For the second time this decade, the US economy is sinking into a recession due to the collapse of a financial bubble. The most recent calamity is likely to produce a downturn deeper and longer than the stock market crash of 2001. Dean Baker argues not only that competent economists should have recognized the developing housing bubble, but also that policy makers and the media cheerfully neglected those economists who did predict danger. Baker doesnt engage in 20-20 hindsight, but documents the fundamental policy changes since 1980 that destabilized the economy and eroded the broad prosperity of the post-war period. His expert analysis explains the outcomes clearly so we can prevent similar financial disasters in the future.
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Thomas Frank is the author of "What's the Matter with Kansas? "and "One Market Under God," The founding editor of "The Baffler "and a contributing editor at "Harper's," Frank has received a Lannan award and been a guest columnist for "The New York Times," He lives, of course, in Washington, D.C.
Dean Baker has written extensively on the bubble economy over the last decade and was one of the first economists to recognize the stock and housing bubbles and explicitly warn of the risk of their collapse. Previously a senior economist at the Economic Policy Institute and a consultant to the Joint Economic Committee of the U.S. Congress. Baker now co-directs the Center for Economic and Policy Research in Washington, DC. His blog at American Prospect, 'Beat the Press,' features commentary on economic reporting. In addition to Plunder and Blunder: The Rise and Fall of the Bubble Economy (PoliPointPress, 2008), he has written The United States Since 1980 (Cambridge University Press, 2007) and The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (Center for Economic and Policy Research, 2006). His columns have appeared in the Atlantic Monthly, the Washington Post, the Financial Times, the Guardian, American Prospect, and Truthout. He received his Ph.D. in economics from the University of Michigan.
This is an excellent book.The author traces the problem back to 1980.However,it was the Carter administration that started on the road to deregulation in 1978 and 1979,although it is true that the Reagan administration , the two Bush administrations,and the Clinton-Gore administration increased the tempo of deregulation a 100 fold.A common confusion runs through all of these administrations.The misbelief that speculation is enterprise/entrepreneurship is the common confusion held in all of the administrations named above.Adam Smith spent 80 pages in his The Wealth of Nations carefully demonstrating what the consequences would be if the banks loan to speculators or are allowed to speculate on their own.Smith's conclusion was that the savings of the depositors would be wasted and destroyed.Smith reached these conclusions based on his study of the Mississippi and South Sea bubbles that decimated Europe in the 1719-1721 time period.The author, unknowingly, essentially repeats Smith's analysis but substitutes the bubbles of the 1980's,1990's ,and 2000's in the United States of America as the reference point.
The author correctly shows that the Securities and Exchange Commission (SEC),which is supposed to regulate the now collapsed investment banks ,was packed with appointees who were actually trying NOT to regulate .The same goes for the Federsl Reserve System (FRS).Except for the years 1938-1952,the FRS has been run by the big,giant private commercial banks.Too many FRS board members in Washington viewed themselves as cheer leaders for the speculative practices of the major banks.
Academia provided the intellectual fig leaf with a pseudo scientific theory called the Efficient Market Hypothesis(EMH)....This pseudo theory was the brain child of a number of University of Chicago economists from the economics department and business school, such as Milton Friedman,George Stigler,Gary Becker,Robert Lucas,and Eugene Fama.This pseudo theory claims that there can never be a bubble in finacial markets.It assumes that all financial markets can be modeled as being Normally distributed.Benoit Mandelbrot has continuously demonstrated that this is false numerous times since 1958.All goodness of fit tests demonstrate that the distributions are a long way short of close to being normally distributed.In fact,they are all Cauchy distributions,which means that the risk of negative outcomes is a 100-1000 times greater than specified by the Normal Distribution.
Unfortunately,the bubble makers will simply lie low for 10-15 years and then try to start all over again,just as they have successfully been doing for over 400 years.Read more ›
Well we are in a serious economic recession. How did we get here? Rush Limbaugh endlessly repeats that it was caused by laws like the Community Redevelopment Act (CRA) and other efforts by Democratic politician to terrorize the banks into making loans to low income people. Of course in reality, any loans made under the CRA were too small to have any impact on the financial crises, even assuming that a large number of them defaulted. In this book, Dr. Baker does not mention the argument about the CRA possibly because this book went to press before the argument about the CRA became prominent and also possibly because there is no empirical evidence to support Limbaugh's argument.
Dr. Baker explains how an increasing share (perhaps 25 percent of corporate profits) of our economy is dominated by finance. Deregulation of finance during the 1970's and beyond allowed lenders to circulate a staggering amount of money throughout the world. American manufacturing began to seriously decline in the 70's and the trade deficit ballooned. Productivity growth in the United States was very low in the 70's, through the Reagan-Bush Sr. years and Clinton's first term. Then, for unknown reasons, productivity started to pick up substantially. Investors began to speculate in the stock of emergent companies involved in the internet and related fields, which drove the stock prices of these companies into the stratosphere, even as few of the companies were actually registering any profit. The impressive stock market performance of these companies versus their poor performance in the real economy was reflected in the Price to Earnings (PE) ratio. In the past, according to Baker, the PE was around 14 to 1. But in 2000, it reached 30 to 1.... In spite of the obvious fact that the stock market could not be sustained on such a wide PE ratio, market analysts, economists and politicians of both political parties kept insisting that the stock market bubble would never go away. According to Baker, it was the very questionable foundation of the stock market bubble, provided by capital gains tax revenue increases, that allowed Clinton to balance his budget. Idiotically accepting the assumption that the stock market bubble would continue to bring in revenue, politicians suggested that the US national debt could be paid off in ten years. Alan Greenspan refused to publicly warn against the irrational exuberance of the bubble. He bailed out the Long Term Capital Management hedge fund in 1998 so many investors probably thought they could continue to gamble in financial markets and Greenspan would bail them out. Greenspan accepted the assumption that the economy would provide enough revenue for balanced budgets for years to come, arguing that Bush's tax cuts in 2001 were necessary so that the US would not have to pay off its debt too quickly and so have to invest in public assets instead of selling its debt. A bunch of CEO's and speculators took 7 or 8 figure incomes from this bubble before stock prices went down. A few executives, like those of Enron, who inflated their company's stock price with accounting fraud, went to jail but not before millions of shareholders were looted of their investments. Baker writes that the CEO earnings to worker income ratio went from 24 to 1 in 1965 to 300 to 1 in 2000.
It was the real estate market that financial capital turned to after the collapse of the tech bubble. Mortgage companies (including Freddie Mac and Fannie Mae but all their private sector competitors heavily invested in the enterprise too) made money issuing mortgages to be sold in secondary markets. Banking CEO's pursued the short term profit that got them bigger compensation and bonuses. So they issued mortgages left and right and bought and sold them. Since appraisers were paid by the banks, they could be expected to assign greatly inflated prices to real estate the banks had invested in. It was a similar case with bond rating agencies, which were paid by the banks to certify the soundness of securitized questionable loans. New dangerous financial instruments were created to sustain the housing bubble. As the savings rate of disposable income for average Americans continued its decline from the 1980's, the Bush administration encouraged the home buying frenzy. Meanwhile, Baker shows that many signs that the housing bubble was going to end up in disaster were plainly visible but neither economists nor politicians nor Fed officials were willing to risk their favor with the rich and powerful by pointing these out. As with the earlier tech bubble, a small number of people ran off with tens of millions of dollars while many other people lost all their wealth. Then Democrats and Republicans joined together to throw trillions of taxpayer dollars at the bankers to try to save them from the mess they caused.
AT the end of the book, Baker throws around some suggestions for making sure financial bubbles don't happen again. Greater regulation is certainly necessary. Speculation needs to be reduced and the Tobin tax is certainly a good start. Baker observes that in periods where financial markets were more tightly regulated, such as the postwar 1945-73 era, there were no financial bubbles and the wealth of the country was more evenly distributed than it is today. Another course of action would be to weaken the value of the dollar so as to increase manufacturing exports and somewhat lessen the dominance of our financial industry. Our trade deficit is a problem that is in desperate need of being addressed, Baker notes.
Baker, by the standards of economists, at least in this book, writes in a very clear and simple manner. He obviously makes an effort in this book to make economic issues understandable to persons not well versed in economics. Obscure economic terms are defined in a glossary in the back of the book.Read more ›
The title of this book captures perfectly and succinctly the nature and performance of the high-flying US economy over the last fifteen years and its painful, yet very preventable, financial nosedive that has taken tens of millions of average people with it. As the author states, the stock market bubble in the late 90s and the grossly inflated housing market of the mid-2000s and the attendant investment bank meltdown were not inevitable. The cast of characters that failed to recognize the situations - or so many of them allege - and/or to perform professional regulatory functions to deflate the bubbles is many: the head of the Fed Alan Greenspan, the entire Fed Reserve Board, the SEC, virtually every economist in the country, the business media, home appraisers, bond-rating agencies, the Treasury Dept and other administration bodies - the list is quite long.
And then there is the greed aspect - the plunder element. Investment and commercial bank executives knew - or if they didn't, their incompetence defies belief - that they were raking huge fees off the sale of asset bubbles, based on bogus securities. Or in the case of AIG, based on the sale of credit default swaps, a form of securities insurance, that they had no intention of making good on. Households, pension funds, and the like have lost trillions in the real wealth that they invested in now deflated assets, only to see that wealth now held by those executives, who in the author's words, are borderline criminals. Who can disagree with the author's call for accountability, although there is no chance of that occurring?
The financial sector has become an increasingly huge component of our economy. Thirty percent of corporate profits in the US were attributed to that sector in 2004, a huge increase over bygone eras.... By its very nature, that sector is subject to speculation: it swaps paper. Yet, it has become far too important to simply let free-run, as free-market ideologues regard as imperative. The author points out the numerous measures that could have been taken by the aforementioned to deflate the two bubbles before they became serious problems.
The book is best at demonstrating the sheer incompetence of those who should have seen the bubbles. If there is any luster left on Alan Greenspan, at one time referred to as the greatest central banker ever, it would have to be on the part of those who insist on keeping their heads buried neck-deep in sand. In addition, the business sections of the leading media come under withering attack by the author for their cheerleading and failure to analyze and investigate. And there is more than a hint that the economics profession, as a whole, was extremely negligent.
The author notes that the US economy operated quite well without being under the influence of bubbles for the thirty years after WWII. In that era workers with the influence of union contracts obtained increasing wages based on increased productivity that permitted the purchasing of a middle-class standard of living without resort to massive amounts of credit. But that virtuous circle of increasing wages, consumption, and investment didn't continue. Cracks in the economy began to appear with workers taking the brunt of it with the Reagan era assault on unions and the competition of offshore low-wage workers. Inequality rose, with more wealth based on stock market valuations due to such developments as leveraged buyouts and the proliferation of dot-com startups. The stock market bubble was underway.
The book is short and fairly light on explanations, some of which are inadequate or confusing. The author's explanations of budget deficits, interest rates, and the valuation of the dollar and their interactions are at best insufficient. While, it is beyond the author's control, books written within a few months of the onset of the current financial crisis lose currency very quickly. Many painful chapters involving bailouts, bankruptcies, takeovers, and economic stimulation are left to be written over the next few months. Nonetheless, the book is a concise and scathing look at the causes and fallout of this economic crisis through Oct, 2008.Read more ›
