Saturday, May 2, 2009

Re-Post Number 7: "The Road Not Taken: A People's Bailout" (Oct 03, 2008)

Note: This post begins to shift towards the similarities between historical jobs policy and current events, as the Re-Posting series reaches its second half.
The sheer size of the $700 billion bailout proposed by Secretary Paulson staggers the imagination of the American media. Groping for analogies, commentators from all points on the political spectrum, have turned to the past for analogies, dubbing the current proposal the biggest government intervention in the economy "since the Great Depression." But is that really the case?

At first glance, the analogy fails: FDR’s New Deal insured depositors, not bank debts; the Home Owners Lending Corporation provided relief to home-owners in default, not to holders of third-party securities; the government showered Wall Street not with liquidity, but with new regulations. The vision of an activist federal government rescuing beleaguered financial institutions rings false on the most important point – the government sought to rescue people, not firms, and looked beyond immediate crisis to underlying root causes.

As strange as it may seem in an era where conventional wisdom in Washington D.C demands billions for the banks, and not a penny for the people, the leading thinkers of the New Deal understood the Great Depression as caused by a weakness at the foundations of the American economy, and not up in the clouds of financial wizardry. They saw real cause of economic collapse was that the rich had grabbed so much of the nation’s wealth that workers couldn’t afford to buy the goods our economy created.

What’s so strange about the current crisis is that we’ve fallen so far back in our understanding of the economy that we lag behind the New Dealers. Talking heads on CNBC may rattle on about liquidity, counter-party debt agreements, and sub-prime crises, but is the underlying problem so hard to understand? The household incomes of ordinary Americans have stagnated and declined for a decade, and consumers trying to maintain living standards have made up the difference by borrowing heavily on the value of their homes. In those circumstances, who in their right minds would think that home-owners could make huge balloon payments on their sub-prime mortgages, if the real estate boom that increased housing values and allowed for easy re-financing went away? As it turned out, virtually all of corporate America, from Lehman Brothers and Freddie Mac/Fannie Mae to Merrill Lynch, were not in their right minds. And now America is shocked, shocked to find out that the wizards of Wall Street didn’t see the crash coming.

Our current financial crisis wouldn’t have shocked the New Dealers who experienced first-hand the folly of gambling with "other people’s money." For as the legendary economist John Maynard Keynes wrote in 1936, "our usual practice" as investors is "to take the existing situation and project into the future," even when our capacity to predict the future is weak. In a situation of such uncertainty, we cling to the unrealistic belief that tomorrow will always look like today – the collective mind of Wall Street assumed that the good times of the housing bubble would never end, and now assumes that the crisis of liquidity will never pass. Keynes concluded that the government would have to step in, and the New Deal took up the challenge.

But as it turned out, the big bailout that the New Deal engineered was the total opposite of the current proposals of the Bush Administration. In January of 1935, FDR introduced a proposal for $4.8 billion dollars to create three-and-a-half million jobs for the unemployed.

In the midst of the Great Depression, this was a staggering sum – two-and-a-half times the size of the entire Federal budget (equivalent to $6.75 trillion dollars today), the largest in American history at the time. Unlike today, the New Deal bailout went straight to the root cause of the problem – too few workers with not enough money in their pockets – and flowed upwards from the foundations, circulating throughout the economy as wages were spent and re-spent.

The results were dramatic: by 1937, unemployment had fallen from its high of 25% to 14% - a 50% decline! – and GDP had recovered to pre-crash levels. The New Deal bailout worked.

Look at the present day: unemployment has risen to 6.1%, working class family incomes have fallen by more than $2,000 since 2001, and 37.3 million people live in poverty. If these millions of Americans can’t pay their mortgages, the markets can’t recover. Yet the only victim of economic decline that the Bush Administration thinks worthy of support are finance corporations; people in danger of losing their homes are supposed to save themselves. Yet for the $700 billion demanded by Paulson and Bernacke, we could put every single unemployed person in America to work...twice over.

A people’s bailout: a bargain at half the price.

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