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April 14, 2015


We saw in Part I that Bush the Younger’s appointments to his administration ranged from bad to disastrous with their under-regulation of the financial markets and tolerance of new and untried esoteric financial instruments in place of capital reserves and equity which brought the world to its economic knees and saddled our country with Bush’s Great Recession, a recession which featured dried up credit markets which yet further accelerated our downturn as aggregate demand plummeted and bankruptcy filings skyrocketed. I will discuss such credit markets in this part, among other things, in this report on Ms. Bair’s review of Martin Wolf’s book, The Shifts and the Shocks. Ms. Bair’s report, like Ms. Bair, is a gem in the garden.

Ms. Bair points out that prior to 2008, countries such as Germany and China as creditor nations had amassed enormous surpluses, creating a “savings glut,” and along with vast accumulations of dollars by corporations and investment and even commercial banks world-wide such a huge capital pool was “hunting for yield.” It is unfortunate that central banks around the world at the time did not increase interest rates to soak up some of this massive capital and did not adopt policies leading to slower growth rather than allowing the housing bubble to run amok because that might have satisfied such investors’ “hunt for yield” and kept their investment dollars in sovereign debt instead of winding up in Wall Street’s toxic mortgage-backed securities.

There is no law, economic or otherwise, that says that you cannot have growth without asset bubbles, as we found during our Keynesian experience dating from the Great Depression to circa 1974. We found then that all can prosper under a Keynesian economic regime that calls for government to fund needed and important public initiatives that private enterprise cannot or will not fund and where private enterprise simultaneously shares their workers’ marginal productivity with their workers. I know Keynesianism works from personal experience.

We know from some 40 years of Keynesian experience that you can have growth without recession, a booming economy and robust growth of the middle class. Unfortunately, with the purchase of the political class by Wall Street aided and abetted by statehouse gerrymandering and inane Supreme Court holdings allowing virtually unfettered campaign finance, that day, a day badly in need of resurrection via statutory and policy reform, is gone (but not forgotten).

Wolf the author does acknowledge that stronger regulation, while not preventing the crisis of 2008, would have tempered it, and is in favor of an aggressive regulatory agenda which would require higher capital requirements as back-up in such runaway situations as the housing bubble and Wall Street’s attempts to securitize it. He is right. We need to have banks with more of their own money in on their investments and not leveraged (i.e., borrowed) funds. The phrase economists use to describe this regulatory situation is “leverage ratio.” I have blogged before about how banks use leveraged funding for their investments at stratospheric ratios.

European regulators have agreed to a modest leverage ratio five years ago, but have not been able to implement it. Here our rules on leverage ratio have been finalized, but they still allow large banks to borrow about $20 for every $1 of common equity (aka shareholder stock). The big banks have spent over one billion dollars in fighting the implementation of this and other such rules under the Dodd-Frank Act since it became law years ago. Obviously the more borrowed money they can use to finance their investments without putting their shareholders’ equity at risk is a plus for their bottom lines though skewing risk among participating parties.

Wolf has some other interesting ideas. He is anti-bailout and laments our bank-friendly rescues as “undermining the sense of fairness that underpins the political economy of capitalism; There has to remain a belief that success is earned, not stolen or handed over on a platter.” He continues: “People feel even more than before that the country is not being governed for them, but for a narrow segment of well-connected insiders who reap most of the gains and, when things go wrong, are not just shielded from loss but impose massive costs on everybody else.” That is an extremely well-stated rationale for not providing bailouts to the sainted few who are too big to fail and yet another example of corporate welfare gone wild – and in broad daylight!

It’s even worse than that. When a corporation makes a good or bad decision, it is typically their shareholders who either gain or lose. In the case of the bailout of the big banks, we not only bailed them out but bailed out their shareholders and even their insurers. When other corporations or business organizations make bad decisions, their shareholders’ stock becomes worthless and neither they nor their insurers are rescued. They go under and their corporation goes into bankruptcy to provide equitable division of such assets that remain to creditors with shareholders at the end of the line in a creditors-first and shareholders-last debt over equity regimen. Here we not only bailed out the banks but their shareholders as well. Why? Why didn’t the then insolvent big banks’ shareholders take their medicine? Dare I suggest politics?

Why, as I have often blogged, do we allow a bankruptcy statute to be law which (as Robert Kuttner has observed) allows financial elite corporations to “rearrange assets and shed debts while families are denied the ability to escape mortgage debt without losing their homes?” He could have added that corporations under Chapter 11 can shed their labor contracts, change or even entirely escape their pension liabilities etc., and still stay in business. Employers these days need not threaten to move to Mexico or China when employees want a raise and complain about wage inequality. The better threat may be to take Chapter 11 to reduce wage and other costs of doing business. What a far call from the Keynesian heyday above described in which corporations willingly shared their worker’s marginal productivity with their workers!

Sheila Bair identifies the crux of our problem as “an imbalance of power – between decision-makers and those whose lives are impacted by their decisions.” Such an imbalance takes on many faces, from wage inequality to bankruptcy favoritism. Let’s end this imbalance. GERALD  E


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