The Conservatives Battle with Adam Smith

Or Why We are a Long Way from the Bottom

The bailout is failing because it is a trickle down bailout to solve the problems created by a trickle down economy. In case you haven’t noticed the stock market has fallen into the low 8,000’s and gyrates by 200-500 points a day, somewhat akin to a startled herd running from one fence to another, hoping against hope they will find something different when they end up at the same spots trampling what pasture they have left. Meanwhile the politicians argue about “moral hazard”, creeping socialism and Nancy Pelosi and those communists. It would be a bet against human nature that the raw opportunism, ideological posing and hoarding instinct will be thrown out to save the future of America and maybe the world.

The need to act with dispatch to prevent the economic freefall that is coming if we don’t has never been greater. The deregulators, who were drunk on greed ignored the risks, Bush and the political bosses pumped money into the false economy to keep it going, the wealthiest with almost free borrowing and windfall tax breaks, unleashed a speculation monster of unprecedented proportions. Unfortunately those are the folks who are still running the show and creating more disaster.

It will get worse, much worse, why? The bailout solution is based on the same trickle down theory the economy was built on, give it to the rich who know how to use it and it will help the people at the bottom. The theory was if you spread the debt widely, it would have little impact if some of it failed. They used this theory to ignore normal debt to asset ratio, instead comparing it to a drop in the ocean, forgetting enough drops fill an ocean.

Only when some of the underlying debt masquerading as assets began to fail did anyone ask the question, how much of this debt have we put out there? Income to debt ratios suddenly became meaningless. No one knows how much debt is out their, what it is worth or who is holding it. The reality is that until stock values deflate to a reasonable asset to debt ratio and consumers have income to buy, the market will continue to fall.

Simply, it is likely that thousands of businesses will fail including some giant automakers. General Motors assets for example, are estimated to be worth $2.6 billion while its debt is $300 billion. This is a sobering thought, yet the Detroit executives are arguing to keep their bonuses if they get government help as this is being written.

As the amount of debt and the true value of the assets is revealed, the stock price falls, requiring the sell off of real assets to stay in business, workers are laid off to cut costs, reducing their buying power. The feedback loops now in play; deflation, unemployment, more deflation will drive the market artificially low as it wipes out any remaining consumer and lender confidence. The solution with the least pain is to boost both consumer income and let the air out of the asset bubble simultaneously, not try and save those who created the problem.

Wealth redistribution created the problem.

The Bush tax breaks gave more capital to the rich and almost free borrowing to play the market with. At first it was invested in qualified mortgages, credit cards, auto and student loans. These were packaged and sold as bonds which were used as collateral to borrow more, to invest in other speculation. Private equity companies and hedge funds offered inflated prices for companies. They sold junk bonds to finance the deal, loading that debt on the purchased companies’ books and then taking huge fees and bonuses off the top for the debt they had created. Excess cash and deregulation also fueled the buyout and merger markets, creating companies “too big to let fail.” In essence they expected to be bailed out if they got in trouble.

These bonds were then rated AAA by companies paid by the sellers and insured with credit default swaps, which again were traded and used as collateral. How big is the problem? Current estimates are the amount of Credit Default sold equals between $55-62 trillion.

Building an economy on debt worked fine as long as you had enough qualified debtors that would pay back the notes. The problem was they ran out of qualified buyers, so pushed to give credit to those who weren’t qualified. This coincided with removal of usury laws restricting consumer interest rates, the restrictive bankruptcy laws passed in 2005 forcing more repayment and doubling fees and a steady bombardment of advertising selling credit to those least able to afford it. Those with no credit were offered payday loans at 600-750% annual percentage rates. Using extraordinary penalty interest rates and fees on the certain to be late payments, was used to give cover higher interest rates to the bond buyers and to justify the high ratings given on this debt.

Trickle down, flood up.

During the same period those same big money forces forced wages down by an all out assault on organized labor beginning with Ronald Reagan, weakening of worker protection laws, outsourcing, throwing of retirement programs to wall street and discontinuation of healthcare benefits. Americans found out that jobs created in the new economy were low paying part time service jobs, with few if any benefits. Construction was the fastest growing sector compensating for lost manufacturing jobs, of course that’s based on house building. All of this was successful in insuring a disproportionate share of the profits of the “new economy” went to the rich, not the working people and small businesses.

Making it worse were changes made in how unemployment was calculated hiding, actual unemployment numbers by taking those who had given up off the roles, reducing what full time was defined as and exclusion of some classes of workers. Those who were displaced to lower paying part time jobs were employed, whether that employment paid the bills or not was inconsequential to the conservatives in power. Income adjusted for inflation has fallen 30% since the 1970s, extra household members working and borrowing was the only way to keep up.

Federal housing subsidies have declined by over 60 percent since the 1980s, due to lower funding and the increased inflation of housing, pushing more people to refinance and enter risky financial obligations like subprime loans. In many cases, people had no choice but to take this cheap credit when emergencies that in the past that would have come out of savings arose.

While banks and companies line up at the federal trough to be rescued, millions will be abandoned. We hear bankers and politicians about insuring the “irresponsible consumer” is not let off the hook.

The free market boys also campaigned and got the destruction of the safety net that would have assured a bottom to consumer spending. According to a November 16th, New York Times article the tightening of rules has led to only 37% of the unemployed being eligible for benefits, which average $293/week for up to 39 weeks as compared to 65 weeks in the 1970’s. Of those without unemployment only 40 percent of poor families who actually qualify for public assistance receive it. Much of public assistance has been replaced by the Earned Income Tax Credit. The only problem, if you lose your low paying job, you lose your tax credit. The safety net is gone.

No consumer, no profit.

It seems not many people thought about what would happen when the squeezed consumer ran out of money and credit as long as the economy was churning along on speculative investments because of the low interest rates and the inflated money supply. The New York Times reports that bankruptcy filings are up 35% over October of last year and that’s not counting the sizeable number of people that think they can’t file under the new law or just don’t have the money to.

With 70% of the American economy running on consumer spending and not even enough money to buy cheap foreign goods, you can see why big department sales are running Christmas sales at the beginning of November. In normal times, the fed would cut the interest rate and stimulate the economy, but we’ve already been doing that for years to artificially fuel the economy and it is down to .3 percent, there isn’t anything left to cut.

We are now in a downward spiral where stock prices are falling, profit and assets are vanishing from the books, layoffs are becoming the norm and that will undermine the debt given to consumers who were credit worthy at the time of their loans. This will result in further falling stock prices, failed financial instruments and companies and more layoffs. Where the bottom is no one knows. Until the ratio of debt to assets is actually reasonable and determined, this situation will only get worse.

Those who in normal times would look to deficit spending and more national debt as did Franklin Delano Roosevelt to fund our way out of this are going to be disappointed. With a federal deficit this year of $311 billion for a total that exceeds $10 trillion, unfunded Medicare and Social Security obligations at $47 trillion, and confidence in the American dollar will decline. This will make it less likely that countries with reserves will buy more treasury bills, more likely they will dump them.

Uncle China cuts off the credit.

Money flowed into this scheme because the low interest paid on the increased sale of treasury bonds to print money produced a much lower return. While China was content to take these low interest yields as a hedge against a future downturn, our investment houses invested in the bogus debt based bonds with higher and more immediate returns. As long as China was willing to buy our treasury bonds and allow us to increase our national debt the fed kept on selling them, pushing more dollars into the system. This huge transfer of wealth kept their export economy growing and pushed our stock prices to artificially inflate.

Don’t expect China to help now; their internal stability is much more important to their leader’s survival then that of the world economy. China has watched their own stock market drop 60% and over 65,000 factories stop production throwing millions out of work. The instability that brings gives Chinese leaders nightmares.

Their solution, invest $586 billion dollars in the next two years to overhaul their infrastructure, put people to work and keep their national economy from disintegrating. The most likely way to fund this is from selling some of the $541 billion in U.S. Treasury bonds they are holding. Any hope that China will fund this from its annual $300 billion dollar trade surplus is not likely given that recession has already caused rapid descent of its exports to the world markets, a condition that is sure to worsen.

No one knows how little the dollar will be worth if they start dumping treasury notes on the market. The Mid-East, forget it, falling oil prices will force them to defer from buying dollars and improve the lot of their vast poor to prevent being overthrown. The potential for severe deflation followed by hyper-inflation is very real.

Investing in the past won’t work.

Paulson’s recent change from buying toxic debt to direct investment may well indicate there is just too much of it for the government to handle. Direct investment into the financial sector, auto sector and other major players gives the confidence of federal backing without exposing how much debt is really out there. Unfortunately it’s like investing in a buggy factory the day before Henry Ford publically introduced the Model A. The invisible hand the conservatives like so well will find the real value eventually.

There is a way to avoid complete catastrophe, but it is doubtful politicians will make it happen. The real answers are so radical as to disorient the average American and provoke the fiercest resistance against government by big business that can be imagined. Overhaul America.

The global climate catastrophe we are facing is the moral equivalent of World War II.

Conversion from a fossil fueled economy to a sustainable one will require massive green infrastructure rebuilding, tremendous retraining of manpower and all of the research and development that we can muster. It means including all costs in a product not public costs and private profits. It means doing away with inefficiencies in our current economic system that create profits rather than wealth. What are some of those?

1) End the empire of foreign military adventures — The best chance the world has is the redirection of our half trillion dollar military budget (some say the real cost with black box programs is actually a trillion) to develop sustainable energy infrastructure. Putting much more in direct development aid and an expanded peace corps would have a wider and more sustainable impact on world stability.

We have successfully turned from a wealth building civilian economy to a wealth destroying military economy for too long (since WWII). A machine created to create products or other machines creates much more wealth than the creation of machine to make something blow up. Just as after WWII millions of veterans returned to build the national infrastructure, current military and returning veterans have the organizational and other technical skills to rebuild our nation as civilians.

2) Healthcare – With government employees, military and veteran, Medicare, Medicaid, state, county and municipal workers already receiving government paid healthcare (well over 40% of the U.S. population) it is time to go to a single payer system. The difference in administrative costs and overlapping programs would allow us to give everyone in the country health insurance for no more than we are paying as a nation now. It would eliminate the bizarre labyrinth of access and result in lower costs from earlier treatment and preventive care. I’d rather have a government bureaucrat deciding my healthcare then an insurance flunky whose bonus depends on denying care.

3) Education produces wealth — our antiquated, overburdened education system should be completely retooled, free from preschool through trade school or college. Can anyone tell me why we still have summers off except for pressure from the tourist industry looking for cheap labor?

4) Create wealth through small business — provide startup capital in the form of micro loans, technical assistance and training to small scale entrepreneurs’. Restructuring disability and retirement through increased social security taxes would result in an explosion of creative entrepreneurship. Private retirement fund assets and liabilities would be moved into this system with restructured benefits allowing a living wage. While some would lose retirement income the majority would not. It’s better than losing it all, ask a GM or Ford retiree. Take the income cap off from social security; you pay on all of your earnings including capital gains.

5) Pass the Employee Free Choice Bill — Allowing workers to sign up to join a union on a card rather than a company wide vote announced months in advance would allow workers to restore the balance between them and management that has bled consumers of the buying power to keep the economy going. The secret elections argument is totally bogus. Why do you think companies are pouring millions of dollars into a campaign to insure secret worker elections? It allows them months to bully, intimidate, threaten and coerce workers into voting against their own interests. While union membership has dropped to 12.1 percent, 55 percent of Americans say they would join one if given a chance.

6) Raise taxes on corporate profits, capital gains, wealth and high income. Yes that’s right raise taxes, redistribute wealth, take it from the rich and invest it in the people who create most of the wealth in this economy. The rich are hoarding their remaining wealth to take advantage of further concentrating their power with fire sale buyouts or surviving the downturn in style.

People at the bottom of the income pile spend that money and they pay a greater portion of their income in taxes reinvigorating the economy and tax revenues. Raising taxes would encourage longer term investment into products and efficiencies necessary for building a sustainable society and economy instead of speculation in arcane financial instruments that only produce paper profits to justify ridiculous bonuses and salaries.

Chances are most of these solutions will not be adopted, or at least until conditions may well be beyond salvaging, they will seem much too radical to most. I guess allowing banks and other companies to use taxpayer bailout money to continue bonuses to failed and corrupt executives, acquire healthy competitors, and salvage buggy companies seems to make more sense to most people. We are a prisoner of our labels and limited imagination. As Pogo said, “We have met the enemy and he is us.”

John M. Kelley is the Managing Editor of We the People News, a monthly progressive newsmagazine in based in Corpus Christi, Texas. He can be reached at: Read other articles by John, or visit John's website.

4 comments on this article so far ...

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  1. Ron Horn said on November 19th, 2008 at 1:57pm #

    The “enemy is us” is true only to the extent that we believe all the lies that this capitalist system puts out through its propaganda machine, the mainstream media.

  2. bozhidar bob balkas said on November 19th, 2008 at 3:04pm #

    bears repeating: we r ok.
    but having been disinformed/mistaught for millennia by clero-ruling class in all lands and empires, we r at sea.
    we need education. a broad one. in which history wld be studied for what it teaches.
    a history, in which every event ever to have occurred is conected w. every other event.
    education, in which history wld be just one aspect of it. connect to this religion (or, rather, its misteachings) sport, industry, arts/music, money/its (ab)use, political power, farming/fishing, etcetc.
    then add to it the study of our powerful emotions: hatred, envy, anger, resentment, fear that cause so much havoc, and a child wld obtain an education that wld guide him/her.
    we need less competition and more cooperation. am i the only one who thinks this broadly?
    i see that even journalists writing stylish and syntacticly/grammaticly correct pieces dwell on a narrowest possible outlook.
    such as what a person may do or have said. thnx

  3. Ramsefall said on November 19th, 2008 at 5:33pm #


    great opening analogy with the herd going from one end of the pen to the other, hoping to find something different, but not quite the mechanized world of Sinclair’s meatpacking plants in Chicago, appalling either way.

    Low interest money to fund speculated short-term investments for a quick buck, their greed will be the end of them, hopefully. If it weren’t for more than 1 million workers who will lose their health insurance, I’d say let companies like GM sink without hesitating. But, other realities are at stake. Bonuses shouldn’t even be permissible, let alone discussed.

    It has to collapse in order to recover, the entire system must break down. Truly dire circumstances could change the focus of enough people to redesign a system that is sustainable, where greed is not a by-product of a sickly dysfunctional system that simply caters to those who continue to run the show. It can’t be much longer now, we’re on our way.

    It’s time to abandon financial costs/monetary profit/petroleum based thinking and living. Intelligent resource management and green tech infrastructural development owned by public coop is the key to our survival and stewardship of the planet. Before the logic and feasibility of that approach is embraced, it may take complete cataclysmic failure in order to implement. But the awareness curve is accelerating, so anything’s possible.

    Best to you.

  4. Greg said on November 20th, 2008 at 2:06pm #

    No serious discussion can be undertaken until Federal Reserve is abolished. I am continually amazed at so called “experts” who bloviate on the issues without any comment on the rape of the people by the private banking cartel. Continued Federal Reserve = NO CHANGE. PERIOD. EVER.