What Should We Do?

Yesterday's post outlined the problem: demand deficiency and private debt overhang. So what should we do? The obvious answers: increase demand and reduce debt. I understand that the political case for either of these actions ranges from difficult to impossible; but I want to make the best case I can for both. Having put this down on paper, will step back and consider what might be doable politically. In this post, will focus on building a case for increasing demand through government deficit spending.

Increasing Demand


With consumers retrenching, businesses not investing, and the US not likely to give up its pattern of a negative trade balance, the only actor left is the Government. Remember:

                                        GDP = C + I + G + (X - M)

C is the consumer; I is business; and (X - M) is our trade balance, invariably negative, and therefore not contributing to GDP growth. So if C and I are stuck, then G must go up; and assuming Taxes stay the same, this means deficits go up. We all know the arguments against increased government spending and deficits: It won't work, as in the "stimulus did not work". Conservatives and their economists argue that the private sector will exactly offset this increase in G by reducing I, and to a lesser extent C, because they will calculate forward the future tax liability they will have, and they will withdraw just that amount of money, add it to savings, allowing themselves to be "crowded out of the market" by the Government. There is almost no empirical proof for this position, but that seems to make little difference,

The next attack on deficits is that they are inflationary. And the final "take no prisoners - all out war approach" is that deficits create an added debt burden, and that at some point (very soon) the nation will go broke; no one will buy our debt; we will face sovereign default and simply shut down as a going concern.

These arguments are all demonstrably wrong. That won't make much if any difference in the political arena, but I think it's good, occasionally, to be exposed to the facts.

The chart below shows the Sectoral Balances for the US from 1952 through 2010. The Private Sector is in blue and represents Savings - Investment. When the blue bar is above the line, the private sector is net saving, which has been the pattern, except in the 1990s' in the run-up to the dot.com bust, and then in the 2000s', in the run-up to the housing bust. In both periods, the private sector was "dissaving", i.e., borrowing. Net saving (the blue bar above the line) is a use of funds. The green bars are the foreign balance (M - X). Since the 1970s' oil shock, imports have consistently exceeded exports; which puts the green bars mostly above the line, and are also a use of funds. So since uses must be equal to sources, then we know the Government Sector (G - T, or Government Spending minus Taxes) must be below the line sourcing the funds for Private Saving and our Negative Trade Balance.

There are very few years since 1952 when we have not had a budget deficit. The late Clinton years is one brief period; but the only way this was achieved was to turn our nation of savers into a nation of heavy borrowers (blue bars below the line). This led first to the dot.com bust, and then to the much more significant housing bust. the deep deficits we are running now essentially allow us to significantly increase our saving, helping to repair our wounded private balance sheets.

The next question in the attack on deficits: they are inflationary, and in addition, they will lead us to pile up sovereign debt, to the point where no one will buy our Treasuries, and we will have to default, or, just as bad, we will print so much money we will have a Weimar like runaway inflation. Let's take a look at a Sectoral Balances chart for Japan:

Since their 1991 crisis, Japan has run consistent, significant deficits, which have been the primary source of funding the private sector's desire to save and rebuild their balance sheets (in this case, their corporate balance sheets). Inflation has stayed well below 2%. 10 Year Bonds have sold consistently in the 1% range over the period. Sovereign Japanese debt is now well over 200% (more than twice the US ratio) with no ill effects.

I do not hold up Japan as an example of what we should do. They molly-coddled their banks and did not insist on bankruptcy for many insolvent firms, resulting in over cautious banks and too much capacity in the economy. I hold them up to support my argument that deficits are not necessarily inflationary; and that death or disaster is not automatic with an increase in the debt/GDP levels.

So there is a strong case for deficits, and using those deficits to support the private sector's desire to repair balance sheets, but also to engage in serious demand building and job creating. More on this tomorrow, when I present some thoughts on helping the consumer deleverage.

Our Economic Problem: Demand Deficiency

Every once in a while it helps to dig into the numbers. In the political arena, we hear all sorts of reasons given for our prolonged recession: runaway government spending; badly misconstrued government housing policy via Fannie and Freddie; runaway government debt; too much regulatory and government uncertainty, and the like. The one thing you won't hear much about is demand: the problem is deep and continuing government deficits, not demand.

Recall the basic equation: GDP = C + I + G + (X - M)

GDP equals Consumption plus Private Investment plus Government Spending plus Net Exports (Exports minus Imports). Google NIPA (National Income and Product Accounts), click on your top hit, and you are taken to a host of charts and tables put out by BEA (Bureau of Economic Analysis) where you can look up and keep track of the numbers. When any one of the four numbers above go up, other things being equal, GDP goes up. When one or more of the numbers goes down, GDP goes down.

Robert Gordon, an economics professor at Northwestern has put together a great series of charts, which I will include below. He takes the NIPA numbers from 2007 Q1, our last business peak, as the baseline: in the charts, when a category number is up or down a certain percent, this is in comparison to what the same category number was in 2007 Q1.

The first chart shows the 10 year GDP trend in total, and by its four component categories, with 2007 Q1 as the baseline:

And here are the elements that make up the four GDP components: Consumption; Investment; Government; and Net Exports:

Some of these numbers are hard to read. Here is a detailed chart:

What do thee charts tell us? They tell us that consumer demand, business investment, and state/local government spending have all taken big hits. Federal spending is up a bit, and the Net Export position has improved a good bit. Businesses aren't investing and consumers are buried under a mountain of debt (chart from Calculated Risk blog):

  More on this in coming days; but the economy has a demand problem and a debt problem, but contrary to everything you have heard, the problem is a private debt problem. Consumers are not going to begin spending until their balance sheets improve and the unemployed start coming back into the employed workforce. And residential investment/homebuilding cannot recover until the foreclosure mess is cleared up. Together consumption and private residential investment accounts for about 75% of the economy. Other business investment (equipment, nonresidential building) accounts for 10%. Government accounts for about 20%, and Net Exports comes in at -5%.

I don't happen to think business is not investing because they lack confidence. I think they are not investing because they don't have any orders for equipment or new office space. But even if confidence were the problem, this is just 10% of the economy. There is nowhere near as much bang for the buck here as there is finding ways to get the consumer to spend.

Politics has shut down government spending. The consumer is retrenching. If we can't shake out some action in one or both of these sectors, we are in for a long, Japan-like economic slog. Some thoughts on new directions tomorrow.

Irene and Other Storms

Irene made landfall this morning in North Carolina. Winds mostly under 100mph. Will head back out over water before slamming Long Island tomorrow. Huge amounts of rain over a very large area. Signs are that the storm is somewhat less intense than originally forecasted, that folks have taken the advance warnings seriously, and that the state and federal efforts to prepare in advance seem effective. We'll have to wait, watch and continue to pray.

And what about all the other storms? The economy is in much worse shape than most pundits thought, and we seem to be out of ammunition to launch restorative programs. At Jackson Hole yesterday, Chairman Bernanke signaled that the Fed was in a "watch carefully, but take no immediate action" mode. So monetary policy is in neutral. And fiscally, Congress is in gridlock, and the chances of stimulative spending seem remote.

And then there's Europe. Will Germany and France keep supporting the issuance of Eurobonds in quantities necessary to keep all parts of the system liquid? The consensus answer seems to be "Maybe." And that might not be good enough, and the system might not respond fast enough if some sort of bank run develops. And there is probably no such thing as a banking crisis that is confined to Europe.

And then we have our own banks. Readers know how skeptical I am of their real balance sheets, when you adjust for overstated mortgage assets and add large additional reserves for the mortgage litigation liability that is still deeply underestimated. Last week, financial bloggers were doing a real number on BOA's balance sheet, concluding that its $220 billion book value might really be worth next to nothing. While this discussion was happening,  the market bid the economic value of BOA down to below $65 billion, when Warren Buffet stepped in with a $5 billion investment, and market value popped back up near $80 billion. But investors still remember Buffet's last $5 billion investment, which was in Goldman Sachs on September 25, 2008, just before the market crashed, taking Goldman with it, dropping from over 160 to near 50, before recovering. Buffet did just fine on his investment, but for a good time there in October 2008, it was not a sure thing.

So what are the chances of a "crisis" or some kind of market shakeout? I think they are at least one in three, and possibly considerably higher. And I think Europe will be the trigger. I just don't see the political willpower to forge a program that will commit the ECB funding necessary to essentially remove liquidity risk from the picture. They could do it tomorrow, with a simple announcement, but that means the rich North would be on the hook for the "sins" of the perceived to be "profligate South". It's possible; but I don't see it. Without it, chances of a liquidity event are pretty good. And the ripples will cross the Atlantic in no time.

Would such an event trigger a run on a major bank like BOA? It might. The Fed has shown itself very adept at injecting liquidity into the system very rapidly. But the "event" might trigger the need for a TARP II, and I do not think that will fly politically, which means the bank would be taken down.

Yes. I will stick with that: a one in three chance that a European credit event will spread to the US, catching one of our banks badly enough that they need to be put into resolution authority. Time frame? Within the next 12 months, and more likely sooner than later.

Not a pretty picture, but this sort of eventuality could lead to a "wiping the slate clean" scenario, that will help us move through to a healthier, more grounded future path of economic growth.

Leading From Behind

A shot from Tripoli last night. Can you see the American flag in the background? Can you sense how remarkable this is? Do you think this would have happened if this had been an American led project? Or if we had put boots on the ground? Obviously, I cannot know for sure, but I sincerely doubt it.

"We are sort of leading from behind," someone on the NSA staff told a reporter shortly after the operation in Libya began. This comment outraged the right. It was seen as typical liberal abdication of America's rightful and required role of leading from the front, of taking charge of any operation we engaged in. It was nice to have NATO in Afghanistan, but, as always, we were in charge. And our forces were not blended with NATO forces; they were held separately. After all, we're the Big Dog in Town. No one has the military capacity that we do. It is not only natural that we lead; it is our obligation.

I was thrilled with this approach, when Obama first described it, and we rolled it out in the early days of the air campaign. To begin with, we did the brunt of the fighting. After all, we have the  vast supply of Tomahawk cruise missiles, which were needed up front. And we had the most aircraft immediately available. So we led the early fighting and set the parameters and conditions for the air campaign going forward. And then, as Obama had promised, we pulled back.

This was an historical first. We started the project, but made it clear from the beginning that we expected NATO, and specifically, the other NATO countries to finish the job. As a result, an unusual number of other countries stepped up to the plate. My stepmother is Norwegian, and I told her how thrilled I was when a squadron of Norwegian fighter planes (six F-16s) were flying their aircraft across Europe to join the effort. A small number of planes in the total package, but a very big deal for Norway. Other small countries (Sweden, Canada, Bulgaria, Romania, Greece, Belgium, Holland, Jordan, UAE, in addition to Britain, France and Italy)  were able to participate in meaningful ways, and despite the unexpected length of the effort, they appear to have finished the job.

What does it mean to lead from behind? How does it work? What are the advantages and disadvantages of this approach? First of all, a quote from the ancient Chinese master, Lao Tsu:

     "When the Master leads, and the job is done, the people are satisfied and say, 'See, we have done the work ourselves.'"

Leading from behind is not off camera, back room manipulation. There is nothing tricky or evasive. Nor is this an effort to unfairly pass the buck, by pushing the real work onto someone else's shoulders. The leader establishes the principles, values, and central intentions of the work. He/she sets the initial conditions and the framework. This is leadership as "space making" - creating a kind of container or space where extraordinary action and accomplishment is possible, often including multiple and sometimes conflicting parties.

This is coalition-building, certainly. But brilliantly done, as I believe Obama demonstrated in this Libyan effort, something else happens. The engaged coalition becomes, in effect, a learning organization. They can learn, adapt, change and grow as conditions change. There is some absolute clarity (prevent a humanitarian disaster) and some real ambiguity (force Qaddafi out, but no boots on the ground, and we need to stay in accord with the UN Resolution). This is very hard to pull off. If anyone out there reading this has had the great good fortune to work on a truly high performing team, you will know what I am describing. When a team joins together voluntarily to accomplish a mission that is highly meaningful to each and every member of the team, the team "learns how to learn", develops resilience and staying power, and unsuspected wells of creative capacity.

When you have been on such a team, nothing else quite satisfies. It gives us a fierce confidence that people can work together at the highest levels of group capacity, and beyond, and that miracles are, in fact, possible. I think this is what we have just witnessed, because there is a very important addition to the NATO group that was always intended by the President to be the central player on the team, and that was the Libyan people. This revolution only deserved to happen if the Libyan people, mostly by themselves, could make it happen, mostly, if not entirely on their own. This win belongs to the Libyan people. That's why it has a chance.

If we had led the show from the front, this would not have been the case. And it could have been a disaster. Some groups don't coalesce. They never make it to "takeoff speed", and they fail. And that's the downside. Once again, like with Bin Laden, the President took a big risk. And it worked.

What's Ahead?

From time to time, it seems useful to take stock. Where are we heading? What are the major risks? What are the possible offsets? What should we do?

It can be difficult to step back from our current questions, commitments and engagements and seek a broader perspective. Archimedes famously said: "Give me a fulcrum and a lever, and I will move the world." The fulcrum is the key here. In the arena of looking forward, finding a quiet place of non-attachment within ourselves is the key. So let me do my best to find "quiet ground".

Our slow US economic growth and our divided politics comes up first. Europe caught in a possibly unmanageable dilemma comes up next. The near liberation of Tripoli by the Libyan Freedom Fighters and the end of Qadaffi's regime come third. So I will use the energy from these three domains to look forward.

The US economy is hurting. Believe we will see little growth through 2012. Unemployment will stay near 9%. The Anti-Keynesian Republicans have taken control of the field, and there will be no significant stimulus between now and the elections. Europe is in a political economy box: the economic solution is simple (Eurobonds issued by the ECB in massive and unrelenting quantities, a huge liquidity boost, which is exactly what Bernanke and the Fed did in 2008-2009, though without issuing bonds). But the politics for this don't work (Germany has said no; the richer North does not want to go on the hook for the poorer South). The odds of a European credit event (failure of a large bank, sovereign default, etc.) have risen dramatically. The US housing market remains dismal; and one of the little discussed causes of this bottleneck is the slowdown in the foreclosure process, caused by the banks' bad behavior in managing the paperwork in the mortgage trusts, which failure is being discovered and exploited by the foreclosure defense bar.

I am forecasting a 60% chance of a US banking crisis, probably set off by a European credit event, and clearly aggravated by the banks' multiple mortgage problems. I also see at least one bank, probably Bank of America, being put through the new Dodd Frank resolution authority. This eventuality, if it comes, is fraught with risk. Many smart financial analysts say that Dodd Frank is not prepared to deal with the international side of a major US bank, which is why many say Dodd Frank did not change the Too Big To Fail moral hazard problem. Most financial analysts would conclude, therefore, that the Fed would fight to avoid a resolution action, and that Treasury would push for TARP II. I conclude that this won't fly politically and that sometime before next summer, we will have a crisis, where the Fed and Treasury will have to learn on the fly how to wind up a TBTF bank.

I am probably in a small minority when I say I think this would be a good thing. If we want to avoid Japan's fate in the 1990s' after their credit bubble bust, we need to resolve our zombie banks, which Japan never did. We have to get the crap mortgages off their books and force some of their leaders to face the music for the mortgage mess. If a banking crisis in the US could lead us to wash clean bank balance sheets and bring back some sense of accountability of bank leaders for their bad behavior, perhaps we can have a clean and fresh start.

And remember - the third thing that came up for me was the emerging victory of the Freedom fighters in Libya. I know that this just sets the stage for the next domain of political uncertainty in Libya, but we can stop, if only for a moment, and notice the sense of hope and possibility that we all feel when an event like this occurs. More bad stuff will surely happen; but we need to reconnect with our sense of hope and possibility.

And I believe a banking crisis, courageously engaged, embraced and managed, could be such an event for the US. One thing is for sure: it will rattle the heck out of the 2012 elections!

Are US Deficits Truly Unsustainable?

I have spent some considerable time studying MMT - Modern Monetary Theory. Will cover much more of MMT in the future, not because I love economics, but because the insights from MMT are mind-boggling. They upend many of the assumptions I have been running with for 50 odd years, since I took Macro Econ from Prof. Carmichael at Princeton in the Fall of 1960.

For this post, I want to focus on the question of whether our deficits are sustainable or unsustainable, and what makes them the one or the other. All of what follows comes from an article by James Galbraith, John Kenneth Galbraith's son, and like his father, a noted economist and writer. Galbraith presents a formula developed by Willem Buiter, former adisor to the Bank of England and now an economist at Citibank, for describing the elements that contribute to the debt/GDP ratio. Here is the formula and some explanation:


                                   ∆d = –s + d* [(r–g)/(1+g)]

"Here, d is the starting ratio of debt to GDP, s is the “primary surplus” or government budget surplus after deducting net interest payments (as shares of GDP), r is the real interest rate, and g is the real rate of GDP growth. This formula permits us to put the discussion of debt sustainability on a much clearer foundation. We can say that a path that leads to uncontrolled and explosive increases in the ratio of debt to GDP is “unsustainable”—in the precise sense that the path will have to be changed to prevent the explosion from occurring."

Now here is Galbraith's own chart derived from the CBO Baseline Scenario:

Obviously, this is the pits: a debt to GDP ratio going up over 500%. CBO had us at about 300% by midcentury. What are the assumptions here: Nominal interest rate is plugged by CBO and Galbraith at 5%, inflation is set at 2%, meaning real interest rates are 3%; GDP growth rate is 3%; the starting debt/GDP ratio is .74; and the budget defiit stays at 5% of GDP.

But Galbraith asks if these interest rate assumptions are reasonable. The Government does not need to issue long term debt, with its higher rates; it can stay with the much lower short term rates (right now, just above zero). So he runs the model again with one change: nominal interest rates are set to 1%, not 5%. Here's the result:

Obviously a much prettier picture. And if we still think the almost 130% debt/GDP ratio is too high, then Galbraith runs numbers with a 5% budget deficit for 15 years, dropping back to 3%. Here's what he gets:

It turns out that if the real interest rate is positive, any amount of deficit is unsustainable. But with interest rates below the rate of inflation, quite significant levels of budget deficits can be "manageable."

My question: what will Republicans do when we Americans stop being afraid? There are clearly other questions related to deficits and the economy; but certainly one of them has been this fear that our "unfunded entitlements" were going to overwhelm the economy, in the form of rising debt/GDP ratios, and our kids' lives would be ruined. This is simply poppycock. Much more about this soon.

Obama, Populism, and the Financial Crisis Redux

My best friend works on Wall Street. He's been working to teach me about the Street, and in the process we have engaged in a terrific debate about US politics, economics, and the current state of affairs. The following is the major portion of an email I sent him today. Will not try to explain what he wrote that I was responding to. I trust it will be self-explanatory. He did start out in a recent email me to advise me that Wall Street is not a monolith, that there are segments that have differing perspectives and interests: particularly the Bank segment (BOA, JPMChase, Citi, Goldman, etc.) and the non-Bank segments (boutique banks, asset managers, investors, etc.). You could count on these segments differing on topics like TARP, the stimulus, etc. With that short intro, here's the post:



Populism is certainly a divide and conquer approach and might well affect attitudes that affect the markets. So if markets are strong for an extended period of time (March 2009-Spring 2011), wouldn't that indicate that "populism" is absent? Obama was much more "populist" during the "bonus crisis" in 2009 then he is now. And who discouraged Dems from pursuing the "bonus tax"? Do you really think Obama is a populist? I don't.

You criticize Buffett for stepping up and saying the wealthy should pay more in taxes, because he has already made his money. I, for my part, admire him. He's willing to say that the sacrifice must be shared, and that current and proposed Republican tax policy asks nothing of the wealthy. What has been completely absent from the scene is anyone from any side of Wall Street stepping up and saying "We screwed up...all of us...and here's how I/we contributed to the mess..." When I see any part of Wall Street stepping up in op-eds and accepting some responsibility for what this country went through, I will jump on Obama for "populist" comments. In the meantime, I will let him hammer at will.

Re the banks: you have pointed out elsewhere that the Fed successfully used "extend and pretend" in the past to help recapitalize the banks, providing low interest rates that made it easy to make money and rebuild balance sheets. Key difference: then (1990s') we had some uplifting inflation. Now we have deflationary pressure. It won't work this time. Probably before next summer, and most likely catalyzed by some bank or sovereign failure in Europe, we will have a banking crisis in the US. If so, and my probability is over 60%, we will have a second chance to restructure the banks. BOA will surely be the canary in the coal mine, the first to expire. I know what megabank Wall Street will say: "Save me. You can't live without me. And don't even think about restructuring me. It's too dangerous." What will non-bank Wall Street say? Romney should pray daily for this eventuality. It's his ticket to the nomination.

When before, I said I was surprised the chain of title mess didn't seem to register with you, what I meant was I didn't understand why this didn't make you mad. I knew you were aware of it, as you are hugely well read and informed. It makes me furious. You simply cannot have probably millions of mortgages in trusts that have incomplete documentation without system-wide gross negligence, malfeasance and probably fraud. When I first encountered these issues two years ago, I said to myself: "This is impossible. It means every investment banker, every supporting lawyer and accountant, every trust banker, every bank servicer must have worked together and supported a process of seccuritization that at the very best was combined gross negligence, and more likely represented broad scale fraud." Why would they do it? Arrogance is my answer. Treating the investors well, punctiliously following the requirements of the PSA's, didn't matter very much. The investor money was coming or in. Reps and warranty cases are enormously hard to pursue - you (as Brian Moynihan threatened) have to fight them case by case, loan by loan, mortgage by mortgage. Everybody ALWAYS settles early. And chain of title??? You think individual homeowners, those idiot and deadbeat borrowers can take us on? We'll kill them. Trust me, amigo: what I write above is what happened. You can question my preferences, my perceptions, my politics. But you cannot question my facts. And since I know my facts are right, you ought to be upset, because these arrogant idiots are threatening the honor and dignity of your chosen and noble profession.

Two more examples of arrogance, deception and most likely, fraud:

Am sure you know that Clayton Holdings did about 70% of the MBS pre-bond sale due diligence. Am also sure you know that Clayton's former President testified before Congress that over a very broad series of issues, Clayton found that 47% of the sampled mortgages did not meet the reps and warranties in the MBS bond prospectuses. Was anything done about it? Mostly no, except to go back to the mortgage poolers and negotiate a discount. And who got the discount? The investors? Of course not. The banks. Were investors informed of either the size of their portfolio that was outside of reps and warranties, or that the sponsor bank had negotiated a discount on the mortgage pool acquisition? No. Fraud, in my book. Apparently Dodd-Frank now makes it clear that this sort of information must be disclosed.

Again, as you know, the housing market peaked in the summer of 2006. The 2 year Option ARMs sold in subprime deals and packaged into RMBS bonds in 2004 began to trigger to new, higher rates, and defaults began to jump. There was a brand new CDS index measuring CDS spreads on subprime. The index didn't start moving for six months. And then, in early 2007, the shit began to hit the fan. Bear Stearns fell in March. So why didn't the crisis happen then? What put this off until September 2008? The shorts. Paulson. Magnetar. And their synthetic CDOs' that probably only 5% of either side of the Steeet understood. The synthetic CDO: truly a creation of evil genius. It looks like a AAA, investor grade, all is well in the mortgage world bond offering. What it really was is a huge bet that the mortgage market is about to tank, with true "chump" investors on the buy side, presumably convinced by the AAA rating that the investment was safe. For 2007 and the first half of 2008, the synthetics dominated the market, and probably kept the bubble going 18 months beyond its "sell by" date. Goldman picked the market peak in late 2006 and decided to start a scramble to offload subprime bonds in their inventory. They were a prime player in the synthetics market, and shoved a lot of their dreck into the offerings. What should we call this sustained, strategic, and focused behavior? "Screw your customers. Kill them. Give them all the shit you can..." Some traders, after just a short period "in the pits" with the real "killers" at Morgan or Goldman were heard to report: " Brother. I've had competition before. But this pure bloodlust to tear the eyes out of your customers. This was absolutely brand new and exciting." What do you call this? I call this money-making pornography, where, like sexual excitement and other excesses, it all turns eventually to violence. When the Wall Street denizens sat and faced their Congressional interrogators, and seemed surprised and confused by some of the questions, that implied that they might have acted badly...these were the violent capitalist warriors that Congress faced. When you trade, a customer is an object. Nothing more. And the possibility that someone might think they were more than objects to be toyed with, and sometimes crushed, was literally confusing. The people Congress met were traders. Warriors. Kill or be killed. And of course, as Goldman's CEO, Lloyd Blankfein said: "We are doing God's work."

The malfeasance and fraud was extensive. And we haven't even touched the rating agencies, who allowed themselves to be convinced that a pile of crap, subprime mortgages, if organized in descending, waterfall-like trenches, could, as if by magic, be turned into AAA gold securities, on a par with US Treasuries. And how about the next "miracle", when the unwanted triple B, mezzanine portion of the first CDO, comprised totally of crappy, subprime mortgages, was repackaged, sprinkled with fairy dust, and magically converted into a triple A offering, called a CDO-squared,  without any new, higher quality mortgages being added to the pool. And no one, from bank or non-bank Wall Street has complained.

This is a very sorry story, well deserving of criticism. And the fact that no one from the Street has provided any form of self-critique convinces other Americans that most of Wall Street simply lives in a separate universe, hopefully running parallel with our universe, but we are not quite sure of that. To my mind, Obama is not guilty of too much populism. He's guilty of molly-coddling the banks, listening to Geithner and "extending/pretending". Not too much populism. Too little real critique. Not done for politiical gain, but to excise a wound in the American experience.

Obama, Nonviolence, and the Civil Rights Tradition

The following is the full comment from reader Tom on a post by Steve Benen at The Washington Monthly on August 11. The comment has gone viral.  I found it tonight on Andrew Sullivan on The Daily Beast. Very few observers see how Obama's approach to governing and dealing with the opposition Republicans is firmly rooted in the nonviolent, "let us reason together as friends sharing common values" civil rights tradition. For those of you out there who are convinced Obama just got clobbered in the debt ceiling negotiations, pay very close attention to what Tom says. Of course, we won't know for sure until November, 2012, but I think Obama, on a deep, moral and character-based level is supporting Republicans in cleaning their own clock!

"The predominately white progressive intelligentsia don't see Obama clearly because of our racial blind spot. We don't see the role of race in how he seems to understand himself and how other perceive him.

First of all, we think that he understands himself as one of us. A progressive activist, heir to the radical and New Left movements most of us were raised in. He is not; I think that he understands himself (and certainly his real base understands him) as the first African American President. We're thinking Jimmy Carter and Bill Clinton. We should be thinking about Harold Washington, the first African American mayor of Chicago. Washington was elected and immediately faced a solid wall of opposition from most white aldermen in the city. Washington understood his role as breaking down that wall of opposition and assembling a governing majority, which he finally did after his re-election. Unfortunately, he died shortly thereafter. By the way, one of Washington's political strategists was David Axelrod.

How does Obama break the iron unity of the GOP opposition to assemble a governing majority in the US Congress?

If we progressives were not blinded by our own assumption that our history is the only history, we might see how Obama may be seeing his situation.

White progressives often think that African American elected officials are politically naive. We will far more credit to Cornel West, who has never been elected to anything, than to an elected state senator, or even the President of the United States. We think that Obama does not understand the nature of John Boehner, Mitch McConnell or Eric Cantor, as though he has not sat across the table from them. He doesn't understand how mean they are, we think.

Obama acts entirely within the tradition of mainstream African American political strategy and tactics. The epitome of that tradition was the non-violence of the Civil Rights Movement, but goes back much further in time. It recognizes the inequality of power between whites and blacks. Number one: maintain your dignity. Number two: call your adversaries to the highest principles they hold. Number three: Seize the moral high ground and Number four: Win by winning over your adversaries, by revealing the contradiction between their own ideals and their actions. It is one way that a oppressed people struggle.

Obama has taken a seat at the negotiating table and said "There is no reason why we cannot work out solutions to our problems by acting like responsible adults. That is what people expect us to do and that is why we have entered into public service." That is the moral high ground.

Honestly, I have been reminded more than once in the last few months of those brave college students sitting in at a Woolworth's lunch counter, back in the day. Obama sits at that table, like they did at the counter. Boehner and McConnell and Cantor clown around, mugging for the camera, competing to ritually humiliate Obama, to dump ketchup on his head.

I don't think those students got their sandwiches the first day, but they won in the end.

Obama is winning. Democrats are uniting behind him, although some white progressives think that they could do the job better. Independents are flocking to him. Even some Republicans are getting disgusted with their Washington leaders. Obama is not telling us about lack of seriousness of the Congressional GOP; he is showing us the vivid contrast between what we expect of our leaders and their behavior. The last two and half years have been a revelation of the essential conflicts in our society and politics.

If white progressives understood much about the politics of the African American struggle in the United States, we would see Obama in the context of that struggle and understand him better. And you don't have to be African American to know something about the history of the African American struggle. The books and the testimony is there. It's not all freedom songs. But you have to be convinced that it is something that can teach you something you don't already know."

Obama as Transformational Leader

A good friend of mine asked me how I define transformational leader and why I considered Obama to be such a leader. Here, more or less, is my reply:


Transformation - from the Cambridge dictionary:  a complete change in the appearance or character of something or someone, especially so that they are improved.

So as I see it, a transformational leader is one who has the capacity to effect, directly or indirectly, transformation.Profound change that makes things better. Affects interiors (culture, values, group psychology) and exteriors (systems, structures, process) of a definable group (GE, the auto industry, Wall Street, Main Street, the US, etc). Obviously a judgment call as to when change is fairly labeled as transformational. And, as always, people will disagree what is improvement, versus what change  makes things worse. As always, beauty is in the eye of the beholder. Disagreeing with the quality of the result in most cases does not call the transformational naming into question. But "profound" or "complete" must be present.

What transformational changes do I credit Obama with:

1. Healthcare legislation - Like it or not, hard to argue that this legislation is not transformative. Pretty sure it will make it through the Supreme Court, and that it will weather Republican challenges. If Obama loses in 2012, it's toast. but better than even odds that it will make it through 2014 and the opening of the Exchanges. Many don't like the legislation, and feel it was crammed through on a partisan basis, that the public doesn't like it, and that it wasn't what the country needed. All good points, but not in question now. If the change is transformational, did Obama effect it? My answer is yes.

What did he do that others before him did not do? He established three key principles that he said needed to be present: near universal coverage; bend the medical care cost curve; and no more than $1 trillion investment that needed to be earned back in savings. He then stayed out of the trenches, to the frustration of many Dems. and to the horror of the hard left, when the public option was lost. There is some fascinating evidence from the biological sciences on how change occurs in highly complex and open systems: turns out a clearly articulated identity, if combined with open information exchange and effective relationships is what expedites and nurtures systemic change. Set the identity-determining principles, and step back. This is the very best way to herd cats. And, as the leader, only intervene when something starts to go south (in this case, the Scott Brown election, when Obama had to step in to bolster the troops). This doesn't mean that the leader is absent; he acts as space holder - constantly restating the principles, ensuring good communications, and promoting good relationships throughout the system, especially around the creative, chaotic margins.

Obama did this masterfully. Clinton did not. Nor did the other Presidents who gave healthcare a shot. This is not a leadership practice or approach that is easy to master. It takes vision, patience, fearlessness, trust, courage, resilience, and "my-house-is-built-on-a-rock-and-will-not-blow-down" sort of self confidence. Obama, I believe, has thee qualities, as do other leaders I consider transformative (Lincoln, FDR, Gandhi, King, Mandela).

2. Auto industry restructuring - Many objected to the way the secured creditors were treated in this deal, especially relative to the unions. Again, a completely legitimate question, but not at issue here. Was the change transformational? And if so, did Obama effect it? The answers to both questions, in my book, are Yes. Could the same results have been accomplished in regular chapter proceedings, with less bruising to bondholders? Perhaps, but it is not clear if anyone other than the government have could provided the DebtorInPossession financing, and if the government was going to do that, why not go all the way. Bold. Courageous. Timely. Very different skills than needed for the healthcare arena. There, the President had some, but not too much power and control. He needed Congress and outside groups. In the auto bailout, he held the cards and had the money. In this case, he effected the transformational change more directly.

3. Deficit/debt/debt ceiling discussions - Why do I have this on the list? The President got rolled by Republicans, and the result of the mess was an S&P credit downgrade and very upset markets. I put this on the list because I believe the President made a conscious choice to enter negotiations over raising the debt ceiling, thinking he could get a Grand Bargain, combining spending cuts, tax reforms and new revenues. Was he naive? Possibly. But I believe he still would have gone forward to negotiate, even if he knew he was going to lose. Why? He felt he needed to transform the conversation and put Democrats squarely in the path of embracing fiscal discipline. The people were afraid about the country's economic foundations. Democrats could no longer be "tax and spend", with Republicans owning the "cut and cap" terrain. They would lose big in 2012. Obama lost the battle; but he may well win the war. Republicans no longer own the fiscal discipline title. Dems want revenues as well as cuts, but no longer are we talking revenues/programs versus cuts. Obama moved way out ahead of his Party, a huge risk, as evidenced by his losing half the House in the final vote. But the Party stuck with him, and they now can claim co-ownership of the discipline domain. This is transformational precisely because he had a choice to shut down the conversation by threatening to use and then using the 14th Amendment. He chose the tougher road, and a transformation in his Party's mental and political positioning was the result.

4. War on Terror - This is one of the invisible transformations Obama has effected. It's sort of like the fish in the water: he/she has no idea that they are swimming in water; it's just how things are. What happened to the War on Terror? Where did it go? Why is no one much talking about it anymore? Why does this almost never come up in the Republican races that are beginning to heat up? Why do people feel less afraid now than they did before? Would Americans agree in any numbers with what McCain and Lieberman were saying not so long ago - that Islamic jihad is an  existential problem for the US that needs to be combatted through a global war on terror? I think not. This conversation has lost its bite. Why?

For a whole host of reasons. First, he changed the language. He simply stopped describing our military engagements as part of the war on terror. There was great hesitation to focus on Islamism, Islamic jihad, or Islamic terrorism in DOD or State communiques. Conservatives objected loudly, for a while. But most just gave it up. Nobody seemed to care very much anymore. Iraq was winding down. Afghanistan was surged up, and now will be wound down. "Victory' is off the table for Afghanistan as an objective, as it was earlier taken off the table for Iraq. In an extraordinary act of presidential leadership (Bob Gates says "It was the gutsiest call he has ever seen a President make."), Osama Bin Laden was killed. And going back to the beginning, Obama made a critical decision not to pursue any of the Bush team on the torture questions. Obama also backed down on Guantanamo and civilian trials, when it was clear he did not have the votes or the public support. So a lot of actions contributed to the changed awareness we see today. Worriers on the Right will say you don't fix a problem by pretending it doesn't exist. True. But if it really wasn't an existential problem to begin with, then the only way to bring balance is to step back a bit and simply change the terms of the conversation. Obama did this, and the effects are transformative.

5. International politics of engagement - Would the Arab Spring have happened in quite the same way if Bush had been President? Or Clinton? I don't think so, but obviously, this cannot be proved. Obama made his big speech to the Muslim world in Cairo, soon after his inauguration. The Right calls it the Great Apology. I call it an Invitation to Engage. He then proceeded to unwind from Iraq, and to step up in Afghanistan, but with obviously limited and time specific objectives. On January 4, 2011, Mohamed Bouazizi, a small Tunisian merchant, set himself on fire in protest against the government, and the Arab Spring began. I believe Obama's invitation to the Muslim world in Cairo, followed by the US stepping down in Iraq, and stepping up in Afghanistan, but with limited objectives, played a part in what happened. Whether this is right or not, it is very hard to argue that US policy since then has not adapted pretty well to the rapidly changing circumstances on the ground in the Middle East. We are not "home free" but we are neither resisting the changes to protect old autocrat allies, nor are we trying to force the change or run the revolution ourselves. We are letting a critical part of the world, in effect, go a bit wild mostly on its own. Scary. Amazing. Transformative. Would Bush or Clinton have done this? I am pretty sure the answer is No. I am still very much in the minority, but I believe the forces unleashed in the Arab Spring, in ways I can only guess at, will eventually lead to an Israel-Palestinian Peace Agreement, and a transformation in Iran. There's a long way to go, but I would bet on it. If this all were to happen, would it be fair to give the credit to Obama? Probably not. But by not interfering too much, and clearly indicating our support for freedom and dignity for the region's people, and not sending in our troops, Obama will have gone a long way to nurture the transformations underway.

That's all for now. More tomorrow.

How Bad Is It?

The markets tumbled again today. Down 520 points. The market: Monday - big down; Tuesday - big gain; today - big down. Net loss: over 700 points. Paul Krugman had a tough post this afternoon, titled "Dismal Thoughts". His ending sentence:

"I’m still trying to make sense of this global intellectual failure. But the results are not in question: we are making a total mess of a solvable problem, with consequences that will haunt us for decades to come."

Here, in the US, we need to spend. With the consumer retrenching, and business seeing little demand and therefore not investing, government spending is needed to create jobs and generate demand. To Krugman, a student of the Depression, this is obvious. To conservative economists and Republicans, this is anathema. Progressive critics of the President like Krugman and Robert Reich say the President has failed miserably. He has bought into the Conservative argument that deficits and debt levels are the problem, that we must cut back. He says we now need to pivot to jobs, but with almost no prospects for real legislative progress.

My question: if Obama agreed with Krugman, would he have been smarter to ignore spending and deficit issues, and try to mobilize support for a second stimulus? Even if he had not been successful, would this have been the right path? Does a good leader always have the responsibility to stand up for what he/she believes is right, even if the public does not agree?

I don't think so. No leader can get too far ahead of his troops. America is afraid again. The last time we became afraid was after 9/11, when America's splendid geographic isolation was penetrated by terrorists. This time the crisis was economic - the September-October 2008 financial meltdown. Through completely false Republican messaging, this private debt crisis was converted into a sovereign debt crisis, brought on by "terrifying deficits" and "completely unsustainable debt levels". The Tea Party arose out of this ground of fear, spurred on by endless Republican attacks, decrying the coming "government takeover of healthcare" and "exploding. unsustainable entitlements".

Polls may show that the American people are more concerned about jobs than they are about the deficit. But try polling: "Would you support a second stimulus of $1 trillion to create jobs?" I think Americans in much larger numbers than just the Tea Party, would have risen up in opposition. Many Americans were afraid that the country's economic system was teetering, and that it might all fall down if we did more government spending.

I believe Obama needed to engage the spending and deficit conversation, because even though Americans wanted more jobs, what they were terrified of was that the economy would collapse under the weight of government spending and debt. The President needed to engage this conversation. If he had done otherwise, he would have moved too far ahead, or even way off to the side of the "conversation road' the people were traveling. He needed to travel with them, and demonstrate he understood their fears.

Obama did this honestly.  He adopted the people's desire to put America's fiscal house in order. Progressives like Krugman and Reich were and are dismayed. But I think Obama made the right choice. Right economic policy thinking would have had him push for more spending. Right political thinking had him step squarely into the people's concern about fiscal order and discipline. He does not own that ground. He shares it with Republicans. But he did not abandon this ground, nor ignore the people's concerns, in order to pursue correct or right economic policy.

I don't come to this conclusion lightly, because economically, I completely agree with Krugman and Reich. But a leader must stay with his team. He must understand their concerns and represent them fairly in the day to day rough and tumble of life. There will be time for the "right policies". But first we need to be in the coming 2012 election fight. And we need to win.

So how bad will this be? Double dip recession, or just Japanese like limping-along? Right now, I favor the latter, but if Europe were to go down hard, we are quite probably looking at a double dip.

Hold on to your hats. The ride will be a bit rough.

Obama as Leader

This has been a rough week for the President. The debt ceiling deal was finished up last Tuesday, August 2, and was largely seen as a win for Republicans. The S&P downgrade came late Friday, August5, the same day that the President got word that 30 servicemen were shot out of the sky in Afghanistan. Yesterday, the Dow dropped over 600 points (although it recovered much of that ground today) and Obama's early afternoon presser was widely panned.

There has also been a host of hard-hitting critiques from Progressives: Drew Westen in Sunday's New York Times. Yesterday, Mike Tomaskey wrote in The Daily Beast. Today Cenk Uygur in The Huffington Post. Yves Smith, writing in Naked Capitalism, tells us she has started a hashtag on Twitter - #ReasonstoPrimaryObama. The Right, unsurprisingly, is relentless. This morning's Wall Street Journal example in an op-ed by Bret Stephens is noticeable, but not remarkable for its ad hominem attacks. The Right doesn't dislike Obama. They hate him. It is felt very personally. This is not confined to the Tea Party. It's up and down Wall Street.

I will let the reader, if you are so inclined, read the pieces I link to. All of them are thoughtful and well-written. I will not lay out in detail all the arguments. I will focus on a central and recurring one that the Progressive writers make: Obama is weak. The Caver-in-Chief. Too nice. Unwilling to place markers down or draw lines in the sand. No one knows, so we hear, if he holds any progressive, or even any other values that he would go to the mat for. Does he believe anything strongly enough to really fight in the trenches for it, perhaps to risk dying for it? Is he so obsessed with his "Red and Blue Together" meme that he cannot accurately perceive the battle terrain or the nature of the enemy? Will he ever call Republicans out? Will he ever not compromise, and engage in a real and worthwhile fight?

These are important questions. By now, if you have followed this blog, you know my perspective. I think Obama is an extraordinary, in fact, transformational leader. He may or may not win a second term, though I think he will. Even if he does not, I suspect my perspective on what sort of leader he is will not change much. Remember: transformational leaders can be defeated, as any leader can be. Victory is just one of the measures of enlightened and great leadership. But I will try not to look at the current critiques or the present situation with completely preset lenses. I will start with a question: Did Obama cave in the debt ceiling deal? If so, why?


Yes, he did cave. He wanted revenues and he didn't get them. Going in, he thought he could get a Grand Bargain with the Speaker, which would include revenues. He came close, but close only counts in horseshoes. When he saw Boehner would not try to override the Tea Party, he gave up on revenues. And he took an unbalanced deal, which he had said he would not do. Why? I believe he did not want to put the country into a constitutional crisis, which would have happened if he had invoked the 14th Amendment. I favored the 14th Amendment defense. I thought it would have been a remarkable way to define Republicans as the radical and dangerous party. But Obama is not a trickster. Pulling a presidential rabbit out of the hat would have been , in many peoples' eyes, a trick. So he relented. Was this weakness or strength? I increasingly think the latter.

And how have Republicans fared with their victory? The CNN poll released today has some remarkable findings: Republican Party approval/disapproval ratings are in the worst shape they have  been in since 1992 when CNN began the tracking report. 33% approve, versus 46% for Democrats. The Democratic rating has been holding steady, where Republicans have dropped over 20 points in net approval since last November. Andrew Sullivan  makes an important and intriguing point tonight: Obama has an "an uncanny ability to get his opponents to destroy themselves."

Obama is a nonviolent leader in the tradition of Mandela and King. He is also a warrior leader in the tradition of Lincoln. These qualities don't blend, you might say. I disagree. And I hasten to point out that Obama has miles to grow and many mountains to climb before he can be truly compared to these towering figures. What I am saying is that he is walking in their shoes, exhibiting some of their patterns, expressing elements of their being, demonstrating some of their practices.

Obama is not antiwar. As he told us in the beginning, he is against "dumb wars". He is thoughtful about strategy, unafraid to confront his generals, courageous in decision-making, and effective in follow-through. The Bin Laden mission demonstrated all of these qualities. He has grit, backbone. He's not afraid of taking big risks. Just ask Bob Gates: "It was the gutsiest call I ever saw a President make." Even the Right is strangely quiet in their critiques of him on military leadership and policy.

As for the non-military domain, here is where the Peaceful Warrior shows up. War, this individual knows, is a highly ineffective and inefficient way of getting things done. There are many good arguments against the nonviolent or peacemaking approach: You have to live in the real world. It's tough out there. If you don't stand up and fight, your own people won't respect you. Neither will the enemy. And they will run you over. You've got to draw clear lines so people know who you are and where you stand and what you are willing to fight for. Give an inch and you'll have to give a mile. America loves winners and hates losers. It's a dog eat dog world out there, and victory goes to the toughest, meanest cat in the jungle. I could go on and on.

The Peaceful Warrior knows there is, or can be a better way. It's based on listening to everyone, respecting them, and looking for areas where your interests coincide. You are not naive: Jesus, in Matthew says, "Be gentle as a dove and shrewd as a serpent." Do your best to "know" your enemy, what their goals are, what tricks they may have up their sleeve. Notice even their hatred if it is present. Recognize it, but don't respond in kind. In the wonderful words of Lao Tsu, don't be stiff or brittle; rather be flexible and fluid. Jesus said: "Resist not evil." Lao Tsu told his disciples to open themselves to the slings and arrows of others, and they will pass right through without harming you. Stay peaceful inside. Let the fighters fight and the battles rage around you. But don't take this inside; don't let it destroy your interior quiet.

When an enemy attacks, use his energy and divert it, so it works against him. Do not attack first. And do not attach to either victory or defeat. This is the Way of the Peaceful Warrior. It is Obama's path. I doubt he would describe it this way. But it is how I understand it. This is an extremely difficult path to master. As Aikido students have a very long journey, much discipline and practice before they can become sensei, so it is in the world of politics and everyday life, before someone can become what I call a Peaceful Warrior. Obama is the first political leader who consistently, over the three years I have studied him, exhibits the qualities of being that a sensei in the political domain must have: courage, vision, compassion, patience, fierce discipline, fearlessness, resilience, equanimity and joy.There is one word that best describes the complete package: presence. This is the source of Obama's oft-noted "zen-like" imperturbability.

I believe Obama is a Master, a true Peaceful Warrior. There is no absence of courage, no inability to be decisive. I think he has the capacity to help us heal our very wounded country. He is not, I do not believe, a healer himself. But I believe he has the capacity to create the space for us to heal the country ourselves. Will this work in our country at this time in history. I believe so. But I am not sure. We will have to see.

Taking Stock

Every once and a while you come across a post that speaks volumes to you, and seems to tie things together, at least in some parts of your thought universe. Yves Smith at Naked Capitalism had one this morning, where she included a recent speech by noted economist Jamie Galbraith, John Kenneth Galbraith's son, keynoting the 5th Annual Post-Keynesian Conference in Dijon, France: Bad Economic Thinking and What Got Us Into This Mess.

Galbraith looks at the three main threads that grew out of Keynes' work and shows us where they are today. I addressed this topic of why Keynes has been shot down in conservative circles in a July post: Why Have We Discarded Keynes? Please do read Galbraith's Dijon speech in the posting above. I will highlight key points that jumped out or me.

We have no consensus among economists about how the world works. Galbraith laments that the 2008 crisis gave economists a unique chance to step back and reevaluate; unfortunately nothing much changed, and there was precious little rethinking. The neoclassical/neoliberal worldview dominates Western thinking: consumers are rational; markets are efficient, except when government intervenes; markets can be modeled (dynamic stochastic general equilibrium models are the rage) but are hard to understand for non-mathematicians; demand (for goods, services, or labor) is never a problem; markets tend towards equilibrium; asset bubbles can't happen, and when they do, they are the exception that proves the rule; unemployment is mostly caused by people choosing not to work, or government regulatory interference in the market, or people not having the right skills (structural unemployment); government spending cannot create jobs because private people will hold back an equivalent amount of money to pay for the taxes this spending will require; deficits are inflationary; in a recession governments should lower taxes and cut spending, in other words, austerity is the key to growth.

This is the prevailing "economists' consensus" that rules in Washington DC, European capitals, The European Central Bank, and the IMF. Summers, Geithner, and Bernanke disagree with key parts of the neoliberal consensus, but they totally missed the housing bubble; they think markets work efficiently most of the time; and their thinking seems to allow no place for the institutional brokenness in the financial sector that took us down. Obama is being creamed by lots of smart progressive folks who believe he has been very badly advised by Summers, Geithner and Bernanke. They were fine, these critics say, during the liquidity crisis. They were downright lousy when it came to seeing, understanding, and acting to correct the "heart of darkness" at the center of our financial system. I count myself as one of those critics.

According to Galbraith, there are three threads flowing out of Keynes: one, originating with Wynne Godley, focuses on national accounts accounting and sectoral balances - this school leads to Modern Monetary Theory, which I addressed here; a second, originating with Hyman Minsky, argued that markets do not tend to equilibrium, and that greed propels a market to move out of balance in to increasing waves of instability; and third, Galbraith pere, Jamie's father, who focused on the institutional and legal framework, created with the New Deal, within which a workable capitalist system must be contained. This is the part of the Keynesian heritage that has been most completely overlooked.

Galbraith makes the fascinating point that economists don't really know what to do with the financial economy that is dealing with contract created products that bear no resemblance to the real economy. Economics in the "real economy" depends on the commodification of hard products and measurable services about which many rules and models can be devised. But contract-based products like mortgage backed securities or credit default swaps don't seem to make much sense, and, therefore, are not studied. Yet it is precisely this part of the economy that blew up.

Galbraith then makes a frightening assertion: the legal/institutional framework is greatly affected by technology, which overtime corrupts the system beyond repair. The financial system, specifically investment banks and the banks, have a terminal illness. Technology has rendered financial products completely unintelligible and have guaranteed a level of fraud and corruption that is totally untenable.

Stocks were simple: every share looks like every other share. But mortgages - that's a different story. Each mortgage is tied to a different house, in a different location, with a different owner. The opportunity for chaos and corruption to emerge out of computer generated models and programs used throughout the securitization daisy chain was and remains too great: bundle a group of mortgages; sell them; bundle them together with another group of mortgages; sell them again; collect a large group of bundles and put them into a trust that then supports a security offering; that before it is sold is presented and highly blessed by the rating agencies (AAA versus our US AA); then the security is sold to investors who have no idea what the quality of the collateral pool really is and do not realize that when the investment bank doing the deal did a check on whether the trust mortgages met the reps and warranties in the bond offering, and found out they did not, they would leave most of the mortgages in the pool, or substitute even worse mortgages in; and when the mortgage pool began performing badly, and the bank servicers had to manage large numbers of house foreclosures, they found out that the trusts did not really have the required and certified (by the large bank trustees) to be present notes and fully endorsed mortgages; so they had to create new paperwork from scratch, and since time was of the essence, they hired foreclosure mill law firms to "robosign" the documents.

And I'm leaving out some of the best/worst parts: predatory loans on the front end - loans that everyone in the chain knew would not be repaid, but no one cared, because eventually the investor owned the mortgages - not the originating bank, not the intermediate bundler, not the investment bank selling the security; MERS - Mortgage Electronic Registry System, a technology facilitated system that allowed computer tracking of mortgage assignments and transfers, and avoided that irritating detail of paying local real estate recording fees at each transfer stage (leading now to a massive problem in the court foreclosure process establishing chain of title and standing to foreclose - and this problem is only getting bigger); the creation of mortgage tranches, or levels/tiers that quite magically, using computer modeling, converted a very similar pile of junk into a security containing 70-80% perfectly safe AAA mortgages; and the synthetic collateralized debt obligations, where major players, who wanted to short the market, made credit default insurance payments into the trust, referencing a specific pool of mortgages (which they often helped to select), with their insurance payments mimicking real mortgage payments and the resulting "synthetic (no real mortgages at all) CDO" receiving a AAA rating, and these securities that were really just big short positions, gave a luster of continued energy to the entire mortgage market, and probably delayed the crash by two years.

When you study all of this in some detail, it is appalling. My Dad was CEO of the Quaker Oats Company, now part of Pepsi. I worked at Quaker for 12 years. Honesty, integrity, quality, service were key values. They were in the very air we breathed. It absolutely never occurred to me that an entire industry could go bad. Galbraith's point is that technology/computers/computer modeling has made large scale fraud and deception so extraordinarily easy. We all know how impressed we are when we see a multi-page computer spreadsheet report that shows us a giant pool of something or another, with a summary page showing how all the numbers add up in attractive ways, and we simply know it's going to be fine. This is what we have now. This is what caused the crisis. And the patient is terminally ill. As soon as the consumer starts buying again, this same process will restart, in some new corner of the financial universe.

There is much we must do. This post is already too long, so I will tackle the to do list tomorrow. A simple summary: regulation must be greatly stiffened; regulators have to regulate again; and most likely, our banks must be restructured. More tomorrow.

Evening Thoughts

It's Saturday evening. Almost bedtime. Just a few evening thoughts.

Friday late afternoon, S&P downgraded the US to AA from AAA. Accusations are flying from both camps. I think Ezra Klein at the Washington Post is right when he says that S&P is downgrading our political capacity to effectively manage our economy, not the US' ability to pay its bills. If there is a hostage taking crisis each time we need to raise the debt ceiling, the odds are not negligible that one of those times we will slip over the edge. That in S&P's eyes is a real risk. Hence the downgrade. Hard to pin that on the Democrats, and I am very comfortable calling this the Republican downgrade.

Will the markets spook? Yes, but not just because of the downgrade. The markets are waking up to the fact that the US is in for a tough slog. Double dip? Possibly. But whether it's a second dip or only meager growth, it will, in either case, be rough sledding. If the consumer has pulled back, and business is not spending because there is little demand, and the government will now be retrenching, there's no source of economic demand. And we have one party that honestly believes that demand is not the issue: it's lack of confidence. According to Republicans, business will only spend when they have confidence that government will not change the rules and will stay out of the way. This is the myth of the confidence fairy. It's just utterly wrong. Business will start spending when orders start coming in the door. Right now the consumer is not spending, and until she does, or until government does, there will be no growth. With the softer dollar, exports have gone up some, and we have an improved trade balance, but exports will never drive the US economy.

These are different and difficult times. I do not think I have seen anything like this in my lifetime: We have a true balance sheet recession: the private sector vastly overleveraged; housing maxed out; the housing asset bubble burst; probably half the US households, and possibly much more, experienced a 30-50% decrease in their net worth, mostly from loss of housing value; unemployment is running, on a true basis, between 16 and 18%, so consumers, in many cases have little coming in; so they are not inclined to spend until their balance sheets have been repaired.

At the same time, we have Europe moving visibly towards the edge of their precipice; and there are even clear signs of trouble in China and Japan. So who will stimulate the world? And through all of this, we have a radically intransigent Republican party who does not believe stimulating the economy can work, who believe deficits and debt are the problem, and think austerity will help us grow. It's beyond crazy. It's incredibly sad.

Afterthoughts (2)

The Progressive feedback is quite consistently negative. Here's a good example: William Galston - Obama's Three Biggest Mistakes. Galston argues well that there were three big errors: not doing the deal in December; not locking Boehner in when he had agreed to $800 billion in new revenues; and not endorsing the Deficit Commission's findings.

I agree with Galston that the deal could have been done in December. Would this have been better? It might have been. But we forget that Obama wanted to have a debate about getting the country's fiscal house in order. He wanted to engage on budget and debt issues. He felt these issues weighed on the public's mind. People were afraid, he felt,  in some not fully articulate way, that the country's economy might somehow slip away. So he made a choice not to bury the debt ceiling question in December. He made a choice to engage. Good idea or bad? I think the decision will wear a bit better with time. We will see.

On Galston's second point, why didn't Obama lock Boehner in at $800 billion in new revenues? He didn't because Democratic legislators had revolted, and told him it was lunacy to give up the coming Bush tax cut expiration revenues in return for just $800 billion. He responded to his team, which I think he needed to do.

Galston's third critique is, in one form or another, echoed across the web. Why didn't Obama endorse the Deficit Commission and seize the high ground up front on the debt ceiling debate? Quite simply, I do not think he wanted to put entitlement reform on the table as a starting position. Remember, the Commission never officially issued a report. They could not get the required number of Republican votes. Paul Ryan did not sign on. It looked like Republicans would not support a balanced (spending cuts plus new revenues) approach. In fact it wasn't clear where they were headed on deficit reduction. Were they just going to play political chess, or were they serious about coming up with a plan? Obama did not want to put entitlements on the table without a real negotiating partner in the conversation.

And then there's the larger point, which looking back, we can see clearly: as soon as the Tea Party Freshmen were sworn in, a "going over the cliff crisis" was inevitable. They were going to use the debt ceiling debate to force transformational change. They did not care if the country defaulted. No negotiating strategy could change this dynamic. Once you have hostage takers and, yes, terrorists, inside your government, particularly if they control one House of Congress (or any other branch of government), the country is in  grave risk.


The hostage takers are deemed to be legitimate. They have a place at the negotiating table. And they can burn the economic house down. The only way to prevent a repeat performance in 2013, or the next time we need to raise the debt ceiling, is to vote them out of office.


This is the job ahead for 2012. With the tough economy, it will be an uphill fight.

Postscript: here are some links to more positive takes on our hostage drama:

Obama's Hope-a-Dope Strategy, Kevin Drum, Mother Jones. Calm and cool, not guns and knives, is a "way of being" for Obama and his team.

The Liberal Screech, Andrew Sullivan, The Daily Beast. Obama got the best deal possible, given that he was negotiating with radicals.

Obama's Pyrrhic Defeat. Comments from Sullivan's readers.

Obama's Pyrrhic Defeat (2) . More comments from Sullivan's readers.

The Beginning, Not the End. Another Andrew Sullivan piece saying it is too soon to tell how this will unfold in the larger context. What will the Super Committee do? What will happen in the election? What will happen to the Bush tax cuts?

Afterthoughts

It is Tuesday early afternoon, August 2, and the deal is done. Nobody seems to like it very much. The Dow is off 150 plus points. Obama just spoke in the Rose Garden saying the entire, frustrating exercise was a manufactured crisis and it is high time to focus on investment and jobs. The Tea Party seems disgusted and angry. Hard left liberals are convinced Obama has sold out, that he is owned by Wall Street, and that he has been waiting for his chance to gut spending for the middle class. Moderate Progressives see this as a demonstrable failure of leadership. But John Boehner says he is happy and that he got "98% of what he wanted".

Where do I come out?

In retrospect, I am surprised I so misjudged the Tea Party/Republican intransigence. I sincerely thought they would agree to revenue increases, particularly when Boehner was working for the Grand Bargain. I was dead wrong. I hope I don't make this mistake again.

I also underestimated the President's reluctance to use the 14th Amendment. He simply did not want a constitutional crisis, and therefore he needed a negotiated deal, properly passed into legislation that he could sign, lifting the debt ceiling. The Tea Party was willing to have no agreement, to pass the August 2 deadline with no legislation, and to risk default. The President was not willing to do that, because if he got to August 3 without a deal, he knew he would have to invoke the 14th Amendment, and that was a very last choice scenario. It is tough to negotiate with someone who is completely indifferent to the outcome, when you, on the other hand, care.

So imaginatively, let's restart the clock on December 1. We are on the President's team and we have full knowledge of the Tea Party/Republican intransigence. We probably would urge the President to include the debt ceiling in his deal with Republicans on taxes, but here is how the President might respond:

"The Tea Party and the GOP are obsessed with deficits and debt levels. It doesn't make sense to focus here, when the problem is jobs; but we need to get this deficit/debt conversation aired thoroughly in the public arena or we'll never get to jobs. Given the make-up of the House, we may not get there anyway, but we have to try. We could try to make this a Jobs versus Debt discussion, but it probably won't work. The American people are worried about both. Getting a debt ceiling deal right now would delay our having this conversation. I think mid-summer, more than a year before the election in 2012, is the right time. And I think we should work toward a Grand Bargain type of deal - spending cuts, including  modifications to entitlements, and tax reform with revenue increases. Progressives will beat us up for including entitlements, but it is time for Democrats to wake up and realize that adjusting the safety net programs carefully can preserve them. The alternative is to end them. But I will not put entitlements on the table until I am in serious discussions with the other side negotiating a deal in good faith.""

So the President might punt in December, even with foreknowledge of the extortionist nature of the coming negotiations. He might decide that having a full blown conversation, even in a crisis atmosphere,would be the best thing to do. But how to respond to the Simpson-Bowles Deficit Commission, which included entitlement cuts? Warm comments, even praise, but no endorsement. What about the Budget? Put out a "strawman Budget", that you will later be hammered for. Wait the Republicans out.

When their Plan emerges, which the Ryan Budget did in March, then go to the people with a Big Speech and talk about the outlines of a Grand Bargain. Obama gave this speech in early April. It looked like a complete repudiation of his budget, which it was. Critics would later say it was never a Plan, and the President's answer would be/was:

"Plans are important, but what is more important is having a set of principles with specific objectives and then beginning a process of discussions with a willing negotiating partner from the other team. Negotiating through the media doesn't work."

And that would bring us to the debt ceiling discussions and negotiations. I am suggesting that, even with 20/20 hindsight the President might choose to follow the same trajectory: no deal in December, wait the Republicans out, broad invitation to a Grand Bargain, followed by negotiations running up to August 2.

Could the President (whom we have now given 20/20 hindsight) get revenues as part of the deal?

I say no. And this was my mistake before. This was not going to happen, given the ideological intensity of the Tea Party Freshmen in the House GOP caucus.

If Obama had known he would not get revenues in "normal" negotiations, would he still have proceeded?

Yes. Once he passed the December date, where a deal probably could have been done with Republicans, he had no choice. The GOP decided in January, when Boehner responded to Geithner's request for a debt ceiling increase with demands for big budget cuts, that they were going to argue their position strongly. And it was well forecasted that the big battle would come around the debt ceiling, which needed to be raised in June/July or early August.

If part of the body politic is aching for a fight, and there is a date specific coming up when you need them to vote on something the country needs, you can be sure the fight will happen, and more or less when it will happen. And given Tea Party intransigence, this fight meant a no revenue/spending cuts only deal, or default.

If Obama had told Republicans he would veto a spending cuts only deal, would that have made a difference?

No. We all saw the articles by Krauthammer and others that said "Call the President's bluff."

If Obama had told Republicans to give him a balanced (spending/revenues deal) or he would invoke the 14th Amendment, do you think the Tea Party would have obliged?

No. They would have called his bluff again. And the country would have a constitutional crisis on its hands, which Obama did not want.

So that brings us to now. I think the President got pretty much all he was likely to get. So what would the President say are the benefits of the deal for the Progressive/Democratic cause? Here's what he might say:

1. Republicans will claim that they won. An all spending cuts deal. From a limited perspective they are right. They keep forgetting about the Bush tax cuts which expire in late December of next year. Boehner had a chance in the Grand Bargain negotiations, before he walked, to remove this trigger, if he agreed to tax reform with revenue increases of $800 -$1,200 billion. He refused and bailed out of the negotiations. The trigger is still fully in place. Having these Bush cuts expire will raise $3-$4 trillion, and there is nothing Republicans can do to stop their expiration as long as I am President. Revenues will be part of this deal, either in the coming "Super Congress" discussions, or at the end of 2012.

2. We have a more than $2 trillion debt ceiling increase in return for about $25 billion in short term spending cuts. Entitlements are not touched at all in Phase 1, and only Medicare provider payments can be affected in Phase 2, if the automatic trigger goes into effect. Other programs for the poor are protected. And Defense takes a big part of the burden - $350 billion in Phase I and 50% of all cuts in Phase 2. We cannot be held hostage again, until after the elections in 2012, and the truly terrible Balanced Budget Amendment will be voted on in Congress, but not force fed out to the states.

3. Democrats can lay serious claim to caring about fiscal discipline and responsibility. I proposed a larger, "grander" deal than Republicans could stomach. They will argue that this fiscal discipline strain is only showing up because of GOP pressure, but that argument won't hold up very well. I have reasonably high hopes that the new Deficit Commission will make some true progress, and that in the roughly three months they will be working, the commitment of Democrats to fiscal responsibility will become clear. I have always felt that fiscal responsibility can be made an integral part of the progressive platform. It is not HOPE versus RESPONSIBILITY. It is both, together.  But we cannot just talk about it. We must walk our talk. And I believe our Party is ready to do that.

4. In addition to stealing some of the GOP's thunder, we have made progress in demonstrating the radical and dangerous nature of the GOP, now in thrall to the Tea Party. Never before has the country been held up by one of its political parties, at least not since the Civil War. I have every intention of highlighting this extremism during the campaign in 2012.