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The Washington Post had a good update on this issue but I wanted to clarify one point that I think has been muddied in much analysis.

The deficit-reduction super committee could always pull a rabbit out of a hat, I guess, but the likelihood of anything but gridlock has been low from the beginning. I give the Republicans some credit for breaking the no-tax-increase-ever pledge, but their offer is so fundamentally unbalanced — $300 billion in revenue increases from closing expenditures in exchange for rate cuts that will amount to almost $4 trillion in tax cuts — that it can’t taken seriously.

But my point here is about something else. There’s a meme developing that if the committee were to gridlock, markets would react badly, interest rates would rise, and the message that “US = Greece” would be clear to all. To which I say: nonsense.

In fact, I’d encourage you to generally respond to the statement: “if X happens, markets will react badly” with a healthy dose of skepticism. Half the time, this formulation is scaremongering, used to garner support for your side. And the other half, even experienced analysts don’t know how the market will react (remember the S&P downgrade-interest rates on US Treasuries fell after the announcement… go figure).

Most recently, the landscape is littered with Chicken Little warnings about the impact of current US levels of indebtedness on interest rates. At the end of the day, these alarmists do a lot more harm than good, because someday Chicken Little will be right, and no one will listen to him.

In this case, market players have of course priced in the possibility of the super committee failing to agree on a plan. I’m not saying these players are all-knowing or even particularly rational, but if they haven’t figured out that gridlock is the likely outcome, they’ve got no business betting on markets. (more…)

CBS News’ 60 Minutes aired a report last night alleging that several members of Congress have traded stock using information they received during private briefings or meetings, enabling them to profit from inside information. By far the most damning story was about House Financial Services Chairman Spencer Bachus (R-AL), who in 2008, the day after receiving a private briefing from the nation’s chief economic officials on the extent of the financial crisis, proceeded to bet that the stock market would tank:

In mid September 2008 with the Dow Jones Industrial average still above ten thousand, Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke were holding closed door briefings with congressional leaders, and privately warning them that a global financial meltdown could occur within a few days. One of those attending was Alabama Representative Spencer Bachus, then the ranking Republican member on the House Financial Services Committee and now its chairman. [...]

While Congressman Bachus was publicly trying to keep the economy from cratering, he was privately betting that it would, buying option funds that would go up in value if the market went down. He would make a variety of trades and profited at a time when most Americans were losing their shirts.

Bachus, who was the ranking member of the Financial Services committee at the time (since the Democrats held the house) made about 200 trades as the financial crisis peaked, netting about $28,000. (more…)

 By Leo W. Gerard
International President

In the title tune to the 1934 musical “Anything Goes,” Cole Porter says “times have changed,” since the stock market crashed in 1929, but the super rich, like John D. Rockefeller Jr., “still can hoard enough money to let Max Gordon produce his shows.”

The lyrics also tease FDR because Eleanor advertised a mattress from a venerable company:  “Missus R., with all her trimmin’s, can broadcast a bed from Simmons, ‘cause Franklin knows, Anything Goes.”

That 133-year-old company, which employs members of my union, the United Steelworkers (USW), will file for bankruptcy soon. Then it will be auctioned to yet another private equity firm – the seventh such sale in little more than 20 years.

Repeatedly, new owners stuck their greedy hands under the mattress and pulled out money. Each time, that hurt the company and the workers. The firm is $1.3 billion in debt now – eight times what it was when the private equity companies started passing Simmons around like a cheap date. And a quarter of its workforce – 1,000 people – is laid off.

This is Anything Goes capitalism. It destroys companies. And it destroys workers’ lives. But it sure does work for the private equity firms. They made around $750 million in profits from the now-indebted and bankrupt Simmons.

It’s time to flip the mattress on that failed economic philosophy. Time to end the days of Anything Goes, just like FDR did. Time to regulate private equity before it ruins more American manufacturing.

Too often private equity firms buy manufacturers, borrow against their assets, pull out that money as “dividends,” and run off without regard to the future of the company or its workers. It’s smoking instant cash gratification in a crack pipe. Here is how Robert Hellyer, a former Simmons president who worked under several of the private equity buyers, explained it to the New York Times, “From my experience, none of the private equity firms were building a brand for the future. . .Plus, the mind-set was, since the money was practically free, why not leverage the company to the maximum?”

It’s morally wrong. It’s economically wrong. It’s gotta stop.

Bankrupting viable companies – the way the private equity firms did Simmons – for the profit of a few and the pain of the most should be banned.  The New York Times, writing about the Simmons case, noted:

“A disproportionate number of the companies that were acquired during that frenzy are now struggling with the enormous debts. More than half the roughly 220 companies that have defaulted on their debt in some form this year were either owned at one time or are still controlled by private equity firms, according to analysts at Standard & Poor’s.”

The current owners of Simmons, the ones who put the company even further into debt, Thomas H. Lee Partners of Boston, will leave the mattress firm mired in bankruptcy while walking away about $77 million richer. Clearly, Anything Goes for them. All profit; no consequences.

Not so for Simmons bond holders, who stand to lose more than $575 million in the bankruptcy; the workers, who confront losing their livelihoods, and the company itself as it struggles to survive under an extraordinary debt burden. 

Scott A. Schoen, Simmons co-president, whined to the New York Times that the mattress downturn was “unprecedented and unforeseeable.”

On the other hand, as the Times noted of the private equity takeovers, “Many of these deals, cut in good times, left little or no margin for error – let alone for the Great Recession.”  Maybe Mr. Schoen could have shown a better business plan.

Then, again, it wasn’t about business planning. It was all about raiding the company for its assets and shipping out, like a Viking invader.

Before the likes of Thomas H. Lee and partners showed up on the scene, Noble Rogers, 50, worked happily for Simmons, mostly at the Mapleton, Ga., plant. President of the USW local, he loved Simmons because the company cared for its workers, providing a pension, and when workers retired, giving them a bonus of $20 for each year and a mattress set.

“There were picnics, March of Dimes walks, Christmas parties, and we always had Halloween parties. It was really a family-oriented company,” Rogers told the New York Times.

Then in 2003 came Thomas H. Lee Partners of Boston, the latest private equity firm extracting more money from Simmons.

In the spring of 2008, Simmons laid off the entire night shift of Rogers’ plant. A few months later, on Sept. 18, Simmons officials announced they were closing the factory altogether. 

Rogers negotiated with Simmons for the traditional gift of $20 for each year worked and the mattress set for those eligible for retirement. Simmons rebuffed him. But then, that was to be expected. Simmons – under Thomas H. Lee – had stopped the parties and picnics.

The USW has worked with legitimate private equity firms that bought struggling manufacturers, set them on a path to profitability, and moved on to the next money-making acquisition.

That is completely different from buying a company to function as nothing more than a leach, engorging on its assets until huge debts are amassed, then carelessly disengaging to snare a hapless new victim.

Anything Goes capitalism is something that must go.

Leo W. Gerard: Economist James K. Galbraith, the Lloyd M. Bentsen Jr. Chair in Government/Business Relations at the University of Texas, recently told Deborah Solomon of the New York Times that you are “the person with the most serious claim” for predicting the onslaught of the current credit disaster.

The promo for your most recent book, Plunder and Blunder: The Rise and Fall of the Bubble Economy (PoliPoint Press, 2009), says the fall of the bubble economy was “completely predictable.” But you were standing nearly alone out there for some time yelling, “The collapse is coming, the collapse is coming.”

When did you get the first inkling that the collapse was impending and what did that feel like?

Dean Baker: I learned from the stock bubble in the 90s that the timing was hard to predict but  I first became convinced that it was starting to burst in the fall of 2006, (house prices had begun to fall) and I wrote a forecast projecting a recession for 2007. It turned out that I was still somewhat premature. I was expecting the price decline to gain speed more quickly and to have a more immediate impact on the economy. However, according to the National Bureau of Economic Research, the official arbiter of recessions, the current recession did begin in 2007, so I was not too far off.

As a more general matter, I did feel somewhat vindicated, although it was striking to me, that even as the bubble was very much in the process of deflating in late 2007 or even early 2008, most economists were still convinced that it would have little consequence for the economy. I recall repeated pronouncements from former Treasury Secretary Henry Paulson and Federal Reserve Board Chairman Ben Bernanke that the problems were contained in the subprime market.

Gerard: What were the clues you saw that others ignored or missed?

Baker: For most economists, the idea that a market would take leave from its senses – that it would be driven by speculation – is almost inconceivable. Given that we had just seen a massive bubble in the stock market, it really should not have surprised people to see one also develop in the housing market.

The main factor that attracted my attention was the sudden spurt in house prices beginning in the mid-90s. For the hundred years from the 1890s to the 1990s, house prices nationwide had just tracked the overall rate of inflation. Yet, from 1995 to 2002 (when I first noticed the bubble), house prices rose by 30 percent in excess of the rate of inflation.

There was no explanation for this sudden jump in prices based on the fundamentals of supply and demand. Income growth had been healthy in the late 90s, but not extraordinary by the standard of the early post-war years. Furthermore, income growth had largely stopped during the 2001 recession.

Population growth was slowing, which should have slowed housing demand. On the supply side, we were building houses at near record rates, so clearly there was no serious supply constraint.

If there is a big run-up in house prices and no obvious force driving it on either the demand or the supply side, then it sure looks like a bubble. Just as additional confirmation, I checked rents, which tend to more or less follow sale prices. Rents had increased only slightly more than the rate of inflation in the late 90s, and by this decade, they were falling behind inflation. There certainly was no evidence of growing demand pressure on the housing market there. 

Finally, I noticed the rise in vacancy rates. This is consistent with people buying homes for speculative purposes. Many investors were willing to gamble on a high price for a new home or condo, betting that it would go up even more in the future. Of course, this is not sustainable. Not many people can afford to keep a unit vacant for a long time, since it means that they are paying the mortgage and getting little or nothing back. The high vacancy rates of this era virtually guaranteed that the bubble would burst.

Gerard: Did you also see problems with subprime mortgages contributing to the bubble?

Baker: The problems in the mortgage market were hardly a secret. The subprime share of the market nearly tripled from 2002 to 2006. The Alt-A share, which are typically mortgages taken out by small business owners with variable income (and often in accurate tax returns), exploded from around 1 percent to 15 percent. This should have set off flashing red lights to any serious economist.

And, the stories about liar loans and phony documents were everywhere. I was getting e-mail from people around the country telling me about friends and relatives employed by mortgage banks who were told to put in fake numbers so that the banks could issue loans. Certainly the regulatory agencies must have known this was going on.

Gerard: But if you noticed those clues, and looking back on it, those clues are actually quite obvious, why did the vast majority of financial analysts and economists and managers for large investment funds including pensions and endowments, fail to see the bubble and its implications?

Baker: The bulk of financial analysts and economists largely repeat the conventional wisdom without ever seriously trying to assess whether it makes sense. They unthinkingly follow the conventional wisdom because of the structure of incentives in their profession. No one is going to get fired because they didn’t see the housing bubble. In fact, few people are likely to even miss a promotion because they didn’t see the bubble.

Economists and financial analysts are not like steelworkers or people in other occupations. They don’t get evaluated based on their performance. They can mess up every day of the week through their whole careers, and this would be just fine, as long as they messed up in the same way as their peers.

On the other hand, the few economists/analysts who spoke up to warn about the bubble were taking huge risks. Of course, we were all ridiculed at the time. If you were an economist working at a major investment bank and tried to tell them that all their big money-making deals were going to get them in trouble, they would probably tell you to shut up and fire you if you didn’t.

If the housing market stayed strong and house prices kept rising or just remained stable, then any economist who had warned of the bubble would be laughed off as a chicken little.

In short, the incentives are such that the overwhelming majority of economists will never challenge conventional wisdom even if they think it is wrong. They are there to hold on to their jobs, not to inform the public about the economy.  

Gerard: Did you know the collapse would be this bad? How bad will it get?

Baker: I knew that it could be very bad. I was trying to be contained in my pessimism (I couldn’t completely ignore the conventional wisdom either), but I did warn that the downturn could develop into a Japan-style financial crisis. This obviously is the case that we are looking at.  Of course, if the Fed and Treasury had moved more quickly, they could have prevented some of the damage that the financial system is now seeing.

The same applies to fiscal stimulus. It was painful sitting through the months of the election campaign and then the transition when the government was completely paralyzed. At that point, economists from across the political spectrum all recognized that the economy needed further stimulus, but the politics were such that nothing could move.

As it is, the stimulus package passed by Congress is a good start, but it is nowhere near big enough to turn the economy around. The unemployment rate is virtually certain to shoot past 8.0 percent in the February jobs report and is likely to hit 9.0 percent by summer. If we are lucky, the stimulus will provide enough of a boost to keep the unemployment rate from reaching 10 percent, although I would not take this for granted at this point.

In addition to higher unemployment, house prices will continue to fall at least until summer. The big question in my mind is whether house prices return to their pre-bubble level or they overshoot on the way down. At this point, I would bet on overshooting. This implies an even larger loss of wealth for homeowners, more foreclosures and more big losses for banks.

Gerard: Will the stimulus stop the free fall?

Baker: If we are to turn things around, we really need much more stimulus and we need it quickly. My favorite idea at this point is a tax credit to employers for giving workers paid time off. For example, if employers offer paid parental leave or sick leave, or paid vacation, or increase the days they already offer, then the tax credit would cover the lost work. This can be a quick way to get millions of people back to work.

The arithmetic on this is straightforward. Suppose that employers of 100 million people give their workers an amount of additional paid time off that is equal to 5 percent of their work time. These employers would suddenly have demand for 5 percent more workers, or 5 million workers. I can’t think of a quicker, less bureaucratic way to create jobs at this point, especially now that we have already funded most of the shovel-ready infrastructure projects.

Gerard: What must be done to prevent this from recurring?

Baker: There are two key points. First we must rein in the political and economic power of the financial sector. The financial sector must serve the real economy, not the other way around. There is a long list of reforms that are needed to ensure this outcome, but the main point is that an efficient financial sector is a small financial sector.

One way to keep it small is to tax it. If we had a very modest financial transactions tax, for example 0.25 percent on the purchase or sale of a share of stock, it would have very little impact on people who invest for the long-term. However, it would have a huge impact on people who are buying at 2:00 and selling at 3:00. This sort of tax would discourage such speculation, making the markets friendlier to long-term investors.

It would also reduce the size of the financial sector, since the industry makes much of its profit off this sort of speculation. In addition, such a tax could raise more than $100 billion a year. That’s real money even in Washington.

The other point is that a balanced economy, in which workers share in the gains of growth, is not conducive to financial bubbles. We didn’t have any major bubbles in the three decades following World War II. During this period, productivity gains were passed on in wage gains, which in turn fed consumption, which led firms to invest in expanded capacity. The basis for the bubble economy was created in the 80s when this virtuous circle broke down and workers could no longer count on seeing their wages rise in step with productivity.

In short, if we want to prevent another financial bubble and the sort of economic collapse caused by its bursting, we should support policies that allow workers to share in the gains of growth. That sort of world favors investment in the productive economy rather than financial speculation.

***

Dean Baker, co-director of the Center for Economic and Policy Research in Washington, DC., has written several books. His most recent, Plunder and Blunder: The Rise and Fall of the Bubble Economy (PoliPoint Press, 2009), chronicles the growth and collapse of the stock and housing bubbles and explains how policy blunders and greed led to the catastrophic market meltdowns. 

His analyses have appeared in many major publications, including the Atlantic Monthly, the Washington Post, the London Financial Times, and the New York Daily News. His blog, Beat the Press, features commentary on economic reporting. 

 He is a frequent guest on National Public Radio, Marketplace, CNN, CNBC and other news programs.

By Leo W. Gerard

International President

Within hours of Barack Obama’s election, naysayers chastened caution. Don’t go too far, they inveighed. Build trust slowly with restrained, moderate, and gradual actions, they admonished.

In other words: Start with piddling plans.

Basically, they want to abort hope — kill it before it has a chance.

That is all wrong after an election in which it’s believed that a higher percentage of Americans voted than at any time in the past 40 years; a win that brought tears to the eyes of even hardened reporters; a result that drew joyful citizens into streets across the country to celebrate, a balloting that swept even larger majorities of Democrats into the U.S. House and Senate.

This moment during which the nation is suffering great economic peril pleads for political valor. This moment screams for boldness.

Troubled times demand greatness. Franklin D. Roosevelt knew that. He’s the reason U.S. presidents are judged by the sum of their accomplishments in their first 100 days in office.

When FDR was inaugurated in 1933, the country was in the midst of the Great Depression. He didn’t waste time tinkering. After 100 days, he’d given the country the Emergency Banking Act, the Securities and Exchange Commission, the Civilian Conservation Corps, the Federal Emergency Relief Act and the Tennessee Valley Authority.

Obama may not inherit a Great Depression, but he’ll take the oath during an intense recession. Look at the news that arrived the same week as his election: unemployment rose to 6.5 percent after 10 straight months of jobs losses totaling more than 1.2 million; the stock market dropped 1,000 points in 48 hours after the worst October showing in two decades; auto makers travelled to Capitol Hill begging like hobos for handouts to stave off bankruptcy, two dozen major retailers revealed sales declines, most double digit, and the New York Times reported hospitals strained as they register fewer paying patients and increasing charity cases.

These problems won’t be solved with timidity. In his first press conference after the election, Obama said resolving the economic crisis is his top priority. He said, in fact, “I will confront the economic crisis head on.” No weak-heartedness suggested there.

He said a new president can restore confidence and advance an agenda for the middle class. That is exactly what FDR did with the combination of legislation and fireside chats.

During this brief press conference, Obama got it right, emphasizing aid to the middle class. He said it is essential to pass a rescue plan that would create jobs and extend unemployment benefits. He wants aid to state and local governments so they don’t increase taxes or furlough workers.

The federal government should help both small businesses and the huge auto industry, which provides jobs directly and indirectly through its suppliers.

The $700 billion bailout must be reviewed, he said, to ensure that it is stabilizing markets, that it’s not unduly rewarding the Wall Street risk-takers who caused the crisis, and that it’s helping families avoid foreclosure.

In addition, he said it’s essential to implement policies to grow the middle class such as investing in clean energy technology, resolving the nation’s health insurance dilemma, and providing tax relief for working families.

These are the correct priorities. And his plans are audacious. Which means he needs our help.

He called for bi-partisan cooperation in accomplishing these goals. But he’ll need more than that. He will need the kind of support he got in those weeks just before Election Day.

All of those who voted for him, all of those who want to keep hope alive, and all of those who want real change must demand both houses of Congress and both political parties work with Obama to accomplish it. Those who believe in real change must make it clear that they won’t stand by and allow courageous action to be reduced to faint-hearted baby steps.

On election night, Obama told the crowd in Chicago that the victory was theirs: “I know you didn’t do this just to win an election and I know you didn’t do it for me.”

Then he warned of what is ahead:

“You did it because you understand the enormity of the task that lies ahead. For even as we celebrate tonight, we know the challenges that tomorrow will bring are the greatest of our lifetime – two wars, a planet in peril, the worst financial crisis in a century.”

With more than 10,000 volunteers across the country, the United Steelworkers campaigned hard to help get Obama on that Chicago stage to make that speech. We will back him as he works to fulfill his promises of what is a New Deal for the new century. And we urge every American who wants real change to join us to ensure his success, the nation’s success.