethical’ concerns by pro-Business representatives in Congress losing sleep over growing income inequality and executive pay abuse. That is just a ‘complication’ temporarily affecting the passage of the $700 billion. Splits are emerging because it has begun to appear that past and proposed solutions to date for resolving the financial crisis are not working. Should the $700 billion pass and the financial crisis still not stabilize, with more banks, hedge funds and the like going under, what then? Some of their more thoughtful policymakers have begun for the first time to ask that basic question. For example, one of the regional heads of the FED, Richard Fisher, the chair of the Dallas, Texas, district of the Federal Reserve, recently made the assessment that the financial crisis “is a DNA issue, perhaps no financial system…can prevent nature from running its course?. That statement represents an emerging view that perhaps government bailouts of trillions of dollars of taxpayer money will not resolve the crisis. Fisher’s view implies that perhaps bank failures cannot be prevented by bailouts, which may only drag out and delay the collapse.

A Fundamentally Flawed Recovery Strategy

What capitalist policymakers in the U.S.—Paulson at the Treasury and Ben Bernanke at the FED with the support of Congress and the Bush administration—have been doing is relying on injections of liquidity into the system. The crisis, however, is not one of liquidity. It is a crisis of bank solvency and a crisis of confidence in the entire banking system that is accelerating as this is written. And that cannot be prevented by throwing more taxpayer money at the banks. The current capitalist financial strategy is to transfer the debts of the banks and financial institutions from their own private balance sheets to the public balance sheet, the U.S. government’s in other words. But that in no way eliminates the bad debts. It just shifts them and makes the taxpayer pay for them as the bad debts are recognized and eventually written off.

In the meantime, however, transferring the bad debt to the government will cause a general fiscal crisis of the U.S. government. The increase of $1.6 trillion in debt will blow up the U.S. budget deficit for the coming years. That budget deficit has already been projected at levels of $500 billion for next year. And that figure does not include any further increases in the costs of war in Iraq and Afghanistan and the hundreds of billions in additional lost tax revenues for the government as the recession deepens, as it rapidly will. Nor does it include any future efforts to stimulate the economy as the recession deepens. The real budget next year will be around $700-$800 billion—and that BEFORE the costs of the $1.6 trillion bailout are added! A fiscal crisis ‘train wreck’ is therefore coming and some sectors of the capitalist class see this possibility. Allocating another $700-1,600 billion to the deficit, which may not even resolve the crisis, which may represent another massive income transfer to investors in the U.S., and which may push the U.S. economy over a ‘fiscal cliff’ poses great risks in the view of at least some segments of the class in America.

Other sectors of the class are opposed to the $700 billion for ideological reasons. They correctly see the creation of the fund as rewarding those who are largely responsible for the crisis in the banking sector with generous bailouts at taxpayer expense. Their ideology dictates that the markets should deal with them. If they collapse, so be it. The market has spoken. More successfully capitalist institutions will pick up the pieces and go on from there. The government should not be an intermediary in the process. Still other sectors of the class are worried that the deficits may be so great that there will be little left to stimulate fiscally a recovery from a deep recession by tax cuts or government spending increases. The costs of bailout are projected to be so great, they are also concerned that regardless of which Presidential candidate wins the November election, neither candidate will be able to deliver on their promises of tax cuts or other social programs. Whichever candidate will be forced to impose a general ‘Austerity Program’ on the nation come January 2009.

They are thus posed in the short run today with a basic dilemma: bail out their investor and banker friends in the short run and possibly provoke a more fundamental set of fiscal and financial problems in the next 12-18 months; Or, refuse to bailout more banks and nonbank institutions and be blamed for the inevitable further collapses of banks and the collapse of the U.S. real economy that is coming.

The Real Economy Accelerates Into Recession

The deteriorating financial crisis, as serious as it is and continues to become, will soon be trumped, however, by an accelerating deterioration of the real, non-financial economy in the U.S. That deterioration has been partly covered up by the manipulation of government statistics on economic growth and unemployment, with growth data on GDP exaggerating the growth of the economy and unemployment data underestimating the extent of growing joblessness in the U.S. economy.

U.S. GDP data show, for example, the economy actually accelerating in terms of economic growth over the past year. In the last three months of 2007 the economy officially declined by -0.2%. It then rose in the first three months of 2008 by 0.6, and grew even faster in the second quarter by 2.8%. On the other hand, jobless data show consistent and growing unemployment over the same periods.

Officially, around 600-650,000 workers lost jobs in 2008. But the way the U.S. government collects and counts unemployment is to count a part time worker as fully employed. What has been happening in the first half of 2008 is that businesses have been laying off full time workers in larger numbers and hiring part time (or converting full to part time) in the hundreds of thousands. It appears therefore that joblessness has increased slower than it really has. At least one million workers have lost their jobs in 2008 up to August.

Conversely, government data overestimate economic, GDP growth. The way it calculates GDP, it appears the economy is growing simply because Americans are buying fewer imports. But they’re buying fewer imports because the economy and US consumers’ spending power is rapidly declining, not because the economy is improving. In fact, just the opposite.

The combination of the two statistical misrepresentations is that joblessness is rising rapidly while the economy appears to be growing more rapidly. That conclusion is economic nonsense.

This picture of the U.S. real economy perhaps weakening but not in serious trouble is about to reverse dramatically in the next few months, even in terms of the reported data. GDP will record a major drop in the third quarter of 2008 and jobless numbers will rise dramatically in the next few months. Companies will begin announcing mass layoffs in the final months of 2008.

A major cause of the clear shift in the economy as it slides toward deep recession is the current financial crisis is causing a second, major credit contraction. That means businesses cannot get financing to even continue their daily operations in some cases and will turn to cost cutting, and in particular mass layoffs, to maintain operations.

A direct consequence of the current collapse and bailouts of Fannie/Freddie, AIG, Lehman, WaMu and others has been the rapid ‘freeze up’ of various credit markets in the U.S. and globally.

Banks are no longer lending to each other. That is reflected in the so-called LIBOR rate rising at historic rates. Markets for Commercial Paper (which businesses use to lend to each other if they can’t get money from banks) are freezing up as well. Municipal bond markets, which allow state and local governments to borrow money, are freezing up. Short term credit market after market are virtually shutting down across the board. This will result in sharp cutbacks by nonfinancial businesses, and a growing list of defaults and bankruptcies by some very large nonfinancial corporations. High on the list of instability are companies such as Chrysler, GM, Sears, Airlines, trucking companies, and many other smaller companies and chains in retail, restaurants, and other consumer goods.

Indicators across the board for the U.S. real economy in September are plummeting. Jobless claims data, which foreshadows future layoffs, rose by 100,000 alone in September. Durable goods orders fell by 4.5%, a level not seen in decades. New home sales, existing home sales, housing starts are all falling. Industrial production declined in latest figures by –1.1% for the month. Factory orders and business equipment spending are sharply falling. Retail sales are declining significantly and consumers are cutting back on credit spending by margins well beyond forecasters’ predictions. All the data show far worse performance than forecasters had predicted a month ago. In short, real nonfinancial sectors of the economy are all accelerating in terms of decline. And all this is happening BEFORE the credit crunch enters a more serious stage as a consequence of the financial collapses of the past month.

While Paulson, Bernanke, Congress debate the terms and extent of bailout for their financial investor and bank friends, an even greater crisis is gathering momentum in the nonfinancial sectors of the U.S. economies. The crisis in the real economy—the emerging EPIC Recession as this writer has called it elsewhere—will trump the financial crisis in 2009. The dilemma for policy makers will be how to ‘bail out’ both, the real and the financial economy, and to which to give more emphasis in 2009. Perhaps that is also why Paulson, Bernanke and friends are rushing to push through the financial bailout first. If there is little money left the banks and finance sector will at least get theirs first. But after all, that’s what the system is largely about: ‘Socialize the costs’ in times of crisis, and ‘privatize the profits’ in times of expansion.
Some critics are now calling the throwing of $ trillions at the banks and financial institutions, reverse ‘Socialism for the Rich’. Perhaps then we should give them a new defining motto for Finance Capitalism in the 21st Century: “From each according to his balance sheet; to each according to his Portfolio?.

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