Winning Progressive

(By NCrissie B)

This week I’ve been discussing Michael Grunwald’s The New New Deal: The Hidden Story of Change in the Obama Era. First, we saw the challenges of drafting and passing the American Recovery and Reinvestment Act. Today we look at the challenges of making the stimulus bill work. Next, I’ll interview Michael Grunwald and see how the ARRA’s successes became ‘The Greatest Story Never Told’ … until now.

Michael Grunwald is a senior national correspondent for Time magazine. Before joining Time, Grunwald was a congressional correspondent, New York bureau chief, and investigative reporter for the Washington Post, and a local and national reporter at the Boston Globe. He has received the George Polk Award for national reporting, the Worth Bingham Prize for investigative reporting, the Society of Environmental Journalists award for in-depth reporting, and numerous other journalism awards.

A $10,000 shopping list and a 10-cent stick of gum

Imagine sending someone to out prepare your home or business for an approaching Category 5 hurricane. You give them a shopping list and $10,000, with instructions to buy only necessities. At the end of the day, they return with $9,999.90 in hurricane supplies – enough to minimize the storm’s damage – and one 10-cent stick of gum.

In economic terms, the 2008 meltdown was a Category 5 hurricane. In the fourth quarter of 2008, the economy was collapsing at an annual rate of 6.3%. The downturn was already underway in January of 2008, and between September 2008 and August 2009 over 5,131,000 Americans lost their jobs. But this was no act of nature. As we discussed earlier this month the collapse was a man-made disaster caused by blind faith in an economic myth, and outright financial looting.

The American Recovery and Reinvestment Act was a $770 billion shopping list to minimize the damage from that disaster. Grunwald reports that economists, using data from other large government and corporate projects, expected about 5% to be lost in fraud. Instead auditors found only $7.2 million in fraudulent claims. That’s 0.001% … one 10-cent stick of gum from a $10,000 shopping list.

Transparency at work

That astonishingly tiny level of fraud was due, in part, to President Obama’s commitment to transparency. The Recovery Act website, online immediately after the landmark bill was enacted, details every project funded by the ARRA, and every grant and contract awarded. President Obama assigned Vice President Joe Biden monitor the ARRA, and Grunwald reports that the Recovery Oversight Board used state-of-the-art software to not only detect fraud but to identify and preempt likely offenders before they got their hands in the till.

The transparency came with a price, Grunwald reports. With so much data being made public, media watchdogs made hay with “Gotcha!” stories like contracts and grants going to non-existent congressional districts. Those were, of course, typos made by clerks hurrying to post data in almost real-time as reports arrived at the oversight offices. Grunwald cites stories grousing that too many weatherproofing grants were going to hot-weather climates and – weeks later, by the same reporters – that too many weatherproofing grants were going to cold-weather climates.

Prompted by the lure of being the next Woodward or Bernstein, in a media culture focused on government failure, fed by often outlandish Republican claims, Grunwald writes that thousands of reporters began acting as special prosecutors. Fraud that didn’t happen, and grants and contracts for projects that made sense and were done on time and within budget, were as interesting to report and as likely to make headlines as stories about planes that land safely and pets that don’t get lost.

Yet even the incessant, exaggerated, and often false stories about fraud had a silver lining. With so much data so so public, being picked over by so many, fraudsters may have stayed away. As an Oversight Board member told Grunwald, “It would be stupid to try to scam here.”

Change You Can Believe In

The “Recovery” part of the ARRA could not stop the economic hurricane, and Republicans have made hay on President Obama’s over-optimistic prediction that the bill would hold unemployment under 8%. In fact, unemployment was passing that mark when he made that prediction, although the horrific January-March data wouldn’t reveal that for several weeks. Still, the Congressional Budget Office and other independent analysts estimate that Recovery Act projects created or saved at least 2,300,000 jobs. Despite the unemployment and increase in poverty, homelessness actually declined during the Great Recession, due to Recovery Act projects like the Homeless Prevention and Rapid Re-Housing Program Recovery Plan. A 2010 First Focus report found that the Recovery Act provided “a lifeline for low-income families” whose children might otherwise have gone hungry.

Beyond simply easing the pain, the “Reinvestment” part of the ARRA laid the groundwork for a sustainable, 21st Century economy. Grunwald reports countless examples of “Change You Can Believe In,” including:

• The world’s largest wind farm is now being built in Oregon, primarily with American-made components.
• Total U.S. wind power generation went from 25 gigawatts in 2008 to 50 gigawatts in 2012, a level forecasters said we would not reach for decades.
• Weatherproofing programs have saved the equivalent of 21 coal-fired power plants in energy.
• The U.S. solar energy industry went from “death’s door” in 2008 to a net exporter in 2012.
• Advanced biofuel companies can now create jet fuel from algae, with minimal CO2 emissions.
• Programs underway to reach zero-net energy consumption within 20 years in office complexes, malls, government buildings, and military bases.
• Total U.S. CO2 emissions are now 20% lower than in 1994.
• Many parts of the U.S. now have a long-needed “smart grid” that provides real-time monitoring of electricity production, transmission, and usage, to reduce our energy needs and prevent and minimize blackouts.

And that’s just in energy. The Reinvestment Act has also destroyed hundreds of obsolete dams, renovated thousands of roads, bridges, tunnels, and utility lines, helped to modernize schools, brought broadband internet access to millions of businesses and families, computerized millions of health records, and funded research comparing the effectiveness of prescription drugs, surgeries, and other treatment options.

That “Change We Can Believe In” is already happening, improving our lives and our grandchildren’s futures, even as we struggle with the lingering damage caused by the Great Recession. And, contrary to Republican claims, President Obama has limited federal spending better than any president since Dwight D. Eisenhower.

That’s a very big, very effective shopping list … and next we’ll discuss with Michael Grunwald why the media narrative has been all about that one piece of gum.

(Crossposted from Blogistan Polytechnic Institute (BPICampus.com))

(By NCrissie B)

This week I’m discussing Michael Grunwald’s The New New Deal: The Hidden Story of Change in the Obama Era. Today I look at the challenges of drafting and passing the American Recovery and Reinvestment Act. Tomorrow I’ll examine the challenges of making the stimulus bill work. Finally, I’llinterview Michael Grunwald and see how the ARRA’s successes became ‘The Greatest Story Never Told’ … until now.

Michael Grunwald is a senior national correspondent for Time magazine. Before joining Time, Grunwald was a congressional correspondent, New York bureau chief, and investigative reporter for the Washington Post, and a local and national reporter at the Boston Globe. He has received the George Polk Award for national reporting, the Worth Bingham Prize for investigative reporting, the Society of Environmental Journalists award for in-depth reporting, and numerous other journalism awards.

Four Pillars

Barack Obama was elected during the worst economic crisis since the Great Depression. Several of the nation’s oldest banks had collapsed. The stock market had plummeted. Lenders weren’t lending. Consumers weren’t consuming. Millions had already lost their jobs, and millions more soon would. Economist and Obama transition team member Christina Romer put it bluntly: “Depressions really, really suck.” Yet although most Americans knew the economy was bad, almost no one knew how bad it was. In December of 2008, we had not yet had what Grunwald calls “our ‘Holy s**t!’ moment.”

President-elect Obama and his transition team knew their first priority would have to be patching the gaping holes in a leaking economy. Yet he had campaigned on “Change We Can Believe In,” and he meant to keep the four pillars of that promise:

• Green Energy – In his first policy speech in 2007, Candidate Obama said “The country that faced down the tyranny of fascism and communism is now called to challenge the tyranny of oil. The very resource that has fueled our way of life over the last 100 years now threatens to destroy it if our generation does not act now and act boldly.” The last phrase quoted FDR’s ‘Arsenal of Democracy’ speech, and just as the humming factories of World War II had lifted the U.S. from the Great Depression, President-Elect Obama believed green energy initiatives could help lift us from the Great Recession
• Health Care – Candidate Obama saw health care as both a moral crisis and an economic crisis. Health care spending was one-sixth of our economy and on pace to be one-third by 2040, yet our life expectancy and infant morality outcomes were mediocre. Insurance costs squeezed businesses and workers, and rescission and cancellation often turned illness into bankruptcy. Research focused on individual drugs or treatments, tested against placebos, with almost no comparative data on whether a new drug or treatment was better than those already available. Reforming health care, the president-elect believed, was essential to economic recovery.
• Education – Candidate Obama had attended a prep school in Hawaii and Ivy League universities, yet in Chicago he saw struggling schools that offered excuses instead of excellence: “these kids can’t learn” because gangs-drugs-parents-the-system. President-elect Obama saw “these kids” as “our kids” and was determined to provide schools that gave them a chance to thrive.
• Community – Energy, health care, and education were all part of our national economic crisis, but Candidate Obama saw a deeper problem: the fraying of our sense of community. “I am my brother’s keeper. I am my sister’s keeper,” he said. While he recognized the productivity of market economies, he also recognized a role and a duty for government. New investment in infrastructure, from roads to rails to electricity to broadband connectivity, would both grow the economy and rebuild a shared sense of purpose.

These were the four pillars of change on which Candidate Obama had campaigned, and President-Elect Obama wanted his economic recovery plan to address all four.

Three Ts

But first that plan would have to prevent a Second Great Depression, and most economists agreed on how to do that. Triggered by a banking crisis, the economy now faced a death spiral. Families who had lost or feared losing their jobs were spending less, providing less revenue for businesses, forcing them to lay off more workers. With more workers unemployed and more businesses closing, tax revenues plummeted at the very time people needed more community support, leaving governments – federal, state, and local – with budget crises that could force yet more layoffs.

Both struggling families and struggling state and local governments had to balance their budgets. That left the federal government as “the spender of last resort,” the only economic actor that could intervene to stop the death spiral. But just spending money would not be enough. Larry Summers and other economists had studied government stimulus efforts in the U.S., Japan, and elsewhere, and identified three conditions for success:

• Targeted – Government spending had to boost consumer spending in order to boost business revenues, end layoffs, and spur new hiring. Data showed that during an economic downturn, family spending decreased as a percentage of income for wealthier families. Simply, they could afford to save or pay down debt, while median- and lower-income families had to scramble to get by from month-to-month. Thus, jobs for the unemployed and assistance for the working poor would boost consumer spending more and end the death spiral sooner than tax cuts or credits for the wealthy.
• Timely – Government spending also had to happen at the right time: before the bottom fell out of the economy and left any stimulus futile, and before consumer demand began to recover and left any stimulus likely to spur a burst of inflation.
• Temporary – Thus government spending programs that were intended solely as stimulus needed to stop when consumer demand recovered. Ideally that meant built-in end triggers. Unemployment benefits end automatically when a worker gets a job, and assistance for the working poor tapers as they find jobs that pay better wages. Startup loans help innovative, risky, yet potentially transformative new companies get through ‘The Valley of Death’ until private capital and sales revenues make them self-supporting.

The Obama transition team agreed on the Three Ts, both in principle and in most of the details. There were a few quibbles, but the larger problem was how to find enough targeted, timely, temporary projects to fill out the $500-750 billion package most economists predicted would be needed to forestall a depression and create a recovery.

Sixty Votes

When the Obama transition team took that number to Capitol Hill, jaws dropped. House Speaker Nancy Pelosi had been considering a stimulus package of just $300 billion. President-Elect Obama was asking for more than twice that, on the heels of the $700 billion TARP program just rushed through to prop up the financial industry. Passing that had been fractious enough, and its failure to pass on the first vote had pushed the markets even further into crisis. The 2008 elections had given her a larger majority, but $750 billion was still a lot of money.

And then there was the Senate, where Democrats had only 58 seats, with Minnesota’s Al Franken was still locked in a recount. Without at least two Senate Republicans – really three, so no one could be pilloried by the Senate Republican Caucus as “the deciding vote” – no bill would pass. That assumed the new president could get every Senate Democrat to agree, including fiscal conservatives like Nebraska’s Ben Nelson. Indeed no one was sure whether Democratic stalwart Ted Kennedy, who had collapsed at the president’s inauguration, would be able to return to cast a vote.

As the economic news grew ever more grim in January, with new data showing a Second Great Depression was nearer than anyone had imagined, the ‘ideal’ size for a stimulus bill grew to over $1 trillion. But in the Senate, both the few Republicans whom the president had any hope of swaying and the conservative Democrats whose votes he could not lose, the number was “under $800 billion.” Grunwald reports that number was based not on data but emotion and the echoes of the TARP bailout.

Even had Congress been willing to reach for $1 trillion, Grunwald writes, there remained the problem of meeting the three Ts. There were plenty of ideas for how to spend money, but not enough would be targeted, timely, or temporary enough to work as depression-sparing stimulus. As one Hill staffer put it, “We can’t stuff that much pig through the python that fast.”

The American Recovery and Reinvestment Act did pass. Republicans denounced it as waste and cronyism, even as many progressives complained it was not enough. It was not waste, not cronyism, and not enough … but Grunwald doubts any bigger package could have met President Obama’s four pillars, Treasury Secretary Summers three Ts, and found 60 votes in the Senate.

And as we’ll see in my next post … it did work.

(Crossposted from Blogistan Polytechnic Institute (BPICampus.com))

(By NCrissie B)

I’ve been considering Yves Smith’s 2010 book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism. In my first post, I looked at the economic theory that enabled the Great Recession. In the next post I examined how blind faith in that theory led to deregulation, looting, and the shadow banking system collapse. Today I conclude with Smith’s proposed remedies and our ideas for talking with median voters like our archetypal Fred.

Yves Smith is the founder of Naked Capitalism and has over 25 years experience in finance. A graduate of Harvard College and Harvard Business School, she has worked in corporate finance for Goldman Sachs, was the head of mergers and acquisitions for Sumitomo Bank, and currently heads Aurora Advisors in New York City. She has written for The New York Times, The Christian Science Monitor, and several other print and online publications.

The Story of Shady Eddie

Shady Eddie’s business card says he’s an electrician, and he is, sort of. Most electricians’ make a tough living, but Eddie and his bosses are raking in the dough. What’s their secret?

For starters, he uses complex, ‘innovative’ wiring schemes that use fewer and cheaper materials. Eddie’s bosses don’t understand his wiring schemes, but they’re making money so they don’t look too hard. City code enforcers don’t understand Eddie’s work either, but his company’s fees pay their salaries so they sign off on the permits. He also gets do to the rewiring when customer have problems, because no one else knows how to fix his work.

But even cutting corners on materials and getting the rewiring jobs aren’t Eddie’s real business secret. He knows that, sooner or later, at least some of the buildings he’s wired will have electrical fires. So he buys fire insurance. He makes a nice profit on the initial installations, gets paid again on the rewiring jobs, and gets yet another payday when the insurance check comes in.

Of course, Shady Eddie is only an electrician, so once the city catches on to him he’ll be charged with insurance fraud, at the very least. If only he’d become an investment banker instead….

Why They’re Not In Jail

Yves Smith explains that credit default swaps – the highly-leveraged bets that exploded the global economy in 2008 – are basically insurance policies against the failure of an underlying derivative. Many traders who set up those credit default swaps on mortgage-based derivatives knew the housing bubble would burst soon. In fact, many were structured so the trader stood to profit most when homeowners defaulted and the credit default swaps paid off. Like Eddie’s ‘creative’ wiring schemes, the mortgages were set up to fail, providing refinancing fees for mortgage brokers and bonuses for traders packaging those mortgages into derivatives. And as with Eddie’s scam, the traders convinced companies like AIG to guarantee credit default swaps if the mortgages failed.

But unlike Eddie, those credit default swaps were not regulated as insurance policies, so the traders weren’t committing insurance fraud … at least not under the law.

Shining a Light on Shadow Banking

Changing the law to regulate credit default swaps as insurance policies – not reinstating Glass-Steagall or breaking up ‘too big to fail’ banks – is Smith’s most compelling reform proposal. She concedes that credit default swaps are now so central to the ‘market-based credit’ model that the swaps cannot be shut down. But they can and must be regulated, including rules that require those who buy or sell swaps to have an insurable interest in the derivative on which the swap is based.

Smith acknowledges that regulating credit default swaps as insurance policies would increase the cost of the swaps, thus increasing the cost of the derivative bonds being insured, thus requiring the bonds to pay and the lenders to charge higher interest rates. In plain language, regulating the swaps as insurance would make credit more expensive.

And that, Smith argues, would improve the stability of the global economy. Cheap credit allows too many investors to leverage too much speculation – and creates too many profits for too many bankers – based on too little real productivity. “Finance should be the handmaiden of business,” she writes, “and not its master.”

While Smith does suggest reinstating Glass-Steagall, her reasons are not the reasons you’ll hear in the progressive media. Small commercial banks can be as profitable as larger competitors, because the services they offer do not benefit much by economies of scale. But investment banks benefit greatly by economies of scale. To remain competitive in an international market, investment banks must be ‘too big to fail’ and backed by implicit government guarantees.

A new Glass-Steagall, Smith argues, would both encourage small commercial banks to thrive again and also allow the federal government to treat huge investment banks as public utilities, with what she calls “strict and intrusive” regulations on their risk-taking, accounting, and compensation practices. If investment banks require government support during market crises – and they will – then government must be able to limit the risks being underwritten by We the People.

Alas, Smith acknowledges that enacting these reforms will require both business and political leaders to abandon the myth of Marketopia. She does not believe that will happen until the ‘free market’ dogma has failed so completely that its manifest flaws can no longer be excused away. And on that point I disagree.

President Obama and several other Democrats like Elizabeth Warren are using their 2012 election campaigns to make a case for shared responsibility and regulated markets that allow capitalism to flourish. If we activists do our part to help – including telling archetypal Fred the story of Shady Eddie – polls show that President Obama, Ms. Warren, and other Democrats can win on that case and change our economic dialogue.

Realworldia is not as tidy as the precise formulas of Marketopia. But we live in Realworldia, and our political and economic systems must admit that.

(Crossposted from Blogistan Polytechnic Institute (BPICampus.com))

(By NCrissie B)

This week I consider Yves Smith’s 2010 book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism. Today I look at the economic theory that enabled the Great Recession. In the next post, I’ll examine how blind faith in that theory led to deregulation, looting, and the shadow banking system collapse. Then I’ll conclude with Smith’s proposed remedies and our ideas for talking with median voters like our archetypal Fred.

Yves Smith is the founder of Naked Capitalism and has over 25 years experience in finance. A graduate of Harvard College and Harvard Business School, she has worked in corporate finance for Goldman Sachs, was the head of mergers and acquisitions for Sumitomo Bank, and currently heads Aurora Advisors in New York City. She has written for The New York Times, The Christian Science Monitor, and several other print and online publications.

Beyond the Search for Villains

Economists have a mystique among social scientists because they know mathematics. They are quite good at explaining what has happened after it has happened, but rarely before. I don’t think of myself as an economist at all. — Daniel Kahneman, Nobel Laureate

There is no shortage of theories to explain the Great Recession. Villains abound: greedy bankers, bought-off ratings agencies, clueless pension fund managers, shady mortgage brokers, and the working poor living beyond their means. Some blame policies and political actors: regulation, deregulation, taxes, tax cuts, deficit spending, spending cuts, Congress, the SEC, the EPA, Fannie Mae, Freddie Mac, lobbyists, and public employee unions.

Each of these theories has elements that seem plausible, and parts of each may be true, yet Yves Smith argues that none addresses the deeper issues: a flawed theory – neoclassical economics – and the almost unchallenged acceptance of that theory by business and political leaders.

Dr. Kahneman’s statement nicely encapsulates the opening three chapters of Smith’s book. Applying rigorous, scientific-seeming mathematical equations and logical proofs, neoclassical economics claims to offer a comprehensive theory of how markets work. By implication, it also claims to offer a policy roadmap for government. Create the conditions described in the theory – the neoclassical argument goes – and markets will work as the theory proves: efficiently and to the benefit of everyone. Yes, some will benefit more than others, but even the poorest and most vulnerable will still be better off than they would have been under any other system.

Storytelling with Mathematics

Given the conditions that serve as premises for neoclassical theory, that ideal outcome would happen. The equations prove it. Yet however much neoclassical economics looks like a science, Smith writes, as applied to Realworldia the theory is little more than “storytelling with mathematics.”

The break point between science and storytelling, she argues, exists in those “conditions that serve as premises.” Specifically, neoclassical theory presumes:

• Rational economic actors – This means that every actor seeks to maximize his/her utility (most gains, least costs) as predicted by game theory equations that include calculable benefits, risks, and probabilities.
• Individual, equal actors – All economic actors act as individuals, each with equal market influence.
• Efficient markets – This refers to information about transactions, and proposes that every actor quickly has access to (or that prices already reflect) all relevant information about any transaction.
• Zero transaction costs – This means a frictionless market where it costs nothing to conduct a transaction, such that any buyer can shift from seller to seller, and any seller from buyer to buyer, with no loss in utility.
• Liquid, continuous, uniform markets – This means that any good or service that anyone might want can be bought or sold, that the market will remain open indefinitely such that a buyer can resell any unused good or service, that any specific good or service is indistinguishable from others of that type, and that all buyers want and will accept an equal quantity of any given good and service.

If all of those conditions (and a few others I didn’t list) exist, the equations of neoclassical economics prove that every buyer will find one or more seller, every seller will find one or more buyers, and the result will be a Pareto optimal equilibrium where no actor can improve his/her position without harming one or more other actors in the market, who would and could act within the market to block that attempt.

What happens if one or more of those conditions does not exist? In ‘free market’ ideology, the answer is that all of those conditions would exist, if only government would get out of the way. As is said so often, “It’s Economics 101!” Welcome to Marketopia.

Economics 102: Meet Lipsey-Lancaster

Meanwhile, back in Realworldia, we know that not all of those conditions do exist. Indeed not all of them can possibly coexist. Humans are not entirely rational – in game theory terms – nor do we act only individually or have equal market influence. Even if humans could and did act with perfect game theory rationality, we would still need all of the relevant information about a given transaction. Goods and services are rarely if ever identical to others of the same type, and sellers often know more than buyers about the advantages and disadvantages of the goods and services they offer. As rational actors, sellers could and would (and can and do!) try to conceal some of that information, and profit on the resulting information asymmetry.

What’s more, any attempt to ensure every actor has all relevant information about each transaction will inevitably create transaction costs (to research and ensure full disclosure of that information). It is not possible – not even as a theoretical exercise – for markets to be both information-efficient and transaction cost-free.

And here’s the kicker: back in 1956, economists Richard Lipsey and Kelvin Lancaster showed – with the same rigorous mathematical equations and logical proofs – that if you can’t meet every required condition for a Pareto-efficient outcome … you cannot assume the next best strategy is to ‘perfect’ each of the remaining conditions. Indeed, the next best possible outcome almost always requires moving one or more of the other conditions away from the theoretical ‘ideal’ states.

In plain language: if not every human will be a rational actor, or if not every human will act as an individual and have equal market influence, or if not everyone will have all relevant information about every transaction, or if their are transaction costs, or if not every market is liquid, uniform, and continuous … trying to push the other conditions to their ‘ideal’ states will almost always make the system worse.

There’s good news. Economists know the weaknesses of neoclassical theory, and that’s why only 3% of economists are “strong supporters” of ‘free market’ solutions. Alas, too many other, louder economic voices – pundits and business and political leaders – keep yelling “It’s Economics 101!” … and tomorrow we’ll see how their blind faith in the flawed neoclassical theory guaranteed the Great Recession.

(Crossposted from Blogistan Polytechnic Institute (BPICampus.com))