As a commenter here noted the other day, Dean Baker is one of those inconvenient figures who puts the lie to any claim that no one saw a dangerous bubble emerging in the housing market. Baker, the co-director of the Center for Economics and Policy Research, saw it all too clearly, and his new book, Plunder and Blunder: The Rise and Fall of the Bubble Economy, is one of the best and clearest works on the subject. In it, he traces the bubble economy forged by an overheated, anything-goes financial sector from the days of the tech stock “new economy” through the inflation and collapse of house prices.
I spoke with Baker (who also writes a blog called Beat the Press about media coverage of economics) by telephone from his New Jersey office yesterday about the TARP program and the pending Obama stimulus package, the political responsibility of the Bush and Clinton administrations, and his views on how best to approach the re-regulation of the financial industry.
SP: I’d like to start by asking you about your view of the stimulus approach envisioned in the Obama plan currently in Congress and undertaken through the TARP program. Have they taken the right approach?
Dean Baker: Just to be clear, no one should use “stimulus” and “TARP” in the same sentence. It wasn’t intended to be stimulus. It was about keeping the banks from collapsing, in its best version. What do I think about what was done with it? The money was given to banks so they wouldn’t collapse. And they didn’t collapse. In that sense, it had purpose. They paid out money as dividends to shareholders. What did anyone expect? They paid out big paychecks to CEOs and other top executives. I don’t know why anyone was surprised. Those of us who were yelling about this, saying that if we gave them money, we should put tight conditions on it, said this was going to happen.
It kept the banks from collapsing. That was a good thing. It kept the financial system operating. It was used to make shareholders wealthier and top executives wealthier. I don’t see any surprises. It was what should have been expected.
SP: What’s your impression of the details of the Obama stimulus package?
Baker: I think on the whole, it’s a good proposal. I don’t think it goes far enough. The size of the hit the economy’s taking is much, much larger than can be dealt with through this plan. He’s talking about spending on the order of $400 billion a year for the next two years. It’s easy to see the fall-off in demand due to the collapse of the housing bubble as considerably larger. In the housing sector itself, the fall-off in demand is on the order of $450 billion. If you add to that the loss in consumption because of people’s lost housing wealth, usually economists estimate that for every dollar in housing wealth, people spend each year five to seven cents. We’ve lost on the order of $6 trillion, and I’m quite confident we’ll lose $8 trillion or more. But just starting at $6 trillion and doing that arithmetic, you’re talking about a loss of between $300 billion and $420 billion a year in annual consumption. We also lost $7 trillion in stock wealth. Again, there’s a wealth effect with that of three or four cents on the dollar. So that’s $200 to $300 billion.
So all in all, we’re talking about a loss in demand of somewhere on the order of $1 trillion that we’re hoping to counteract with a stimulus package of $400 billion. I just don’t see it as being large enough. I’d say it’s a good start. It’s much better than doing nothing. There’s a real urgency to do something now to prevent the economy from just spiraling downward. But it’s not going to be large enough. We’re definitely going to need more.
SP: There are debt bombs waiting to blow up in a number of sectors, ranging from credit card debt to commercial real estate. But home mortgages remain the biggest sector and probably the most dangerous one. Why isn’t there more attention being paid to measures to prevent defaults and foreclosures at ground zero?
Baker: There are two separate issues here. One is what you do for homeowners. One is what you do for the banks. I don’t see any way to prevent the banks from taking huge hits. Nor do I want to. I really don’t feel like taxing people to keep the banks from taking hits. If we don’t hand money to the banks, they’re going to take huge hits even if we help the homeowners. So my view is we want to help the homeowners. I have a proposal on this. I think the best way to do it is to change the rules on foreclosure. And the great thing about it is it doesn’t cost us a penny. We can pass a law saying that homeowners facing foreclosure have the right to stay in their homes as a renter paying the market rent for a substantial period of time. Could be 10 years, could be 20. Maybe it’s only five. I’d rather it be longer than shorter.
That gives the homeowner immediate protection. They can’t be thrown on the street. If they like the home, the neighborhood, the schools, they get to stay there. It also gives the bank incentive to be serious about negotiating terms on the mortgage, because odds are most banks don’t want to become landlords. So they now have an incentive to negotiate terms that keep people in the homes as homeowners.
That’s something we could do immediately that doesn’t require any bureaucracy, doesn’t require any money, that helps homeowners. It wouldn’t be good news for the banks, but I don’t know of anything that would be good news for the banks, and I just don’t want–most of the proposals that are being floated as proposals to help homeowners are actually ways to funnel money to banks, and my view is that the banks are supposed to be big boys and girls, and if they made bad loans that are costing them lots of money, that’s really their problem. We want to keep our financial system operating–which is why we have the FDIC, why is why we’ve had the TARP. But in terms of helping out the bank shareholders and their executives who are getting the multi-million dollar paychecks, I don’t see any public interest in that. Most of the plans for helping homeowners are just disguised ways to help banks.
SP: In Plunder and Blunder, you trace the roots of the bubble economy through the tech stock bubble to the housing market, and you outline the major role played by the Clinton administration in the 1990s. Now, of course, there’s a lot of political blame going back and forth about whose fault this is. Could you summarize briefly how you see the question of political responsibility here vis a vis the Clinton administration and the Bush II administration?
Baker: Just to start with Bush first–you can’t be president for eight years and disavow any responsibility for what happened. That seems to be what President Bush and at least some of his supporters want to do. I’ll explain in a minute how I think the groundwork was laid in the Clinton era, but there was no excuse for Bush. We’re paying these people good salaries. They may not consider them good salaries, but most people would consider the salaries that a Treasury secretary, a Federal Reserve board chair, a president make to be good salaries. They’re supposed to be awake. They’re supposed to be alive. They’re supposed to be paying attention. And they weren’t. The fact that the ground for this could have been laid during the Clinton era is sort of beside the point. President Bush was there, and to say this was something he couldn’t do anything about, that’s literally absurd.
Now, Clinton laid the groundwork in two different ways. One was, he created the sort of economic imbalances that opened the door for the bubble. In particular, I’m thinking that, one, he had a bubble himself, in the stock market. But second, the overvalued dollar was a conscious policy of the Clinton administration. They thought it was really clever to have a very high-valued currency. Robert Rubin, as Treasury secretary, went around pushing the high-dollar policy. And they really put some muscle behind that when we had the East Asian financial crisis. The conditions imposed by the International Monetary Fund, at the request of Treasury, were very, very harsh on those countries. On the one hand, they could essentially write down many of their loans and give them an easier time paying them back. Or they could, alternatively, say no, you have to pay back your loans. And the condition of paying back the loans was that you had to be able to export like crazy to the United States. That meant they had very low-valued currencies. I’m thinking of South Korea, Thailand, countries of that region.
The U.S. had, by comparison, a high-valued currency, and we ran very large trade deficits. Because of how harsh we were with the countries in the East Asian financial crisis, the rest of the developing world got the idea that you never want to be in that situation. You never want to have to run to the IMF and ask for aid. So what that meant was that they also began to build up reserves like crazy, which meant exporting everything they could and running large trade surpluses with the United States.
This led to the huge trade deficits that the U.S. began in the late ‘90s, and it grew to be fully 6 percent of GDP at its peak in 2006. It was over $800 billion that year. So that was one of the main sources of the imbalance, and that was directly Clinton-era. The other really big problem that Clinton passed along for his successor was the one-sided deregulation of the financial industry. Glass-Steagall, the law that separated commercial banking from investment banking, was repealed during the Clinton era, with the full support of the administration. They also prevented the regulation of credit default swaps and other derivative instruments that played a very big role in fostering this crisis.
So we had this one-sided financial deregulation–and I call it one-sided because the financial industry knew it was still going to benefit from government insurance in the form of the “too big to fail” doctrine. We’re being far too generous to them when we say they wanted a free market, or that they’re market fundamentalists. They didn’t want that. They just wanted government insurance without paying for it or being held accountable in any way. And President Clinton’s people gave them that.
That was what set the stage for the housing bubble, but the bottom line is that President Bush had eight years to try to undo the situation that President Clinton put in place. And he did nothing. So the idea it wasn’t his fault is a little loopy. He should have seen what was happening. It was almost impossible for anyone who was really looking at the situation not to see what was going on. He was incredibly negligent for letting it grow to such harmful proportions.
So, long and short, both presidents deserve a lot of blame here.
SP: You mentioned Robert Rubin. And of course Larry Summers, who is now President Obama’s chief economic adviser, was a Rubin protégé and a big part of that. Are you concerned to see him having a central role in the Obama administration?
Baker: Well, I’m certainly concerned. He was obviously very much a supporter of the policies we just talked about. He played an instrumental role in preventing the regulation of credit default swaps and other derivative instruments. He was very much a part of that school. Bubbles were fine. He thought it was just great, because he became Treasury secretary after Robert Rubin resigned, and the stock market bubble hit its peak under his watch. He was just fine with asset bubbles. He thought that was cool. That was the prevailing view.
So yeah, it’s disconcerting. On the other hand, to be fair to Summers, he’s a very smart guy. He’s changed his views on some things. He wouldn’t have been my pick, but we have to see what he’ll do. The immediate issue that I gather he’ll be involved in–besides the stimulus package–is how you handle the second half of TARP or some larger bank bailout. The first half was very much, in my view, a handout from taxpayers to the banks. I would hope that the second half–and actually, we may well go beyond the second $350 billion, because the banks are in such bad shape–involves extracting more serious conditions [from the banks]. Basically, we should be looking to nationalize the banks. And I’m saying that not because I want to nationalize the banks, but because the banks are bankrupt. People say they don’t want the government to come in, but the market solution in a capitalist economy when you’re bankrupt is that you get taken over. And we don’t do that with banks, we don’t have a bankruptcy judge run them, just because that would be too complicated a matter.
So when I say that the government should nationalize the banks, what I’m saying is that they’re bankrupt and we should treat them as bankrupt companies. The shareholders are out of luck. That’s what happens in a market economy. You buy stock in a company, the company goes bankrupt, you’ve lost your money. The executives get replaced with people who can do a better job of running the company. You obviously knock down the salaries. We aren’t going to pay people tens of millions of dollars to run these companies. The point is not for the government to own them, but to reorganize them and sell them back to the private sector. I really don’t want to see the government running these banks. But we don’t have another option at this time, because they are bankrupt and we should be treating them that way.
The question I have for Larry Summers and the Obama administration in general is, are you going to treat the taxpayers fairly and the banks fairly, and really lay down the law to them? I gather we’ll probably know pretty soon whether that’s their plan.
SP: I wanted to ask you about the signs from the Obama administration about enhanced regulation going forward. Most of the public discussion up to now has been about immediate responses to the crisis to keep the system on its feet. But there was a piece in the New York Times last weekend about the regulatory goals of the Obama administration, and they’re on the hook to provide suggestions by the end of April. Based on the signs you’ve seen so far, how do their regulatory proposals comport with the suggestions that you lay out in Plunder and Blunder?
Baker: Well, I haven’t seen what they’re looking to do, exactly. But my view is that we’ve really got to rein in the financial sector. And I say that as purely a practical matter. When you have a hugely bloated sector–and we did; it was accounting for 30 percent of all corporate profits just a few years ago, which is crazy–you aren’t going to be able to effectively regulate them. What we saw was that because of their political power, they were able to override regulators who wanted to do the right thing. Just to give an example, back in 1998, Brooksley Born, the head of the Commodity Futures Trading Commission, wanted to regulate credit default swaps and other derivative instruments. She was prevented from doing so by Robert Rubin, Larry Summers, Alan Greenspan–people with close ties to the financial industry.
If we don’t rein in the political power of the financial industry–with economic and political power really being one and the same–we’re not going to be able to regulate them, because they’re going to be able to use their political power to override the regulators. So I would very much like to see them reined in. Downsized. One of the things I’ve proposed–and I’ve supported it a long time, but the more I think about it, the more I like it–is a financial transactions tax. A modest tax on stock trades and other financial transactions, which could a) raise a lot of money, and b) would reduce waste in the financial sector. Because it is waste if we could get by with a smaller financial sector that’s better. We don’t want to see a hugely bloated transportation sector; we don’t want to see a hugely bloated financial sector. It’s an intermediate good; it’s not an end in itself.
The third point about the tax is, by making the sector smaller, we would better be able to rein it in and control it. So I’d very much like to see the tax for those reasons. Now, will the Obama administration go for something like that? I think it’s almost inconceivable. Basically, their ties to the financial industry are too close.
In terms of other measures, we’ll have to see. But I’m not terribly confident that they’ll be putting forward measures that will really impose adequate discipline on the financial sector.
SP: And you believe that this micro-tax on financial transactions that you propose in the book would also discourage high-volume day trading and the tendency to constantly engage in financial speculation, correct?
Baker: Yeah. The point is, if you have a very modest tax and someone’s looking to buy stock and hold it for five or ten years, it has almost no impact. I’m talking about something on the order of 25 hundredths of a percent. Obviously people aren’t going to want to pay it. But we change the capital gains tax all the time. That has more impact than this tax would have for people. On the other hand, for someone who’s buying stock at 1:00 and selling it at 2:00, it would be a big deal. So it would discourage the sort of speculation that can be a destabilizing force. If nothing else, stock-flipping adds to the inefficiency of the sector. If we have stock flipping over a lot and it’s not serving any economic purpose, then it’s simply wasted resources.
SP: Last question. I have tried to watch the amount of money pledged on behalf of the U.S. taxpayer throughout this crisis as it’s unfolded since last fall. The popular understanding seems to start and end at the TARP liabilities. But I’m sitting here looking at a November 2008 Bloomberg News report that’s titled “U.S. pledges top $7.7 trillion to ease frozen credit.” Can you help me sort out the vast discrepancy between that figure and the $700 billion in total TARP funds?
Baker: Bloomberg took a lot of high-end numbers. They said, what money could conceivably be called on? The vast majority of that is not even guarantees, at this point. But the biggest source of the difference is the Fed. The Fed has been lending out money–I think they’re up to about $2.5 trillion at this point. They’re lending out money to investment banks, and commercial banks have been buying up commercial paper of non-financial corporations. I think that’s around $1 trillion at this point. They recently took to buying up mortgage-backed securities. I think it was on the order of $100 billion of mortgage-backed securities they’ve bought up. It might have been more than that. So they’ve increased [Fed] balance sheets by buying up a wide range of assets. And they’ve done so ostensibly supporting the financial system, but what it means is that these are all potential liabilities for the federal government, because obviously the Fed is the federal government’s bank. If some of these [assets] wind up going bad, and they have to take a writedown of 20 percent, that’s in effect a loss to taxpayers.
So our liabilities from efforts to support the financial system go far beyond what we have with the TARP.