Deregulating the Banks and Risking Another Economic Disaster

The economic crash that happened around 2008 was truly horrible, as many who lived through it are aware. The negative effects of the crash were felt overall worldwide and included trillions of dollars lost in worker pensions and savings, chronically high unemployment, trillions of dollars worth of lost output, and lots of other residual suffering. There were also woefully inadequate positive changes — there have been insufficient measures to help the vast majority of the population and the criminogenic structure of the too big to fail banking industry is mostly the same as it was in 2007.

All of these considerations about the economic crisis warrant thinking about why it happened in the first place, so that the same foolish mistakes that caused immense human suffering don’t have to be repeated again. Beyond possibly referring to the inevitable instability of the state capitalist economic system, it’s rational enough to look back to 1999, when a large part of the consequential deregulation happened.

In 1999, the U.S. Congress passed the Graham-Leach Act that (among other things) repealed important sections of the 1930s Glass-Steagall Act. Glass-Steagall’s important provision was that it by law set a firewall between depository banking and investment banking. There were unpunished violations of this law by the banks over the decades, but it’s a rational law and it did quite well at its specific purpose, which is to try to prevent the reckless gambling with consumer savings that’s actually still allowed today.

The big story of why the crash happened though is the housing bubble that the big banks and certain other financial corporations (with immoral behavior and using predatory lending practices to consumers) largely created. This housing bubble was evident enough to reasonable economists that don’t serve plutocratic interests, but there are few of those, so only a select few economists spotted the bubble early on.

“We had a 8 to 10 trillion dollar housing bubble over the decade from ’96 to 2006,” said economist Dean Baker, who in 2002 predicted the bubble and the recession it caused. “House prices rose by more than 80 percent by one measure, 100 percent in excess of inflation. Over the prior hundred years — 1895 to 1995 — house prices had just kept even with inflation. This should have been real simple.”

The housing bubble did drive the economy forward through what’s known as the wealth effect, where people (primarily lower- and middle-income people) spend more money — typically 5 to 7 cents on a dollar — if they have a higher net worth. The higher spending (estimated at between 400 to 500 billion dollars a year, about a twentieth of $8 trillion, and about $3000 per 2018 U.S. household) drove more demand and contributed to some economic gains. These gains came with a heavy cost though, and that cost was the bubble popping and causing the worst economic collapse since the Great Depression.

Why the Great Recession was as bad as it was in the U.S. is actually fairly simple. About $8 trillion worth of housing bubble wealth disappeared with the bubble’s pop, and with that went a lot of consumer purchasing power or what’s known as demand. The main problem for the Great Recession being as horrendous as it was is due to there not having been enough demand in the economy, or to use different terms, the vast majority of people were screwed over too hard and weren’t given adequate resources to recover with. Instead, the U.S. government (and some other governments with different measures) acted with urgency to bail out the financial corporations that primarily caused the crash problem.

The story of the big bank bailouts is particularly noteworthy because it was unnecessary. Actually, a strong majority of the U.S. population was opposed to the bailouts, and if the U.S. had a real, functional democracy, that strong majority opposition would have translated into policy. The bank bailouts were unnecessary though because it was known how to keep the financial system operating when the banks failed — this was seen in the S&L crisis of the late 1980s, for example. There were also simply other ways to help most people — the central bank of the U.S. that loaned trillions of dollars at extremely low interest rates to failed banks could have been used for numerous superior purposes, such as providing an investment stimulus that would actually fully compensate for the shortfall of demand. The stimulus enacted by the Obama administration simply wasn’t large enough, and many people suffered for that.

Now today on March 15, 2018, it’s being reported that the U.S. Congress is about to deregulate the banks again. The process of another significant economic recession and expensive public bailout are a real possibility. This is noted as banks such as Morgan Stanley and Citigroup wouldn’t even exist today if they hadn’t been bailed out, and it’s disturbing that the deregulation will allow them increased opportunity to boost profits through extracting money from consumers via fraud.

It’s also noted as the implicit regulation — that there will be a bailout if a big bank fails — also remains in place, and this implicit subsidy (which prompts riskier financial activities) has been estimated by the IMF to cost about $70 billion ($550 per U.S. household) annually. This is yet another drain on the economy through the corrupted financial system, which could be eliminated or reduced through enacting a financial transactions tax, breaking up the big banks, and/or bringing democratizing measures to economic institutions.

In sum, the history of this deregulation and misregulation of the financial sector presents a clear picture of the problems it causes. More people must be aware of this and organize effectively to prevent these same unnecessary mistakes from being made yet again.

Advertisements

There Isn’t a Giant Bubble Threatening the U.S. Economy

The U.S. economy isn’t doing real well for most people, but it currently isn’t threatened much by a bubble as giant as the housing bubble that spawned the economic crash of 2008. Because there’s importance in knowing the basics of what happened then, I’ll relay the analysis of it from one of the few people who saw the housing bubble.

There has been much greater concern about the danger of asset bubbles ever since the collapse of the housing bubble sank the economy. While it is good that people in policy positions now recognize that bubbles can pose a real danger, it is unfortunate that there still seems very little understanding of the nature of the problem.

First, an economy-threatening bubble does not just sneak up on us. Often the discussion of bubbles implies that we need some complex measuring tools to uncover an economy-threatening bubble that’s lurking in some far corner of the data.

This is absurd on its face. If a bubble is large enough to threaten the economy, it is hard to miss. This was true of both the stock bubble in the 1990s and the housing bubble in the last decade.

At the peak of the stock bubble in 2000, the ratio of stock prices-to-trend corporate profits was more than twice its long-term average. This may have been justified if there was an expectation that profit growth was going to be much faster in the future, but almost no economic analysts projected this speed up.

[…]

In the case of the housing bubble, inflation-adjusted house prices had risen by more than 70 percent above their long-term trend. This unprecedented run-up in house prices occurred at a time when rents were essentially moving in step with the overall rate of inflation, suggesting that there was no major shift in the fundamentals of the housing market. Furthermore, vacancy rates were already at record highs even before the bubble burst, providing clear evidence that house prices were not being driven by a shortage of housing.

And, both bubbles were clearly moving the economy. In the case of the stock bubble, investment hit its highest share of GDP since the late early 1980s, as start-ups were taking advantage of sky-high share prices to finance crazy schemes. Also, the wealth generated by the stock bubble led to a surge in consumption that pushed the savings rate to a then-record low.

In the case of the housing bubble, high prices led to a flood of new construction, raising the residential investment share of GDP to almost 6.5 percent, compared to a long period average of less than 4 percent. The wealth created by the housing bubble led to an even larger consumption boom than the stock bubble.

All of this was easy to see from widely available government data sets. It required no more than an Excel spreadsheet to analyze these data. So this was not rocket science, it was basic economic logic and arithmetic.

Should we be concerned about a bubble now? Stock prices and housing prices are both high by historical standards. The ratio of stock prices-to-trend corporate earnings is more than 27-to-1; this compares to a long-term average of 15-to-1.

House prices are also high by historic standards. Inflation-adjusted house prices are still well below their bubble peaks, but are about 40 percent above their long-term average.

In both cases, these markets are high, although in ways that are at least partly explained by the fundamentals of the market. In the case of stock prices, the profit share of GDP is almost 30 percent above its trend level. If this persists, then the ratio of prices-to-earnings is much closer to the long-term average. Of course, a big cut in the corporate tax rate increases the likelihood that a high-profit share in GDP will continue.

Extraordinarily low-interest rates (both real and nominal) also mean that stocks provide a relatively better return compared with alternatives like bonds and short-term deposits. This also would change if interest rates rise substantially, but for now, that doesn’t seem likely.

The run-up in house prices also seems less disconcerting when we consider there has been a parallel run up in rents. While rents have not increased as much as house prices, they have been substantially outpacing the overall rate of inflation for the last five years. Low-interest rates would also help to explain house prices being above long-term trends, as they justify a higher ratio of sales prices-to-rents.

Here also, there is a risk that higher rates could send prices tumbling. This could be an especially bad story for moderate-income homeowners, since the bottom tier of the housing market has seen the largest price increases over the last five years.

But even in a bad story, where for example higher interest rates send both stock and house prices back towards their trend levels, we don’t have to fear an economic collapse and probably not even a recession. The high stock market is not driving investment, which remains very modest despite near record-high after-tax profits. Housing construction has come back from its post-crash lows, but is roughly in line with its long-term average share of GDP.

The loss of trillions of dollars of wealth would be a hit to consumption. Consumption has been unusually high in recent years with the savings rate averaging just 3.6 percent of disposable income in the last year. A more normal savings rate would be closer to 6 percent. But even if the savings rate were to rise to 6 percent over a span of a year or two, it would likely dampen growth rather than cause a recession.

In short, there is little reason to think that the economy is threatened by the risk of collapsing bubbles at the moment. This doesn’t mean that holders of large amounts of Bitcoin or Amazon stock may not have something to worry about, but most of us don’t.