Beyond the Abyss: America’s Economic Future After the Financial Crisis

Beyond the Abyss: America’s Economic Future After the Financial Crisis

M. Andrews: The Liberal Economic Agenda

I.

Two Financial Crises: From Main Street’s Blues to Wall Street’s Panic

IT IS hard for Americans to think clearly about the economic condition of the nation ten years hence when we currently find ourselves on the brink of financial catastrophe. Globe-straddling investment banks have been devoured by their own intricate financial schemes that had once transformed outsized risks into even larger profits. The titans of banking, insurance, pension funds, money markets, and hedge funds, who promised us all that they had mastered the balance between risk and reward, now cower before the monsters of their own making like Dr. Frankenstein before his creation.

The nation’s financial system is in the grip of mind-numbing fear at the prospect that borrowing and lending—the lifeblood of capitalism—will soon cease. So many owe so much to so many others and with so little hope that the debts will be repaid—especially when it comes to the mortgages—that recession is assured. Banks won’t lend to people and businesses in trouble, which in turn forces us to spend less on the goods we buy and on the people we hire, and thereby creating a downward spiral of shrinking incomes, collapsing markets, and escalating misery.

The frantic negotiations earlier this month between Democrats in both houses of Congress, Senate Republicans, and the White House were driven by the plausible and ever more likely prospect that the accelerating downward pull of the current recession—falling employment, declining incomes, mounting bankruptcies, escalating foreclosures, and the prospect of one or two million lost jobs and dreams—will, in time, annihilate ten or twenty million jobs and an untold number of small businesses.

Yet Wall Street and Washington’s panic in the shadow of financial collapse, as well as Main Street’s righteous fury about using the public purse to save high-flying capitalists, divert our attention from the fact that the current financial crisis is connected to a far deeper crisis—the declining economic fortunes of the working majority in this country. While financial panics and crashes are a regular part of life under capitalism and are best addressed by intelligent regulation that establishes an evolving balance between the risks of speculative excess and the rewards of innovation, our current meltdown is also rooted in a systemic rot that is gradually crippling the capacity of the nation to deliver a decent and secure standard of living to all of its citizens. Put bluntly, the financial crisis delivers the hard message that the American dream of prosperity and opportunity is no longer within the reach of a growing segment, and soon perhaps a majority, of Americans.

The vast majority of American workers find themselves with stagnant or declining incomes that cannot keep pace with their necessary expenses—housing, medical care, education, energy, even food—much less their aspirations for a better life for themselves and their children. Tens of millions of American workers have tried to solve this problem by borrowing to “buy” a house, to “buy” a college education, even to the point where they use credit cards to pay their medical bills. Americans have given up on saving for their retirement (or, for that matter, much else) because they have used debt to cope with the steady and now accelerating mismatch between what they can afford and what they need and want.

Bankers on Wall Street and Main Street used their considerable financial brilliance to create a nearly endless set of new ways to borrow and lend money to millions of ordinary people who were willing to pay an ever larger fraction of their incomes in interest in exchange for access to a middle-class standard of living. But financial innovation cannot overturn the unforgiving rules of arithmetic: People with stagnant and declining incomes cannot maintain their standard of living by borrowing. They only push off the day when their limited means collide with their needs and dreams. Our national financial mess is only the first stage of America’s adjustment to the fact that its model of middle class capitalism is no longer viable and the reform of the system requires radical reconstruction of our economy, society, and politics.

THE RECENT collapse of AIG (American International Group) is, to be sure, an example of the perils of lightly regulated financial capitalism. But AIG’s failure is also an example of Wall Street’s vain attempt to find a way to finance the consumption and home-ownership aspirations of millions of ordinary people in a time when middle-class capitalism is in profound trouble. AIG’s demise was due to its attempt to provide a form of insurance, which are called credit default swaps, to all financial businesses that had directly or indirectly funded risky mortgages for economically insecure borrowers.

Bankers on Wall Street (and Main Street) believed that they had found a way to provide mortgage to all sorts of home buyers, including people with bad credit histories (and, on more than a few occasions, people without income, jobs, or assets of any kind: the infamous “ninja” loans as in “no job, no income and no assets”) without putting their own operations at risk. But these same companies were smart enough to know that they were lending good money to shaky borrowers and therefore needed some kind of protection against the possibility that a large number of loans might go bad at the same time.

AIG offered this protection by agreeing to cover any losses associated with bad loans in exchange for what amounts to an insurance premium. The “swap” part of “credit default swap” is exactly what it sounds like: a promise to take on someone else’s financial problem for a fee in the way that an insurance company promises to take care of a policyholder’s bad luck, under certain conditions, in exchange for a regular premium. AIG collapsed for two reasons. First, the conservative antipathy to regulation that runs through all elements of the Bush administration allowed AIG to sell a staggering amount of “protection” —$441 billion—to radically exposed lenders. And second, the housing slump led to such a large number of mortgage defaults that the company could not honor its promises.

Lax regulation and uncommon stupidity and greed on Wall Street are the primary forces behind the current financial nightmares, but the free market did try to find a solution to the deeper financial calamity affecting millions of American workers. Good regulations and alert regulators—both banished by conservatives in power—would have prevented Wall Street from taking such extreme risks in pursuit of high profits, but regulation would also have shut off Americans’ access to cheap credit, thereby forcing us to face the hard fact that our form of capitalism simply cannot deliver the goods.

MOST BLAME the bankers and financial wizards for the collapse of this house of cards, but the most hardheaded—call them economic realists—deliver harsh lectures about how our contemporary predicament confirms the age-old virtues of prudence, patience, saving, and delayed gratification. The economic realists are right in many ways, not in the least because Americans have used public and private debt to avoid paying for what they want. And they have done this for so long that one can fairly describe our current problems as a debt crisis of the sort that we once thought only happened in the so-called Third World, where other, usually brown, people just don’t seem to know how to run their economies and societies in a competent manner.

Our debt crisis is the result of a connected set of choices that America has made in public and private life. The first choice is the attempt to use private debt to maintain consumption levels in the face of stagnant or declining inflation-adjusted incomes. The second set of choices was: (1) our collective decision to cut taxes without cutting our demand for public services and thereby committing the federal government to borrow money more or less forever and (2) our refusal to use the borrowed money for sensible public purposes—such as improving the competitive capacities of the economy by fixing our rotting transport, power, and water management systems or increasing the quantity and quality of essential public goods like schools and health care.

Ordinary Americans, borrowing to maintain their consumption, were complicit in their country’s readiness to buy more than it produces and the consequence of this was that the U.S. imports more than it exports. At the same time, our decision to cut taxes without cutting spending required the government to borrow from Japan, China, the various oil-rich players in the Middle East, and other societies that held large piles of dollars initially acquired by selling goods to the Americans. Borrowing money to finance consumption rather than to invest in infrastructure and public goods meant that we deliberately chose to make ourselves less able to compete in the global economy as well as to let ordinary people fend for themselves in their ever more desperate attempt to pay for the housing, health care, and schools they need.

Most people will object to the idea that ordinary Americans deliberately put the country on the path to a debt crisis and that they consciously chose to undermine the competitive capacity of the nation in the global marketplace. Yet a moment’s reflection on the popular tax revolt and the more general demand for small government suggests just that. The conservative program of supply-side economics, with its fantastic claim that tax cuts would unleash such a wave of technological innovation, investment, and savings that the economic well-being of the common man and woman would grow without limit, has been known to be a fraud (or worse) for the better part of two decades. No sensible person believes that cutting taxes is the road to economic bliss, much less that borrowing money to finance an excess of imports over exports will solve the problems of a nation unable to deliver a sustainable standard of living for the working majority. The tax revolt and small-government mantra of American conservatism was, and is, a distinct species of economic populism. It promises to boost the well-being of economically insecure people by attacking racial, religious, cultural, and intellectual scapegoats while borrowing against the future.

Can one honestly say that the American people were hoodwinked by conservatives to act against their interests? For as long as these populist economic fantasies have been a winning electoral strategy, there has also been a large number of economic realists from across the political spectrum who have warned about the inevitable disaster that would follow from a national attempt to borrow our way out of economic decline. The hard truth is that many Americans closed their minds to economic realism because they cannot face the fact that our way of life is no longer affordable without drastic reforms that include much higher and fairer taxes and a reduction in our standard of living.

II.

Liberalism as Economic Realism

MANY ON the left are cheered by the prospect of larger Democratic majorities in the House and Senate, and of a slightly center-left President Obama being sworn in on January 20, 2009. But the joy we will feel at seeing the end of the Bush years will fade quickly, and not in the least because the tasks before us include managing a deep recession and facing the financial crisis’ root problem—the declining fortunes of the working majority.

The return of liberalism as the central political and policy narrative in American life means that liberals must somehow convince the American people that their memories of good times during the conservative bubble economy were, in the end, bribes that diverted their attention from the task of rebuilding our society. If we are successful, the liberal regime of the next couple of decades will become an inertial force pushing all parties and institutions in the direction of structural reforms that enhance fairness, competence, productivity, and social justice—this last one is deemed as an illusion and even a deadly threat to liberty by the right. Yet the liberal program must still be austere because the job before us is so immense, and conservatism has squandered so many of our resources (not the least of these being the place of reason in politics).

The economic tasks of liberalism are clear and daunting:
1) Rebuild a fair and effective public sector capable of promoting economic growth and social justice in cooperation with a rationally regulated yet vibrant private economy.

6) Balance the needs of the old and the young by crafting a new social contract that offers development to all children without robbing parents and grandparents of economic dignity.

These steps will put us on the road to creating a freer, fairer, cleaner, more sophisticated, and stable form of middle-class capitalism, but they must fit together in just the right way and in a timely fashion because immense problems are bearing down on us after decades of right-wing misrule.

This program may seem to be both generous and expensive and therefore constrained by our nation’s ongoing debt crisis, which will not be solved quickly given the grand scale of conservative profligacy. Our debt problem constrains us, but not because budget deficits are in and of themselves a bad thing; most people borrow to buy a home or send their children to college. Our problem is that the defunct conservative regime has piled up so much debt over such a long period that we will have to establish a sequence of liberal development projects that respects the constraints that reality imposes.

An austere liberal regime will have to recreate a social safety net that promotes work and increases pay and thereby recruits the vast majority of all people, no matter their level of skill or education, to the task of economic reconstruction. Work and fairness are the guiding spirit of the liberal realism being described here and which recognizes the basic fact that freedom cannot exist if people are deprived of the means to develop their abilities.

How will we pay for this program? By doing one thing at a time in a sustainable sequence. Infrastructure investment, health care, and educational reform will come first, along with entitlement reform and the reinstatement of a smart version of progressive taxation. Many economists have noted that the Social Security problem will be less difficult to solve than the staggering costs of dealing with Medicare, though there is good reason to believe that a unified approach to health care in a common system of insurance and regulation may be able to handle many of the problems associated with the diseases of old age. Still, there are limits to how much taxes can be restructured and raised, both because the majority of Americans have not experienced the benefits of economic growth during the conservative bubble economy and because one lesson of the conservative era—that a nation must pay attention to the incentive effects of taxation—is not wrong, just badly exaggerated.

The U.S. will certainly have to reduce its borrowing from abroad, in part by reducing its trade and budget deficits, and by using borrowed funds mainly to invest in forms of capital that enhance our productive capacities. This choice to restrict borrowing for consumption purposes will cut into the living standards of ordinary Americans, though the reinstatement of progressive taxation combined with other redistributive policies will on balance improve the well-being of people in the lower half of the income distribution.

It is also certain that the American military system will have to shrink, beginning with the abandonment of the current misguided adventure in Iraq. The fiscal pressure of our defense establishment will have to be reduced as a first step toward the economic reconstruction of this country. While the complexity of this undertaking is far too great to be sketched out here, the need for recasting our military power to fit our limited means is crystal clear.

Will this program be attractive to ordinary Americans, whose fortunes will be battered by recession and inflation over the next few years, whose dreams of owning a home have turned into a nightmare of debt and foreclosure, and who have surely become hardened to the promises of politicians? Perhaps, but only if liberal ideas can become the default public philosophy and only if liberals can describe a plausible path to prosperity and the good life for the future. This means that we have a lot of cultural as well as economic work to do.

Marcellus Andrews teaches economics at Barnard College. Homepage and feature photo: President Bush and Treasury Secretary Henry Paulson in 2006 (Shealah Craighead / White House / Wikimedia Commons).