POLICY FAILURES WITHOUT END
By Wayne Jett
© November 10, 2008
Ultimately, President George W. Bush’s administration succumbed to the same Achilles Heel as his father’s: the Wall Street connection at Treasury and the Federal Reserve. In 2006, the Iraq War was the only threat to a Bush 43 legacy of historic dimensions. Two years later, the Iraq War is won, but U. S. and global economies are undercut more seriously than at any time since World War II and Bush’s presidency is presently dismissed as unmitigated disaster.
The pivotal event between 2006 and now was Bush’s replacement of Treasury secretary John W. Snow in July, 2006, with Henry Paulson Jr., CEO of Goldman Sachs. Paulson’s pre-condition that he be given complete authority over policy as “economic czar” and his unanimous confirmation by the Senate implied that Bush accepted Wall Street dominance to gain Democratic cooperation in Congress. Regardless of the president’s motivation, the move proved to be his worst.
Liquidity Diverted from Jobs to Speculators
Before Paulson, Alan Greenspan and then Ben Bernanke carried the ball for Wall Street at the Federal Reserve. In June, 2004, Greenspan began raising the overnight funds rate above yields on short-term Treasury bills. Commercial banks raised their prime rates in unison on that basis, making their loan rates higher than reasonable. By mid-2006, bank loan rates were about four per cent above market. Small business was shut out of bank credit. The sector stopped growing and started shrinking – meaning they fired employees. This was the Fed’s intention. Chairman Bernanke confirms the Fed staff uses Phillips Curve theory which espouses higher unemployment to retard price increases.
The Supply Side Guide of August 16, 2007, reported that 666,000 net payroll jobs were added in 2005, but 272,000 jobs were lost in the first seven months of 2007. In 2008, the Fed’s higher unemployment policy worked so well the U. S. destroyed 240,000 jobs in October alone, just in time for newly unemployed to vote in federal elections and bury many Republicans, including presidential candidate John McCain.
Paulson at Treasury did nothing to alter the Fed’s high-interest-rate-weak-dollar policy until August, 2007, when credit markets began to break down. The malfunction occurred because credit denied to small business by Fed policy flowed instead to banks, prime brokers and hedge funds, which hyper-leveraged to exploit financial derivatives. All took on too much risk. Paulson was active in this exploitation while at Goldman Sachs, and did nothing to slow it at Treasury. Neither did he influence the SEC to stop fraudulent securities trading practices, nor did he encourage the Commodities Futures Trading Commission to prevent manipulation of the price of crude oil. Paulson may have influenced the SEC and CFTC to do nothing; it is hardly conceivable either group of commissioners would disregard his expressed wishes.
Financial Consolidation Rolls
Paulson’s role in the serial slayings of Bear Stearns, IndyMac Bank, Fannie Mae, Freddie Mac, Lehman Bros., AIG, Merrill Lynch, Washington Mutual, Wachovia and National City was remarkable in its consistently destructive impacts on private equity investors (and its proportionally beneficial effects on short sellers’ interests). Paulson proposed no comprehensive plan to deal with the financial crisis until President Bush and Congress demanded he do so, and then he rushed legislation that gave him almost unfettered power over $700 billion.
President George H. W. Bush lost his bid for re-election in 1992 in comparatively benign circumstances. Bush 41’s Treasury secretary was Nicholas F. Brady, former chairman of Wall Street investment bank Dillon, Read & Co. Brady worked through the savings and loan debacle, but helped persuade Bush 41 to break his “no new taxes” political pledge in exchange for Democratic support of financing for the Gulf War. The resulting economic downturn brought Brady to jawboning Greenspan and the Federal Reserve for lower interest rates. Greenspan’s aversion to public criticism brought a brief, shallow recession and Bill Clinton into the White House.
Prospects for Reform
With Barack Obama as new president-elect, prospects for addressing policy issues are marginal and uncertain.
• Monetary policy at the Federal Reserve – Democratic Party politics is the bastion of Keynesian economic theory, which masks objectives of Wall Street influence. Impetus for reform of Fed policy and practice is unlikely to emanate from President Obama and the Democratic Congress. The Fed is much weakened after astonishingly rapid expansion of its balance sheet, up 130% in the past year above $2 trillion. (Is this not enough to demolish finally the canard of orthodoxy that one per cent interest rates in 2003-2004 – when Fed operations injected about $35 billion annually – caused our current problems?) During the week ending November 7, the Fed bought commercial paper with $185 billion of newly created currency. Simultaneously, Treasury piled trillions more on federal debt. As Fed and Treasury continue papering over policy failures, Wall Street and Main Street fight to survive Treasury-assisted predatory “consolidation” of assets at fire-sale prices.
Impetus for policy change will come from other global economies, stirred to action by the calamities of 2008 that emanated from the U. S. France, Russia, Brazil and China, among others, are moving definitively to bring about a new nternational structure for finance, and that must include monetary policy. The first meeting with U. S. authorities will be November 15 in Washington, D.C. Neither Wall Street nor Washington will yield eagerly, but the depth and extent of harm caused by U. S. policies have engendered great resolve in other countries to make real progress. Hopefully, international reforms will be beneficial, but that is not a given.
• Securities trading regulation – Senator Charles Schumer of New York raised a lot of money from Wall Street and the hedge funds of Connecticut for Democratic Party candidates. With Schumer and Senator Christopher Dodd of Connecticut calling the shots on securities law issues in the Senate, real reform of the SEC and fraudulent trading practices is most unlikely. Whether president-elect Obama adds anything new or unexpected to that mix remains an open question. However, some dissident Democrats in the House learned of the fraudulent trading problems during review of Paulson’s bailout plan and may want to revisit the issue.
• Crude oil price manipulation – The world price of crude oil dropped near $60 per barrel primarily due to retrenching in economic growth after high energy prices caused lower demand for oil products. In May and June, Congress gathered evidence of price manipulation in U. S. futures markets that are not monitored by CFTC. Legislation drafted during the Summer scared speculators enough to start the price slide, but leaders in both houses of Congress blocked passage. Dissidents in Congress are not likely to succeed alone, but if the president-elect is a real reformer he could gain real traction by leading on this issue.
• China’s $586 Billion Infrastructure Plan – China says about 15% of GDP will be spent on infrastructure projects during 2009-2010. The move takes up slack in Chinese economic growth resulting from recessive U. S. demand, and will employ Chinese workers otherwise idled. In the U. S., China’s infrastructure spending will have these impacts:
o China’s demand for U. S. Treasury securities will decline by the amount of infrastructure spending, so Treasury yields will rise.
o The current account deficit with China will decline as U. S. infrastructure builders gain revenues while consumption of Chinese manufactures falls.
o Threats of tariff increases against Chinese goods by the new Democratic president and Congress ought to be relieved as the current account deficit subsides.
Infrastructure spending in China has the added benefit of reducing appreciation of the Chinese currency by reducing accumulation of financial reserves. The plan appears well conceived and beneficial, assuming its implementation minimizes corruption and emphasizes merit. ~