The Bubble Economy: The financial meltdown is the logical consequence of deregulation. .....

[marmar]

from The American Prospect:


The Bubble Economy

The financial meltdown is the logical consequence of deregulation. Will we reverse field in time to prevent another 1929?

Robert Kuttner | September 24, 2007



We have all been here before. -- Crosby, Stills, Nash, and Young


The federal reserve is still struggling to contain what is already the most severe credit contraction since the Great Depression. Yet in all of the press coverage, commentators have scarcely acknowledged that this old-fashioned panic is a child of deregulation. During the past decade, the financial economy has repeated the excesses of the 1920s -- too much borrowing to underwrite too many speculative bets with other people's money, too far beyond the reach of regulators, setting up the entire economy for a crash.

The sub-prime mess, the huge risks taken by hedge funds, and the conflicts of interest that led to Enron and kindred scandals, are all the consequences of serial bouts of financial deregulation. Since the 1970s, in the name of free-market efficiency, Congress and presidents of both parties repealed key protections put in place by the New Deal. But the main effect has been to engineer windfall profits for financial insiders, replace real productive innovation with financial engineering, shift wealth from families to corporations, and put the entire American economy at ever greater risk.

As a result, the economy has increasingly come to depend on asset bubbles -- overvalued stocks, overpriced real estate, and dubious financial instruments like derivatives. The bubbles have been pumped up by speculative borrowing. The borrowing feeds on itself, as it did in the 1920s, since an inflated asset is handy collateral for still more borrowing. Alarmingly, these bubbles turn out to be interconnected -- hedge-fund profits reliant on high-yield sub-prime mortgages, and a soaring stock market bid up by risky private equity deals -- so if the air goes out of one bubble, it goes out of others. That's why the crisis is so hard to manage, even by a very aggressive Federal Reserve.

Supposedly, we can't have depressions anymore, for three reasons. First, the Fed has gotten far more sophisticated about containing financial panics. In recent weeks, the Fed's and the world's other central banks have poured hundreds of billions of dollars into credit markets so that risk-averse banks keep lending against shaky collateral. This in turn keeps the price of that collateral -- bonds, stocks, real estate -- from sinking still farther in a 1929-style meltdown. However, once a bubble bursts, low interest rates can't necessarily revive it; the Fed can cheapen money, but it can't make anxious creditors put it at risk.

The other story we all learn in Economics 101 is that ever since Franklin D. Roosevelt, the volatility of a market economy has been steadied both by regulations and by the ballast of "automatic stabilizers" -- unemployment insurance, public spending, Social Security, and so on. Meanwhile, the regulation contains financial bubbles before they start. But both the regulations and the automatic stabilizers have been seriously weakened, leaving only the Fed, to whose limitations we will return shortly.

Meanwhile, back in the real economy, most people are working longer hours for flat or declining incomes. Since 2000, productivity is up 19 percent, but median earnings are down. Ordinary people, and the larger economy, have come to depend on inflated prices of both real estate and stocks and on increasing debts against those assets as a substitute for rising incomes. Household savings rates are currently negative, meaning that new debt exceeds new savings. Home equity as a percentage of the value of the house is at a record low as people borrow against their homes for living expenses, while credit-card and tuition debt are at record highs. In short, the increasing financial insecurity and inequality for ordinary people, and the increasing risk of collapse now afflicting financial markets, are two sides of the same coin. And that coin is the willful dismantling of managed capitalism. .....(more)

The complete piece is at: http://www.prospect.org/cs/articles?article=the_bubble_economy

[Warpy]

1. I said at the time, in the 80s, that deregulation was a bad idea

since there had been a damned good reason for putting those regulations into place since the Depression. I was razzed for it.

Don't you just love being right?

I'm afraid I don't.

[lovuian]

3. I think Bush and NWO has set up our dollar to fail

they want a new currency Amero

which will be able to steal more money from Americans

Steal Steal Steal

its all the plan to make us slaves again

[Warpy]

4. I said for a long time that it needed to fall

because that's the only thing that would stop the hemorrhage of industry pouring out of this country and into the third world. Once our currency is no longer hugely inflated on world currency markets, those people paid enough to live on in rupees or or even more disadvantaged currency won't look quite so attractive. After all, we are the most productive workers in the world. We have been abandoned because we are paid in a first world currency.

The short term will be extremely painful, though, as the true cost of making things elsewhere and shipping them here becomes manifest. Even China will eventually need to let the yuan float, rather than tying it to increasingly worthless dollars.

Whether or not we will have Weimar Republic type inflation remains to be seen. I sincerely hope that won't happen, but it's a distinct possibility, given the talent our current crop of leaders displays in economic matters.

The dollar has been supported by hot air and wishful thinking long enough. With no manufacturing base to support it, there is simply nothing holding it up. It has to fall. How painful the fall is depends entirely on what Washington does to cushion it. My guess is that they won't do much.

I hate to be so pessimistic, but I see few rays of sunshine in the near term. Wages are already depressed. Most people already have leveraged every penny of debt they possibly can. There is nothing left but the crash.

[The Vinyl Ripper]

2. One minor point..

The Fed hasn't "poured" money into the system, they have printed it.

Google "Weimar republic" and "wheelbarrow" if you want to know where that course ends up.

[ProgressiveFool]

5. K & R - very good article - nt

[PDenton]

6. I'm no economist... but the US is bankrupt

Only had a few economics classes, but it seems to me that this will not be a soft landing for the economy. Economists who live up in New York and on the wealthy coasts may not see the same American I do. American really is bankrupt. Once the bubbles are gone there is so little left of value.

Americans really don't make much of anything the rest of the world, or even Americans themselves, want (first it was manufacturing, then it was dogfood via internet, now it is empty McMansions that are suppossed to be filled by burger flippers... and now there is nowhere for the capitalist pirates to go). With nothing produced of value, pretty soon you will see less demand for services, and it will cascade into a recession or a depresion.

Especially don't underestimate the poverty in the service sector, people living paycheck to paycheck, or more likely Amscot to Amscot. Once the ability to loan money is gone (no credit), the service sector is going to implode. So many service workers have nothing, and if gas prices aren't already killing them, the lack of credit will. They won't be able to buy goods or services, and the effect will keep cascading down the economy in shockwaves.

I place blame on something deeper than deregulation. It is the hollowing out of the New Deal promise that American would no longer be abandoned by their government and forced to fend for themselves. Forcing poor people, working class people, to depend on credit for everything. The invisible hand that moves the markets won't hang around to catch you when you fall.

[liberation]

8. Of course this country is bankrupt

The big white elefact in our collective living room is that the Debt that our federal and local governments have contracted is so large, that there is no way we can ever pay it back.

We are a paper tiger, in every sense of the word, except that the paper we are printed now is even more worthless....

[marmar]

11. "that there is no way we can ever pay it back."

Exactly....The US is indeed a paper tiger, one that's lost its teeth.

[liberation]

7. Deregulation is a better sounding way of saying "let the foxen watch the hen house"

What we are seeing is the economic equivalent of "The Lord of the Flies." Without adult supervision, a bunch of stupid selfish kids, driven by pure impulse and without any formal life experience or education, will without any doubt find themselves in dire straits due to the catastrophic consequences induced by their primal impulses.

Ironically a lot of the GOP types believes in two things: an invisible being up above taking care of us, and an invisible hand taking care of the economy. Who needs reason and logic when you can just have faith. I said it many times, taking economic advice/lead from these so-called free market types that propose deregulation is like taking medical advice from a televangelist.

[kenny blankenship]

9. And who presided over the final and official repeal of the Glass-Steagall Act?

which (repeal of) made possible all these shenanigans of selling bundles of subprime mortgages off as an "asset backed securities", thus allowing banks to leverage 1 dollar of bad loans into 20 dollars of fun money and thus ensuring they would make hundreds of billion$$$ of bad, uncollectable loans?

The answer may surprise you. It's not Bush and it's not Reagan.

[Elwood P Dowd]

10. Bill Clinton - Greenspan's favorite rebublican.

:evilfrown:

[depakid]

12. Those who long to harken back to the Clinton Era should pay attention

His administration and the DLC'ers in Congress had plenty to do with this.