a three-pronged approach to economic meltdown

#1 - DEREGULATION - no one wanted to kill the goose that laid the Golden Egg

According to reports [Aug. 29, 2011], the Justice Department is looking into instances in which S&P’s analysts wanted to award lower ratings on mortgage bonds but may have been overruled by their superiors.

During the years leading up to the financial crisis, ratings agencies like S&P earned record profits as they awarded their highest ratings to bundles of troubled mortgage loans, which made the mortgages appear less risky.

In the aftermath of the ultimate collapse of the mortgage market, the agencies’ business practices and models have been sharply criticized in Congressional hearings and reports. Agencies such as the Securities and Exchange Commission have also raised questions about whether independent analysis took a back seat in the quest for profit.

If the government finds enough evidence to support such a case, which is likely to be a civil case, it would refute S&P’s longstanding claim that its analysts act independently from business concerns. A successful fraud case would also be good news for investors, as the agencies would be forced to address the inherent conflicts of interest generated by their business model under which the agencies are paid by the companies who securities it is supposed to rate.

It should not be surprising that S&P is not the only rating agency that may have profited at the expense of investors.

The 1933 Glass-Steagall Act, and later the 1956 Bank Holding Company Act, mandated the separation of banks, insurance companies and securities firms.  Then along came Ronald Reagan, who led a movement that came to power in 1980 proclaiming faith in free markets and mistrust of government. That conservative philosophy has dominated America for the past 28 years.

Even after taxpayers had to rescue deregulated savings and loans, or S&Ls, with a $200 billion bailout in the late 1980s, the push to loosen regulation paused only briefly.  In 1999, President Clinton signed the Financial Services Modernization Act, which tore down Glass-Steagall's reforms by removing the walls separating banks, securities firms and insurers.

Under Clinton and his successor, George bush, the government became eager to promote home ownership. Interest rates were low, the market grew for loans to borrowers with weak credit and private-sector mortgage bonds boomed. About 38 percent of those bonds were backed by subprime loans. They are at the root of today's financial crisis.

A generation ago, banks, credit unions and S&Ls issued home mortgages that they retained on their books as an asset. The lenders had a stake in receiving full repayment of the loans from creditworthy borrowers.  But in recent years, mortgages began to be sold to firms that cobbled the loans together to create mortgage-backed securities, or mortgage bonds. Loans to the least creditworthy borrowers carried the highest risk but gave the highest returns, so banks and other institutional investors bought loads of them. Except no one was policing the credit-worthiness of the borrowers.

The process helped more people buy homes, and a booming mortgage-bond market, led by investment banks, was in full swing by 2005.

When borrowers who had secured loans with adjustable interest rates, however, found their rates going up, many were unable to pay. That meant that holders of bonds backed by these mortgages were stuck with securities worth much less than their face value — or nothing at all. That created a solvency crisis for the banks that loaded up on them — and virtually all of them had.

Warning signs began to appear. At least nine federal agencies oversee some part of the mortgage market, and from 2004 to 2007, at least three had issued warnings about risky loans.

Still, none was willing to end the financial revelry.

 #2 - TAXATION [or a lack thereof] and ST. RONNIE et al

In 1982, the first full year after the REAGAN tax cuts were enacted, the economy actually shrank 2.2%, the worst performance since the Great Depression. And the effect on the federal budget was catastrophic.

Jimmy Carter’s last budget deficit was $77 billion. Reagan’s first deficit was $128 billion. His second deficit exploded to $208 billion. By the time the "Reagan Revolution" was over, George H.W. Bush was running an annual deficit of $290 billion per year.

Yearly deficits, of course, add up to national debt. When Reagan took office, the national debt stood at $994 billion. When Bush left office, it had reached $4.3 trillion. In other words, the national debt had taken 200 years to reach $1 trillion. Reagan’s Supply Side experiment quadrupled it in the next 12 years.

When Bill Clinton took office he intentionally reversed the Supply Side formula, raising taxes on the wealthy and reducing them on the lowest wage earners. Supply Side true believers predicted the arrival of the Apocalypse. Bob Dole said the stock market would collapse. Newt Gingrich said the world would fall into another Great Depression.

What actually happened?

Between 1992 and 2000, the U.S. economy produced the longest sustained economic expansion in U.S. history. It created more than 18 million new jobs, the highest level of job creation ever recorded. Inflation fell to 2.5% per year compared to the 4.7% average over the prior 12 years.

Real interest rates fell by over 40% producing the greatest housing boom ever. Overall economic growth averaged 4.0% per year compared to 2.8% average growth over the 12 years of the Reagan/Bush administrations. Most impressively, Clinton reversed the mammoth deficits of the Supply Side years, turning them into surpluses. He used these surpluses to begin paying down the national debt.

By virtually every meaningful measure-employment, growth, inflation, interest rates, investment, deficits and debt-the economy performed better once the Supply Side experiment was terminated and replaced with a more honest economic policy where we actually pay our bills as we go.

This might all be ancient history if the specter of Supply Side economics had not reared its ugly head again once Bush II took office. In selling his $1.6 trillion tax cut-half of which went to the wealthiest 1% of Americans-Bush promised in 2001 that it would produce 800,000 new jobs. In fact, by 2003 the economy had already lost 2.7 million jobs - the worst economic performance since the Great Depression.

The effects of Bush’s tax cut on the deficit and debt were exactly what we would expect having seen Reagan’s results - only worse. Bush inherited from Clinton a fiscal surplus of $127 billion.  In his first year alone he turned that into a deficit of $158 billion. 

#3 - THE WINDS OF WAR

War spending falls behind tax cuts and prescription drug benefits for seniors as contributors to the $14.3 trillion federal debt. The Pentagon's base budget has grown every year for the past 14 years, marking the longest sustained growth period in U.S. history, but it seems clear that that era is ending.

Since the U.S. government issued war bonds to help finance World War II, Washington has asked taxpayers to shoulder less and less of a burden in times of conflict. In the early 1950s Congress raised taxes by 4 percent of the gross domestic product to pay for the Korean War; in 1968, during the Vietnam War, a tax was imposed to raise revenue by about 1 percent of GDP.

No such mechanism was imposed by the Bush Administration for Iraq or Afghanistan, and in the early years of the wars Congress didn't even demand a true accounting of war spending, giving the military whatever it needed.

To be sure, the costs of war are staggering.

According to Defense Department figures, by the end of April 2011 the wars in Iraq and Afghanistan - including everything from personnel and equipment to training Iraqi and Afghan security forces and deploying intelligence-gathering drones - had cost an average of $9.7 billion a month, with roughly two-thirds going to Afghanistan. That total is roughly the entire annual budget for the Environmental Protection Agency.

To compare, it would take the State Department - with its annual budget of $27.4 billion - more than four months to spend that amount. NASA could have launched its final shuttle mission in July, which cost $1.5 billion, six times for what the Pentagon is allotted to spend each month in those two wars.

What about Medicare Part D, President George W. Bush's 2003 expansion of prescription drug benefits for seniors, which cost a Congressional Budget Office-estimated $385 billion over 10 years? The Pentagon spends that in Iraq and Afghanistan in about 40 months.

To those bitching about the fact that what’s going on right now is “Obama’s doing”, get over it.  The toilet in the Capitol was already spewing feces years before he got to town.

the rich require an abundant supply of the poor . . .

The Empire of Debt:  Money for nothing.

[original post by Dee Hon, 24 Sep 2007]

Own a home for no money down.

Do not pay for your appliances until 2012.

No payment for 36 months *interest free.

This is the new American Dream, and for the last few years, millions of Americans have been giddily living it. Dead is the old version - the one historian James Truslow Adams introduced to the world as "that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement."  

This ain’t your grandpa’s economy.

Such Puritan ideals – to work hard, to save for a better life – didn't die from the natural causes of age and obsolescence. We killed them, willfully and purposefully, to create a new “gilded age”. As a society, we told ourselves we could all get rich, put our feet up on the decks of our new vacation homes, and let our money work for us. Earning is for the unenlightened. Equity is the new golden calf. Sadly, this is a hollow dream. Yes, luxury homes have been hitting new gargantuan heights. Ferrari sales have never been better. But much of the ever-expanding wealth is an illusory façade masking a teetering tower of debt – the greatest the world has seen. It will collapse, in a disaster of our own making. 

Distress is already rumbling through Wall Street. Subprime mortgages leapt into the public consciousness this summer, becoming the catchphrase for the season. Hedge fund masterminds who command salaries in the tens of millions for their supposed financial prescience, but have little oversight or governance, bet their investors' multi-multi-billions on the ability that subprime borrowers – who by very definition have lower incomes and/or rotten credit histories – would miraculously find means to pay back loans far exceeding what they earn. They didn't, and surging loan defaults are sending shockwaves through the markets. Yet despite the turmoil this collapse is wreaking, it's just the first ripple to hit the shore. America's debt crisis runs deep. 

How did it come to this? How did America, collectively and as individuals, become a nation addicted to debt, pushed to and over the edge of bankruptcy? The savings rate hangs below zero. Personal bankruptcies are reaching record heights. America's total debt averages more than $160,000 for every man, woman, and child. On a broader scale, China holds nearly $1 trillion in US debt. Japan and other countries are also owed big. 

The story begins with labor. The decades following World War II were boom years. Economic growth was strong and powerful industrial unions made the middle-class dream attainable for working-class citizens. Workers bought homes and cars in such volume they gave rise to the modern suburb. But prosperity for wage earners reached its zenith in the early 1970s. By then, corporate America had begun shredding the implicit social contract it had with its workers for fear of increased foreign competition. Companies cut costs by finding cheap labor overseas, creating a drag on wages. 

In 1972, wages reached their peak. According to the US department of Labor Statistics, workers earned $331 a week, in inflation-adjusted 1982 dollars. Since then, it's been a downward slide. Today, real wages are nearly one-fifth lower – this, despite real GDP per capita doubling over the same period. 

Even as wages fell, consumerism was encouraged to continue soaring to unprecedented heights. Buying stuff became a patriotic duty that distinguished citizens from their communist Cold War enemies. In the eighties, consumers' growing fearlessness towards debt and their hunger for goods were met with Ronald Reagan's deregulation the lending industry. Credit not only became more easily attainable, it became heavily marketed. Credit card debt, at $880 billion, is now triple what it was in 1988, after adjusting for inflation. Barbecues and TV screens are now the size of small cars. So much the better to fill the average new home, which in 2005 was more than 50 percent larger than the average home in 1973. 

This is all great news for the corporate sector, which both earns money from loans to consumers, and profits from their spending. Better still, lower wages means lower costs and higher profits. These factors helped the stock market begin a record boom in the early '80s that has continued almost unabated until today. 

These conditions created vast riches for one class of individuals in particular: those who control what is known as economic rent, which can be the income "earned" from the ownership of an asset. Some forms of economic rent include dividends from stocks, or capital gains from the sale of stocks or property. The alchemy of this rent is that it requires no effort to produce money. 

Governments, for their part, encourage the investors, or rentier class. Economic rent, in the form of capital gains, is taxed at a lower rate than earned income in almost every industrialized country. In the US in particular, capital gains are being taxed at ever-decreasing rates. A person whose job pays $100,000 can owe 35 percent of that in taxes compared to the 15 percent tax rate for someone whose stock portfolio brings home the same amount. 

Given a choice between working for diminishing returns and joining the leisurely riches of the rentier, people pursue the latter.  [A rentier is a person who lives on income from property or investments.]  If the rentier class is fabulously rich, why can't everyone become a member? People of all professions sought to have their money work for them, pouring money into investments. This spurred the explosion of the finance industry, people who manage money for others. By 2007 the $10 trillion mutual fund industry was 700 times the size it was in the 1970s. Hedge funds, the money managers for the super-rich, numbered 500 companies in 1990, managing $38 billion in assets. When this article was originally posted in 2007 there were more than 6,000 hedge firms handling more than $1 trillion dollars in assets.


In recent years, the further enticement of low interest rates has spawned a boom for two kinds of rentiers at the crux of the current debt crisis: home buyers and private equity firms. But it should also be noted that low interest rates are themselves the product of outsourced labor.  

America gets goods from China. China gets dollars from the US. In order to keep the value of their currency low so that exports stay cheap, China doesn't spend those American dollars in China - it buys U.S. assets, like bonds. [As of 2007 China held some $900 billion in such US IOUs.] This massive borrowing of money from China (and to a lesser extent, from Japan) sent U.S. interest rates to record lows. 

Now the hamster wheel really gets spinning. Cheap borrowing costs encouraged millions of Americans to borrow more, buying homes and sending housing prices to record highs. Soaring house prices encouraged banks to loan freely, which sent even more buyers into the market – many who believed the hype that the real estate investment offered a never-ending escalator to riches and borrowed heavily to finance their dreams of getting ahead. People began borrowing against the skyrocketing value of their homes, to buy furniture, appliances, and TVs. These home equity loans added $200 billion to the US economy in 2004 alone. 

It was all so utopian. The boom would feed on itself. Nobody would ever have to work again or produce anything of value. All that needed to be done was to keep buying and selling each other's houses with money borrowed from the Chinese. 

On Wall Street, private equity firms played a similar game: buying companies with borrowed billions, sacking employees to cut costs, and then selling the companies to someone else who did the same. These leveraged buyouts inflated share values, minting billionaires all around. The virtues that produce profit – innovation, entrepreneurialism and good management – stopped mattering so long as there were bountiful capital gains.


But the party is coming came to a screeching halt. An endless housing boom requires an endless supply of ever-greater suckers to pay more for the same homes. The rich, as Voltaire said, require an abundant supply of poor. Mortgage lenders have mined even deeper into the ranks of the poor to find takers for their loans. Among the practices included teaser loans that promised low interest rates that jumped up after the first few years. Sub-prime borrowers were told the future pain would never come, as they could keep re-financing against the ever-growing value of their homes. Lenders repackaged the shaky loans as bonds to sell to cash-hungry investors like hedge funds. 

Of course, the supply of suckers inevitably ran out.  And hindsight is, as they say, 20/20.
Housing prices leveled off, beginning what promises to be a long, downward slide. Just as the housing boom fed upon itself, so too, will its collapse. The first wave of sub-prime borrowers defaulted and a flood of foreclosures sent housing prices falling further. Lenders somehow got blindsided by news that poor people with bad credit couldn't pay them back. Frightened, they staunched the flow of easy credit, further depleting the supply of home-buyers and squeezing debt-fueled private equity. Hedge funds that merrily bought sub-prime loans collapsed. 

Borrowers stopped making payments on their homes and credit cards; consumer spending and thus corporate profits, will fall did indeed slow to a trickle, though “corporate profits” do not seem to have been effected all that much, thanks in large part to the way the Corporations – now known as “People” -  have manipulated the markets, even though the shrinking economy did – and does - further depress workers' wages. 

For most people, the dream of easy money will never come true, because only the truly rich can live it.