Sunday, September 14, 2008

Double Bubble, Toil and Trouble

Two economic bubbles burst in less than a decade. Is that just a run of bad luck, or is it a financial engineering feat? And how is it related to politics?

Consider that the Internet stock bubble that peaked in 2000 cannot be directly blamed on the Republican Party, since Democrat Bill Clinton was President and his Vice President Al Gore was a early proponent of the Internet. Congress, however, was controlled by the Republicans. The Federal Reserve probably deserves most of the blame for that bubble.

The Housing mortgage bubble that burst in 2007, with aftershocks still shaking up 2008, cannot be blamed on the Democrats. Even though Democrats controlled Congress by the time the bubble burst, we had a Republican President, George W. Bush, during the build-up to the bubble. Again, the Federal Reserve deserves most of the blame for the bubble (if you don't count the banks, the mortgage brokers, and the fools who bought at the top of the housing market).

So should we blame the Federal Reserve? Is the two-party system just a circus to keep most citizens distracted while we are really governed by an all-powerful, appointed, cabal of the highest reaches of banking and government? The two-party system is a circus, but it is not just a circus. The Federal Reserve is powerful, but today the corporate new media is saying the bubbles were because the Federal Reserve had too little power, not too much. There is a bit of truth in that, but they did have the power to raise interest rates. Raising interest rates earlier during each of the bubbles would probably would have prevented many of the excesses that damaged the entire economy when the bubbles popped. Yet those who hate the Federal Reserve would have hated that even more. In the housing bubble, the left would have pointed to the injustice of raising interest rates to the point where ordinary people were unable to buy homes, and the right would have screamed because it would have slowed down a none-too robust economy.

Noam Chomsky has talked about the way our "free market" economy tends to privatize profits and socialize losses. That is, the workers have to clean up after the rich. We are seeing that now with the banking bailouts. Executives walk away with their winnings, they don't have to give anything back to the stockholders or customers or employees or other losers. No one is paying back the fees generated by mortgages that should never have been made. The financial press, at least that part aimed (propaganda should always be carefully aimed, otherwise there might be casualties from friendly fire) at the unsophisticated, have failed to talk about bondholders at Freddie Mac and Fannie Mae. When the U.S. Government backs these institutions, it is saving the bondholders' investments. The bondholders took a risk in lending money to Fannie Mae to lend (through middlemen) to home buyers, but instead of being forced to take their losses, they will get paid all the interest and principle promised. Stockholders are losing almost everything; bondholders are fully protected. Old money tends to be in bonds; new money tends to be in stocks. Even among the very wealthy there is a system of caste and privilege.

Most Americans are just going to have to work harder and make do with less. Of course finding a job if you are an unemployed carpenter or real estate broker is not easy to do right now: you can't work harder when you are not working at all. American workers find themselves in the modern equivalent of lying prostate in the cotton field, genuinely unable to move a muscle because of poor food, heat, and exhaustion, while the overseer (never the master, who is drinking fine whiskey while trying to guess what price cotton will fetch in New Orleans this year) lays on the whip, demanding that they get up and produce more, more, more. You can't work harder or smarter if no work is to be found because the nation's capital was allocated to financial speculation.

The federal government is going to have to raise taxes or spend a lot less money on services, or it will bankrupt the entire nation without having to wait for the long term. Fortunately the Bush Tax Cuts for the Rich (which many Democrats in Congress originally voted for) are apt to expire in 2010, regardless of who is elected President, as long as the Democrats control Congress.

Financial bubbles have many components, but the ones that are large enough to matter are always based on credit bubbles. Credit is needed to provide the money used to bid up the price of whatever assets are in the bubble. The Internet Bubble was a typical bubble; many people called it a bubble long before it burst. Only idiots owned the stocks when they started to crash. Every Internet stock was hyped as the next Microsoft, while stocks of companies that were making real goods and profits were neglected. The credit involved was the ordinary kind, made possible by the Fed keeping interest rates too low.

The Housing bubble was weirder. With an Internet company at least the fiction was there that it might become more valuable over time, when it learned to convert page views to real money. But a house is a house. A neighborhood might become more popular, driving up prices locally, but the whole nation is not a neighborhood. House prices rise gradually over time mostly because of inflation. The bubble got its start because housing was not a popular investment during the 1990's stock market boom. When the Internet bubble broke, housing was relatively cheap and interest rates on mortgages were exceptionally low. Buyers moved in, sending up prices and getting the ball rolling. Then the bubble was driven by short-sighted banks and mortgage companies that were able to give credit at no risk because it was other people's money, and collect big fees for that service. As soon as the Federal Reserve raised interest rates towards normal levels, the bubble started to fall apart.

I think a lot of people saw it coming and decided to grab while the grabbing was good.

The real estate industry has always been a major financial backer of both Democratic Party and Republican Party politicians, from local city councils up through Congress and the Presidency. Don't expect anyone to give the real estate speculators a spanking.

As always, the American worker and small businesses, and a few well-run, non-glamorous, large businesses, will pull everyone's ass out of this mess and get no credit for it. But until ordinary Americans wake up and think things through, organize and act on a sound analysis, they are going to keep getting lashed by the wise guys on Wall Street. Neither the Democratic Party, nor the Republican Party, as currently configured, are capable of taking on Wall Street or the real estate speculation lobby.

With interest rates nice and low now, and no shortage of stupid people in the world, the next bubble is brewing somewhere. Only time will show where.

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