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An accessible book by an economist on our current financial turmoil
, March 2, 2009
This review is from: Plunder and Blunder: The Rise and Fall of the Bubble Economy (Paperback)
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.
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