There are those who might have read my little thought experiment on what would have happened if the federal government had allowed the free market to work itself during the recent financial crisis, and concluded I have lost my mind. As reported by the Wall Street Journal, however, former Treasury Secretary Hank Paulson testified to Congress that things could have gone down pretty much as I described, and that he didn’t say so at the time because he didn’t want to cause panic and make the crisis worse. “If you have a situation where a banking system is frozen and money can’t move between financial institutions, what ultimately happens is that every business, even businesses that seem to be solvent and small businesses across America, will not be able to fund their inventory. They won’t be able to meet their payroll.”
Right. Every company in the United States goes bankrupt. Their stocks are worthless, their bonds are near worthless, mutual funds and pension funds are near worthless, the public employee pension funds are worthless, state and local governments can’t borrow, their tax bases shrink, and they are broke as well. In the short run, another Great Depression, with soaring unemployment (even compared with what we have now) and “people in the streets.” In the long run, however, the free market, and the abuses of power, that have made everyone more and more unequal for 30 years, would have rebooted, and everyone would have ended up equal again, with no one having a piece of paper that said they were entitled to the benefit of someone else’s work in the future. “I didn’t spend a whole lot of time thinking about that because I knew it was going to be very bad, and I never wanted to experience very bad.” Compared with where things are going, bad for whom Hank?
Now I’m not going to argue that nothing should have been done, and people should have been allowed to starve. What I will point out is that something else could have been done, a kind of universal Chapter 11, the mother of all cram downs. What could have been done across the economy is something similar to what has been done with GM and Chrysler, with shareholders wiped out, bondholders owning a chunk of the new shares, and the federal government – which is to say all Americans equally – getting a stake with a guaranteed return and possible upside in return for providing debtor in possession financing. In other words, instead of preventing the devaluation of paper wealth to preserve inequality, the government could have acted after that devaluation to re-boot the economy.
Now really convinced that I’m headed for the loony bin? Consider what Nassive Taleb and Mark Spitznagel (they of The Black Swan) had to say in a recent Financial Times essay. “The core of the problem, the unavoidable truth, is that our economic system is laden with debt, about triple the amount relative to gross domestic product that we had in the 1980s…The only solution is the immediate, forcible and systematic conversion of debt to equity. There is no other option.”
Well there is apparently another option. Try to maintain the existing set of winners and losers, shifting all that private sector debt to the public sector and the cost of public sector obligations to the future, to reassure investors the debts will be paid, because public services and benefits can always be eliminated (except public employee pensions of course) and taxes can be collected by force.
Now consider where all that debt came from.
Over the past three decades, the distribution of income has become more and more unequal, with more and more concentrated in fewer and fewer hands. Normally there is a check on this – if the vast majority of people are paid less, they don’t have the money to buy things, and therefore goods and services cannot be sold, and profits cannot be made. But while ordinary Americans have had less and less income relative to those at the top, they have not spent less and less money. Instead they were invited to go deeper and deeper into debt, promising to live worse in the future in exchange for living better today, and unfathomably they did so thoughtlessly on a grand scale. They also failed to save for old age to the extent that prior generations had, even though old age may be expected to last longer.
The federal government, for its part, collected extra Social Security payroll taxes and spent them, setting aside nothing to meet its future Social Security obligations, and borrowed on top of that, in order to spend more, cut income tax rates, and add tax breaks. State and local governments, particularly ours, also handed out tax breaks, richer deals for unionized public employees and contractors, and occasionally more public services, generally health care services.
And in the corporate sector, businesses borrowed money to buy back stock. This meant that shareholders didn’t feel their ownership rights were being stolen from them at the time the top executives who sit on each other’s boards were awarding each other more and more stock options and other compensation, with costs deferred. The rise in top executive pay, in other words, was balanced by a rise in corporate debt, with the greatest debt in the financial sector, where the greatest pay was. Similarly, state and local politicians and the public employee unions that control them awarded themselves richer pensions with diminished contributions by themselves, after fewer years of work. To avoid opposition that cost was hidden, becoming a devastating off the books debt.
In past eras debts were incurred to make investments that would either create more well-being or reduce costs in the long run. But in the United States over the past 30 years, most debt is nothing more than a person’s promise that they (or everyone in case of public sector debts) will be much worse off in the future in exchange for being able to spend more today (which is now past). There isn’t much future well being that comes from a credit card balance run up to go to Starbucks each day rather than brewing your own coffee at home. To the extent there have been investments in recent decades, however, it is SUVs and McMansions that have been invested in. Those purchases lock in higher costs not lower costs, particularly in energy, into the future when the money borrowed to pay for them also comes due.
So the vast majority of Americans promised (or had promised for them by government decisions) to be much poorer in the future in order to have things (or for more powerful people to get things) up front. It is only these promises that allowed such massive wealth, in the form of stocks, bonds, public guarantees, guaranteed public pensions, and other pieces of paper, to be accumulated by the privileged few. Objections to the growing inequality of income were silenced by the assertion that this was the outcome of the free market, and the free market had to be allowed to run its course. In the public sector, the deals were done in the dark and few paid attention. The whole house of cards kept growing as long as savers, now located outside the United States, believed that younger generations of ordinary Americans would agree or be forced to live diminished lives to pay the value of those pieces of paper. It piled up higher and higher, to the point where those debts were so large they have no chance of ever being repaid in money worth what they were borrowed in.
Then, long after I thought it couldn’t go on any longer, a crisis. And let’s be clear – the financial crisis did not cause the collapse our consumer debt economy. The financial sector engineered a false economy to cover over its rotting foundation. It is the foundation that collapsed, bringing the financial sector down with it. That collapse has years to run.
But when the financial crisis hit, when the value of those pieces of paper were threatened, suddenly the free market didn’t matter so much anymore. Not to Democrats. Not to Republicans. You got government intervention on a massive scale, in a country where intervention on behalf of the less well off had been repudiated over 25 years. The “unavoidable truth” is that the debts cannot be paid. The real options are “the immediate, forcible and systematic conversion of debt to equity,” or a back door debt wipeout through inflation. But another option was chosen. And the thought experiment shows who really benefitted – those who had something to lose.
And now and 20 years from now, who is going to lose the right to Social Security to pay for the past private sector debts that are being shifted to the public sector in order to keep the old consumer debt-driven economy going? Who will lose access to what health care services in old age? What local services will be devastated to pay for all those pensions, schools, police, parks, libraries, or all of the above? How high will taxes rise, even as the workers who will be paying them are told a universal health care finance system that they benefit from as well as pay for is unaffordable?
In the recent past, Americans faced a choice between either living it up and grabbing all they could in the short run, or continuing to build a better country while investing in the next generation for the long run, as prior generations of Americans had done. With the Frat Party in charge and the Cocktail Party going along and grabbing a piece, they chose to sell out a future that has now arrived, individually and collectively.
Our choice is now much less appetizing. Bite the bullet today, and make the sacrifices required to put our society on a firmer foundation to rebuild for the future, or continue to sacrifice the future to postpone collapse at the expense of inevitable and ongoing perpetual decay. That perpetual decay allows the unearned privileges accumulated in the past to be, in part, retained, and with the same people backed by the same interests to stay in charge, despite a political shift that left the Cocktail Party with more authority. At the moment of decision, the choice was gradual decay, a decision that has since been reaffirmed at every level. It will seemingly go on until it can’t anymore, like the original house of cards that collapsed last September.
In every discussion of sacrifices that must be made, it is always younger generations that are made to sacrifice. Regardless of the political party. Lower wages and diminished benefits for future public employees. Lower Social Security and Medicare benefits for those who weren’t “at or over 55” when W. said the words. Ever higher taxes on wages, but not retirement income. Pension costs deferred to a future when members of the state legislature expect to be collecting retirement income.
And incredibly, those who were bailed out, and expect to be bailed out, are acting as if nothing has happened. Asserting that they have earned those pieces of paper. Feeling no need to even pay lip service to the situation of future generations and those who don’t have them. Not even thinking for a moment about their situation relative to those less privileged. The stunning arrogance on display boggles the mind.
This has gone on for so long. But like the seemingly perpetual increase in America’s personal debt, it can’t go on forever. Expect ongoing decay perpetuated by occasional crises – public and private made public – as long as Generation Greed expects to make it do so. In the end, all our institutions will be discredited, grabbing from the majority only through force, and offering less and less in return. Frankly, I have very little respect of the “rights” inherent in many of those pieces of paper, and very little confidence in those I hold as a result of our un-American savings.
Arrogance or no, sooner or later there will be a public revolt against them, similar to the private revolt embodied in people walking away from their mortgages and credit card debts, now that it will no longer be possible from them to go on living beyond their means. Layoffs and lower wages to pay corporate bonds? Higher fares and service cuts to pay MTA bonds? Soaring property taxes, education cutbacks, and lower wages and benefits for working teachers, to pay for the untaxed early retirement pensions of previous teachers? At some point the “circumstances beyond our control” baloney won’t wash, and there will be a conflict that could go extra-constitutional. The big questions that aren’t being asked will come to the front.
More crazy talk? As per Paulson “German leaders who were explaining to me that people in the old east were unhappy with the big discrepancies in wealth, but they at least believed in the system and believed in some form of market-driven capitalism, but that if we had a meltdown of the system, this could even lead to chaos or people even questioning the basic system.” Hence the desperation to paper things over and stretch things out by those who run the system. Eventually, however, gradual decay will lead to the same questions. In order to really preserve the basic system over the long run, those who have taken the most out would have to put a lot more back, but they are not willing. Perhaps what has happened is an inevitable result of human nature. The result in the end could be an institutional collapse.