Guest blogger makes sense of US economy and politics

The author, Santiago Leon, is chair of the Issues Committee of the Miami-Dade Democratic Party

By Santiago Leon

Happy New Year!
Like most of us, I have been giving some thought to how our economy was run into the ditch. I thought you might be interested in some of my conclusions.

MAKING SENSE OF OUR ECONOMY

Over the years, it has been the pattern that Republicans got more campaign contributions from business, and Democrats from other sources. In recent times, however, both parties have been bankrolled by business interests, the difference being that the Democrats got more money from Wall Street, and the Republicans from the oil industry. This was certainly the case in the most recent presidential election. See for example:
http://debatebothsides.com/showthread.php?65889-On-eve-of-%E2%80%9CSuper-Tuesday%E2%80%9D-primaries-Wall-Street-casts-the-money-ballot

For a long time I thought it was nice that the Democrats got money from Wall Street -- my interpretation was that there were progressive people on Wall Street who understood the need for responsible government. I am sure that many progressive Democrats would not have shared this perspective in the first place, and in the last year or so I have come to look at things differently. It is now apparent that the economic policies of both the Democratic and the Republican parties, and perhaps those of the Democrats more than those of the Republicans, have been guided in major part by the influence of Wall Street, which has centered on the expansion of its own profits.

Moreover, it has become apparent that the economic policies designed by Wall Street have done serious damage to the American economy, damage which will not easily be repaired. This damage takes numerous forms including the loss of income and competitive position, but also lasting damage to individuals in the form of both short-term and long-term impacts on health. See for example:
http://www.nytimes.com/2009/05/09/health/09sick.html
http://www.cmaj.ca/cgi/content/abstract/153/5/529

The direct damage which our political leadership has inflicted on our economy falls into two categories: the offshoring of manufacturing and the deregulation of the financial system. These two developments interacted to produce our recent financial disasters.

How did this happen?

HOW ECONOMIC POLICIES PRODUCED THE GREAT RECESSION

First, the offshoring of manufacturing led to enormous trade deficits and lower real incomes for American middle-class families. Families took a number of steps to maintain their standard of living: first women returned to the work force, and then families went into debt using credit cards and mortgages. The federal government also got into the act: as families' financial situation deteriorated, people demanded tax cuts. In addition, declining real incomes meant that recessions were recurrent, and the federal government found itself under pressure to engage in deficit spending to keep the economy going, with the result that the cumulative federal deficit rose (of course, George W. Bush waging wars in the Middle East while cutting taxes did not help).

Lower real incomes and higher household debt would have been bad enough by themselves. However, an increasingly concentrated and deregulated financial system added to the problem. First, the mortgage market became much more volatile. In the past, home mortgages were made by local lenders who kept the loans in their portfolios. As a result, lenders were careful about whom they lent to and about the value of the properties that secured the loans. In recent years, however, those who were originating the mortgage loans sold them immediately to wholesalers who repackaged the individual mortgages into securities.

The buyers of the mortgage-based securities were sure that home prices would never fall, and that homeowners would almost never fail to make their mortgage payments. As a result, the demand for the securities was so strong that the wholesalers asked few questions about what they were buying. The resulting strong market for mortgage-based securities had two effects: it lowered the quality of the mortgage loans and also fueled a run-up in the prices of real estate. The mortgage-based securities were bought in large blocks, which concentrated the risk of default. Ultimately, the real estate price bubble burst, with predictable consequences for the holders of the securities and for companies such as AIG which had issued guarantees on those securities. The federal government then bailed out all the investors and speculators (on the pretext that they were "too big to fail"), massively increasing its own debt in the process.

GETTING INTO DETAILS: SOME RECENT ARTICLES

1. THE OFFSHORING OF MANUFACTURING
Several recent articles have done an excellent job of clarifying the process by which the American economy has been damaged. One set of articles relates to the offshoring of our manufacturing base. This is a special report of The American Prospect entitled "Made in the USA: Reviving American Manufacturing Before It Is Too Late." You can see all the articles at: http://prospect.org/cs/special_report

I would particularly recommend two articles. The first, "The Plight of American Manufacturing," by Richard McCormack, sums up where we are.
http://prospect.org/cs/articles?article=the_plight_of_american_manufacturing

Here is an excerpt:
=======
America's economic elite has long argued that the country does not need an industrial base. The economies in states such as California and Michigan that have lost their industrial base, however, belie that claim. Without an industrial base, an increase in consumer spending, which pulled the country out of past recessions, will not put Americans back to work [because the consumer dollars will be spent in China]. Without an industrial base, the nation's trade deficit will continue to grow. Without an industrial base, there will be no economic ladder for a generation of immigrants, stranded in low-paying service-sector jobs. Without an industrial base, the United States will be increasingly dependent on foreign manufacturers even for its key military technology.

For American manufacturers, the bad years didn't begin with the banking crisis of 2008. Indeed, the U.S. manufacturing sector never emerged from the 2001 recession, which coincided with China's entry into the World Trade Organization. Since 2001, the country has lost 42,400 factories, including 36 percent of factories that employ more than 1,000 workers (which declined from 1,479 to 947), and 38 percent of factories that employ between 500 and 999 employees (from 3,198 to 1,972). An additional 90,000
manufacturing companies are now at risk of going out of business.

[Of course, even with Miami's trade- and service-based economy, we have experienced the offshoring of manufacturing as the garment and medical device industries have moved jobs to other countries.]
=========

A second article, "Industrial Policy: The Road Not Taken," by Jeff Faux, helps us to understand the politics of how we got here. http://prospect.org/cs/articles?article=industrial_policy_the_road_not_taken_

Here is an excerpt, which summarizes not only the policy debate but the relationship between Wall Street, economics departments and "free trade" views :
======
Over the next decade [starting in 1976], a widening circle elaborated the case for a conscious nurturing of a high-wage road to future prosperity as an alternative to the low-wage road on which the country was traveling. Analysts at the Business Roundtable on the International Economy at the University of California, Berkeley, insisted that we had something to learn from the Japanese. Robert Reich, a lawyer, and Ira Magaziner, a business consultant, argued that sectoral policies were essential for growth. Labor economists at the Economic Policy Institute showed how the erosion of wages from the manufacturing sector was spreading throughout the labor force. Economists Barry Bluestone and Bennett Harrison wrote a book whose title, “The Deindustrialization of America,” became the iconic phrase in the policy debate.

But policy debates are rarely settled on their philosophical merits alone. To a large degree, the conflict within the policy class was a proxy for the conflict of interests among those with power and money at stake. For example, the State Department, representing the foreign-policy establishment, which favored helping foreign industries to capture U.S. markets as a way to gain Cold War allies, was opposed.

More important was the hostility of the Treasury Department, which represented the interests of financiers [i.e. Wall Street] who were against giving the government power to guide private investment in ways that would serve the interests of American producers, rather than American global investors. It was one thing for the government to subsidize capital with tax breaks, loan guarantees, and bondholder bailouts. But for the government to do it on some systematic and thought-out basis -- that was the road to socialism, if not worse. America's financial elite was also aware that if manufacturing industries were to shrink, so would the political power of the strongest American unions.

The industrial-policy debate consummated the marriage of Wall Street and the mainstream economics profession that continues today. For believers in the neoclassical synthesis, financial markets are easy to romanticize; buyers and sellers reacting almost instantaneously to minute price changes that are supposed to reflect all of the available information on businesses, about which neither buyer nor seller has to know anything at all. This simulated perfect market lent itself to the mathematical models needed to gain tenure and win Nobel Prizes in economics. And global investors, like neoclassical economists, are free-traders, indifferent to where exactly investment goes, so long as it maximizes what economists call efficiency -- and financiers call profit.

A dowry helped. Wall Street firms contributed funding to friendly economics departments and think tanks and gave consultant contracts to economists to build models showing that their exotic derivatives were low-risk bargains.
=====

2. THE DEREGULATION OF THE FINANCIAL SYSTEM

The best article I have seen on the deregulation of the financial system is a profile of John Dugan, of whom I had never heard before, but who turns out to have played a leading role in that process. The article is "A Master of Disaster," by Zach Carter, and appears on The Nation magazine's web site at:
http://www.thenation.com/doc/20100104/carter

Dugan, while employed at the Treasury Department under George H. W. Bush, oversaw the preparation of a 750-page book which advocated, among other policy changes, allowing banks to expand into multiple states without incurring additional regulatory oversight, allowing relatively safe commercial banks to merge with riskier investment banks and insurance companies, and allowing commercial firms such as General Electric to own a bank. (Of course, we have experienced the effects of interstate banking here in Miami, where the majority of bank deposits have moved from local or regional banks to national banks. Among the effects have been reduced local employment in the banking sector and a diminishing pool of local institutions with a vested interest in the community to provide civic leadership and charitable contributions.)

Dugan's recommendations were ultimately enacted by a Democratic Congress under Bill Clinton's leadership and laid the groundwork for our recent financial disasters. One aspect of the results is summarized in the following excerpt:
=====

"There were two pieces of legislation that facilitated our migration toward too big to fail... Interstate Banking and Branching Efficiency Act of 1994, which permitted banks to grow across state lines, and the Gramm-Leach-Bliley Act, which eliminated the separation of commercial and investment banking," said Kansas City Federal Reserve president Thomas Hoenig in an August 6 speech before the Kansas Bankers Association. "Since 1990, the largest twenty institutions grew from controlling about 35 percent of industry assets to controlling 70 percent of assets today."
=======

However, Dugan's contributions to the current catastrophe are not merely intellectual:  "As head of the Office of the Comptroller of the Currency [to which he was appointed by George W. Bush in 2005], Dugan played a leading role in gutting the consumer protection system, allowing big banks to take outrageous risks on the predatory mortgages that led to millions of foreclosures." The details of how he did this, which included asserting federal pre-emption to prevent states from regulating mortgage lenders and enacting consumer protections, are morbidly fascinating.

It is astonishing that in view of all the damage he has done, Dugan still has his job (this seems comparable to keeping Brownie at FEMA after New Orleans). Dugan's term expires in 2010; however, Barack Obama has the power to remove him at any time. The fact that Obama has not done so is indicative of the degree of influence exercised by Citigroup and its ilk.

WHERE DO WE GO FROM HERE?

I have no hope for the Republican Party for the time being: it has, for example, played no constructive role in anything that has happened in Washington for the past year. I am hopeful, however, that the grass roots of the Democratic Party can push the party and its elected officials to take a more responsible approach to managing our economy, and to escape the gravitational pull of Wall Street.

I think that the effort to re-orient our politics to the needs of the average American will be made much easier if we can reform our system of campaign financing, so that our elected officials of both parties do not have to depend on Wall Street (or the oil industry) to finance their campaigns. A bill has been introduced in Congress and the Senate to provide for public financing of congressional campaigns. You can read about it at: http://www.fairelectionsnow.org/

Public financing is necessary, but not sufficient. Clearly, in Miami as elsewhere, the electorate has a long way to go before it understands the issues well enough to hold its officials to account. Perhaps in the course of making the case for public campaign financing, we can bring more voters up to speed on the high cost of privately financed elections and their results in the form of national economic policies determined by, and
for the short-term benefit of, a small segment of our society.