Wednesday, December 31, 2008

Not Too Big Enough--The Banks Laugh All the Way To the Bank

The country’s financial markets have collapsed, as they tend to do when left without adult supervision, and they’re taking our economy with them. With the large banks refusing to make loans after losing billions on worthless subprime derivatives, the government stepped in and agreed to October’s financial bailout package. The $700 billion legislation was meant to buy banks’ “troubled assets” for cash, and thus improve banks’ balance sheets to the point that they would lend again. This would mean credit for struggling businesses and households, and could encourage expansion and hiring, thus pulling us out of recession.

But it turns out the banks haven’t held up their end of the bargain. All they’re holding up is a glass to a government that would rather shovel cash into the largest banks than take the edge off the recession.

The bailout was highly unpopular, despite a heavy push by the U.S. political leadership.[i] Most citizens apparently couldn’t figure why we should give money to the banks that caused this crisis by investing in complicated and risky securities to the point that they lost their shirts when the housing bubble exploded. Especially when foreclosures and bankruptcies among regular homeowners are out of control—the Mortgage Bankers Association reports that “a record one in 10 American homeowners with a mortgage was either at least one month behind on their payments or in foreclosure at the end of September.”[ii] But the plan has not been carried out as advertised—rather than buying the subprime securities from the banks, the government has instead decided to “recapitalize” them.[iii] Meaning, invest money in the big banks for some equity, money which the banks could then loan to the staggering economy. Well, at least the part where we give them money went well.

The fact is that the banks are not making loans—the “credit crunch” goes on, and the economy is the worse for it. After so many of Wall Street’s great investment banks went bankrupt, or were bailed out by the government, or were bought by competitors, the banks want to “hoard cash” to avoid a similar fate.[iv] But besides shoring up their own finances, the banks are putting our public bailout money to another purpose—buying up their smaller competitors.

Mergers and acquisitions have been a major part of the government’s strategy to deal with the crisis since its beginning. Bear Stearns, the first respectable Wall Street powerhouse to approach bankruptcy, was sold to the larger bank Chase in a shotgun marriage, arranged by the Federal Reserve. Since then, the government has arranged for a tanking Merrill Lynch to be sold to Bank of America, a heavily leveraged Wachovia to Wells Fargo, and a failing Washington Mutual to Chase, again. The Treasury Department would say that the damage to the economy can be limited if larger, more stable banks buy their struggling rivals.

Of course, some of these largest banks, such as Citigroup, are not so secure themselves.[v] But more than that, the money used by the larger banks to acquire the others is capital that could have been used to make the loans our economy is desperate for—and of course, that’s what they were supposed to do with the public money in the first place. But most importantly, remember that the reason we’re paying to bail out these banks at all is that they are “too big to fail,” in the language of the business press—in other words, if these huge banks go under, the loss of employment, lending, and tax revenue could do profound damage to the greater economy. So if these banks were too enormous to allow to die in the first place, why in God’s name would we be paying them to get even larger?

The mergers are large-scale—the Financial Times calls them a “wave of consolidation as banks scramble to use the cash on takeovers and bolt-on acquisitions.”[vi] BusinessWeek reports “what could emerge is a barbell-shaped system with megabanks, small banks, and little in between.”[vii] The business reporters for the New York Times describe the Treasury Department as “using the bailout bill to turn the banking system into the oligopoly of giant national institutions.”[viii] An oligopoly is a market, such as banking, dominated by a few very large companies.

If any doubt remained, it was put to rest by the minor scandal that has emerged over a quiet change to the tax code made by the Treasury Department. This change allows banks to apply the losses of other banks they buy against their own taxes. In other words, when a bank buys a struggling smaller bank, the buyer can deduct the money lost by the struggling bank against its own tax bill. This is clearly meant to further encourage merger activity—for example, when Wells Fargo bought Wachovia, it paid $15 billion. But Wachovia’s losses total over $19 billion.[ix] Meaning, Wells Fargo was paid for buying a highly valuable bank, for a profit of $4 billion, at our expense.

By way of comparison, the SCHIP program granting health insurance to children in low-income families cost about $5 billion in 2007.[x]

In fairness to the Treasury Department, Secretary Henry Paulson has been urging banks to use our public money to lend more.[xi] But tax breaks speak louder than words. It also might be pointed out that in Britain, banks are being recapitalized in a similar way as here, but the U.K. requires banks to formally agree to make loans with the public money.[xii] The American situation was described by David Walker, former U.S. comptroller: “It is the government’s responsibility to set the terms and conditions on this money…They’re giving it out with no rules.”[xiii]

This tax change may be undone if congress confronts the Treasury, since the legislative branch is supposed to be in charge of the tax code.[xiv] But the intention of the Treasury department to encourage mergers at the top of the banking world is very clear.

In fact, the government is going to great lengths to avoid doing what little the Brits have done. Rather than require our banks to make loans with the bailout money, our central bank, the Federal Reserve, “has already started a campaign to lend directly to damaged financial markets and companies—nearly anyone with collateral…officials have effectively concluded that if banks and financial markets won’t extend credit, it will do part of the job for them.”[xv] This is according to the Wall Street Journal, which also reports that Treasury secretary Paulson “acknowledged that banks aren’t lending enough money despite the government infusion, but said the U.S. didn’t want to nationalize the industry and dictate the loans banks make.”[xvi] Our government will do anything, even supply the economy with credit itself, before it will tell our huge banks what to do.

So to summarize, after creating a national economic crisis by wildly overinvesting in securities representing bad loans, the banks are being paid, by us, to become even larger. In spite of their being too big to fail in the first place, and even if that means the government has to do the banks’ job for them. Of course, with one in ten mortgages in delinquency and job losses mounting, it’s easy to come up with some better uses of our tax money. But it would take a whole lot of us putting down the snack chips, turning off When Celebrities Attack and organizing ourselves to put pressure on the government and change the economic system. The “megabanks” of our “oligopoly of giant national institutions” aren’t going to overthrow themselves.

And you can take that to the bank. The one remaining bank.

Rob Larson is getting bigger too, but it’s the holidays. He’s Assistant Professor of Economics at Ivy Tech Community College in Bloomington, Indiana and blogs at

[i] New York Times, “Labeled As A Bailout, Plan Was Hard to Sell to A Skeptical Public,” October 1, 2008.

[ii] BusinessWeek, “Foreclosure Activity Drops To June Levels,” December 11, 2008.

[iii] Financial Times, “Latest Shot Shifts the Goalposts,” October 15, 2008.

[iv] New York Times, “Banks Are Likely to Hold Tight to Bailout Money,” October 17, 2008.

[v] Wall Street Journal, “The Rescue of Citigroup,” November 24, 2008.

[vi] Financial Times, “US Capital Injection Sets Up Bank Consolidations,” October 22, 2008.

[vii] BusinessWeek, “Will Bank Rescues Mean Fewer Banks?” November 25, 2008.

[viii] New York Times, “So When Will Banks Give Loans?” October 25, 2008.

[ix] New York Times, “Treasury to Review New Tax Break Plan,” November 19, 2008.

[x] Wall Street Journal, “A Worrying Prognosis,” November 25, 2008.

[xi] New York Times, “Paulson Says Banks Must Deploy Capital,” October 15, 2008.

[xii] Financial Times, “Lloyd’s Pledge On Small Groups,” December 3, 2008.

[xiii] New York Times, “Banks Are Likely to Hold Tight to Bailout Money,” October 17, 2008.

[xiv] Financial Times, “Schumer Warns Against Change to Tax Code,” October 31, 2008.

[xv] Wall Street Journal, “Fed Cuts Rates Near Zero to Battle Slump,” December 17, 2008.

[xvi] Wall Street Journal, “Obama Works to Overhaul TARP,” December 17, 2008.

Friday, December 5, 2008

In Rude Health--The rich take the crisis in stride

While America holds its breath wondering if the new president will fix the economic crisis, we citizens have to keep the root causes in mind, like our raging wealth and income inequality. As busy as the population is, investing in canned goods and small arms ammunition, there is at least some awareness of the growing gap between the rich and everyone else. Without a better social awareness of this great divide, fighting to change it is impossible. The divide itself has been widening for thirty years, and so have the rich.

A very revealing report on this development was recently produced by the Organization for Economic Cooperation and Development, the group of developed nations, including the U.S., Canada, Western Europe and Japan. The report indicated “Rich households in America have been leaving both middle and poorer income groups behind. This has happened in many countries but nowhere has this trend been so stark as in the United States.” In these parts, the wealthiest 10% was the richest in the entire OECD; and our poorest 10% was the poorest.[i]

In another embarrassing American landmark, several cities in the U.S. have reached levels of inequality comparable to the massive slum-cities of the third world. Cities of great wealth, like New York and Washington, approach Buenos Aires and Nairobi in their lopsided income distributions. In particular, New York City cracked the top ten list of the world’s most unequal cities, unheard of for the developed world.[ii]

A recent study of American tax data over the twentieth century concludes that the share of total U.S. income going to the top 10% of American households has gone from about a third in the 1970s, to half of pre-tax income today. And over the period 1993 to 2006, the income of the top 1% of households increased by an annual rate of 5.7%, while the income of the lower 99% grew by only 1.1% over the same period.[iii]

It’s not just numbers on paper—the well-heeled are going to town, from seven hundred dollar cigars to fifteen thousand dollar facelifts to ten million dollar personal helicopters.[iv] What an average American would make in a hundred years, the rich drop on a chopper to take from Long Island into Manhattan, so as to shop without sitting in New York traffic. And even as the retail chains for the working and middle class decline (except for Wal-Mart), stores with upper-class clientele are another story. With the equity markets crashing, spending by individual wealthy families is somewhat down, and analysts have found “the idea that the high-end luxury market is immune to the economic cycle is a myth.”[v] But there is a silver lining: “luxury brands continue to benefit from a sustained increase in the number of wealthy consumers, particularly in countries like Brazil, Russia, India, and China.”[vi]

Indeed, the world now supports more wealthy families than ever before. According to a report compiled by financial analysts and described by the Financial Times, “The ranks of the world’s rich swelled to eight million during 2007 as the wealthy proved immune to the strains across global economies in the latter half of the year.”[vii] The report suggests that wealth concentration at the top “retained its strength through 2007 and is in rude health.” The report concludes that 2007 saw a 4.5% increase in the number of the “truly rich,” even as they “shrug off the credit crunch.”

The rich have been affected by the credit crisis, of course, since their ownership of financial assets it so disproportionate. [viii] But the “smart money” avoided the worst of the crisis; back in June, well before the implosion of banks invested in property-backed instruments this fall, “the wealthy have responded to the turmoil in the markets by scaling back their exposure to property and hedge funds in favor of safer investments,” according to a report prepared by Merrill Lynch.[ix] The wealthy cut back on property trusts and hedge funds, and committed more to cash and other liquid deposits, big moves from the “more than ten million people on the planet with financial assets worth more than $1 million.” This is not to speak of the “ultra-rich—those with $30 million or more to invest,” who grew even more rapidly than the mere millionaires.

It is these “ultra-rich,” the multi-millionaires and billionaires, who have redefined affluence and conspicuous consumption. One notorious preserve for upper-class consumption is contemporary art, where recently the consensus among the prestigious art dealers is that “while there is some uncertainty in the middle of the contemporary art market, the top end is holding strong.”[x] A recent high-profile art auction included “a stainless steel cabinet of industrial diamonds,” which went for £5.2 million to a Russian bidder.

Besides art, the most over-the-top ruling-class toy is of course the superyacht. These massive state-of-the-art private islands run into tens of millions of dollars, plus about a tenth of the purchase price in maitanance and fuel cost annually. No mere recession is going to put the yacht brokers out of business, “an elite group who matchmake the super-rich with what is regarded as the ultimate luxury.”[xi] But it’s not all easy being the ruling class: When your yacht is 300 feet long, “One thing money cannot always buy is space at the marina.”[xii] Grab the tissues, the suffering goes on. The shortage is aggravated by the lack of suitable new harbor locations, which must have “all the infrastructure needed to attract the big boats, including easy access by air, possibly a nearby airstrip that can handle private jets or helicopters and the potential to become a chic destination in its own right,” as the elite press laments.

But for the lower 90% of us, things aren’t so damn chic. August of 2008 was “the 10th consecutive month that the weekly average salary had failed to keep pace with inflation” according to the Labor Department.[xiii] This fits with the longer trend over the last several decades, where America’s low inflation rate has kept up with our weak wage growth. This has become a minor news issue of late, with the New York Times reporting that since about 1973 “inflation-adjusted wages stagnated or rose glacially” in the American economy.[xiv] The large majority of Americans have been working more hours and borrowing more money over recent decades just to maintain constant purchasing power. The recent chapters of the story of America have been about making do with less.

Much less. The infant mortality rate of the United States is very high, tied with Poland and worse than 28 other nations, including Cuba and Hungary, as well as Western Europe and industrialized Asia.[xv] This is despite the fact that “the United States devotes a far greater share of its national wealth to health care than other countries.” Twice as much, in fact. The giant chasm in our American fortunes shapes our lives to a significant extent—including whether or not we get to live them.

The wealth gap, unsurprisingly, is unpopular. “Public opinion across Europe, Asia and the US is strikingly consistent in considering that the gap between rich and poor is too wide and that the wealthy should pay more taxes. Income inequality has emerged as a highly contentious political issue in many countries as the latest wave of globalization has created a ‘superclass’ of rich people.”[xvi] This is from the Financial Times, the world’s most prominent business newspaper, and not exactly communist. The FT’s survey found large majorities around the world thought inequality had gone too far—87 percent in Germany, 80 percent in China, and even 78 percent in the US, “traditionally seen as more tolerant of income inequality.” In spite of McCain’s railing against “redistribution,” Americans may be more interested in moves toward equalizing wealth than is currently realized.

With the opening presented by a new Democratic administration, expectations are high. But this is a moment to remind ourselves that equality and justice don’t usually come from the generosity of the powerful, no matter who they may be. Only public pressure, usually in the form of a real popular movement, has dragged rights out of the American power structure. The movements for abolitionism, women’s equality, labor organization, civil rights and environmentalism have gotten some results over the years, but by demanding rights and equality from the rich and powerful, not by hoping for them.

It will take a large movement among the public to bring enough force to the Democrats to move the country back toward the progressive taxation that was modest even before Bush took an axe to it. And it will take a revived labor movement to win back bargaining power from the great firms mainly owned by the rich, and to win some desperately-needed wage increases. But more than political reform and wage increases, American citizens ought to ask why our economic system is driven to create the unequal class society we live in, and if we could find a better way of running things.

This means each of us standing up from our comfy, rent-to-own couches and getting informed and getting together. This kind of organizing work is hard, especially for an overworked and underpaid people like ourselves, but it could be motivated by keeping an thoughtful watch on the “superclass” and its “rude health” in our sick times.

Rob Larson avoided taking losses by cleverly being too poor to invest in the market. He is Assistant Professor of Economics at Ivy Tech Community College in Bloomington, Indiana.

[i] Growing Unequal, OECD, October 2008 . Financial Times, Gap Between Rich and Poor Widens, October 22, 2008.

[ii] Financial Times, US Cities Among Most Divided On Rich-Poor Lines, October 23, 2008.

[iii] Striking It Richer: The Evolution of Top Incomes in the United States, Emmanuel Saez, Pathways, Winter 2008.

[iv] All the Money In the World, Peter Bernstein and Annalyn Swan, Knopf 2007.

[v] Financial Times, World’s Rich Cut Back on Luxuries as Crunch Bites, August 25, 2008.

[vi] International Herald Tribune, European Luxury Goods Groups Defy Downturn, August 29, 2008.

[vii] Financial Times, World’s Rich Shrug Off Credit Crunch, April 20 2008.

[viii] Kennickell, Arthur. “Currents and Undercurrents,” Jerome Levy Economics Institute, January 2006.

[ix] Financial Times, World’s Rich Scale Back Exposure to Property, June 24 2008. Obviously, this report is now somewhat ironic. See New York Times, How the Thundering Herd Faltered and Fell, November 9, 2008.

[x] Financial Times, Super-Rich Set To Invest Millions at Annual Frieze Art Fair, October 2008.

[xi] All the Money In the World, Peter Bernstein and Annalyn Swan, Knopf 2007. Financial Times, Father and Son Play Matchmakers to the Rich, September 23 2008.

[xii] Ibid, Berth Pangs Of the Super Rich, September 23, 2008.

[xiii] New York Times, Living Costs Rising Fast, and Wages Are Falling, August 15 2008.

[xiv] New York Times, Falling Fortunes of the Wage Earner; Average Pay Dipped Last Year for First Time in Nearly a Decade, April 22, 2005. See also The State of Working America, Economic Policy Institute, 2007.

[xv] New York Times, Infant Deaths Drop in U.S., but Rate Is Still High, October 16, 2008.

[xvi] Financial Times, Poll Shows Wide Dislike Of Wealth Gap, May 18, 2008.