Foreign Derivative Swaps

This is my first reform effort for the financial industry. I think it's thought provoking. The Americans for Financial Reform (dot org)posted a letter to the same committee stating a similar argument. I'll try to remember to link to it soon. The final concept here is that
finance has not contributed to prosperity, it has diverted our attention. It should be much smaller. The book The Great Financial Crisis is a good source of info that I should review (and I'm writing to myself, as usual). Written around May 12, 2011

To the U.S. Treasury,

Re: Regulations on international “swaps” and the exemptions rule.

This is my suggestion.

You are about to exempt international “swaps” from regulations in the Dodd-Frank Commodity Exchange Act. I object.

I surmise from my reading that the financial system is much too large, and the U.S. Treasury should do its utmost to reduce its size. I gathered the following facts from the book Epic Recession by Jack Rasmus, a professor at St. Mary’s College in northern California. He was commenting on the growth of debt in the U.S. since 1978, and he drew from Federal Reserve’s Flow of Funds Report, Q1 2009.
Total U.S. Debt, 1978 to 2008:
Government debt up 8.0 times (all are ‘78 to ‘08),
Total Consumer Debt (including mortgages) up 10.3 times,
Non-Financial Corp. debt up 9.4 times,
Financial Corp debt up 47.0 times. Financial corporate debt jumped from $412 billion in 1978 to $19.5 Trillion in 2008 — Federal Reserve Flow of Funds.
As Marshall Auerback wrote at New Deal 2.0 in May 14, 2011, “The whole boom of the last 25 years was predicated on financial deregulation, massive fraud, and a huge build up of private debt as a consequence of inadequate fiscal policy to generate full employment and rising incomes.”

I commented, “The huge increase in financial corporate debt had no matching component in real world investment. There were relatively few projects to fund, as the figures prove. But there were corporate mergers and buyouts, and CDO securitization and credit default swaps and financial engineering. Real financial intermediation which is the true function of finance and credit was replaced by financial engineering, and often that resembled gambling more than investing. How else can you explain the numbers that increased financial corporation debt by a factor of 47? Financial corporations’ profit as a portion of all corporate profit also grew, Our financial system has yet to resolve the “frozen negative assets” (a phrase ‘coined’ by H. Paulsen and B. Bernanke) that they hold, and housing prices are expected to decline another 15%. The losses must be faced and absorbed privately, not transferred to the public. Then we need an economy modeled on growth that serves the majority of citizens. “Mark to fantasy” has replaced Mark to Market. “Extend and pretend” is the new banking norm. Banks own over 60% of U.S. home equity since the recession stripped value from mortgage holders. But the book value which the banks show does not reflect the true, reduced value of these housing assets. As Auerback claims, the banks are still bankrupt.”

Another book that makes a similar argument is The Great Financial Crisis by Foster and Magdoff, two socialists. On page 20 they display a graph that shows from 1959 to 2007 two measures, “Debt as percentage of GDP” and “Total goods production as percentage of GDP”. From an index of where both items begin at 100 in 1959 the Debt figure rises to 250, the Total Goods figure falls to 65. “The search by capital for profitable outlets for its surplus despite the stagnation of investment opportunities within production, coupled with the belief that asset prices as a whole went only one way -- up --, generated a secular financial explosion.” But, they conclude with Karl Marx, “The real barrier of capitalist production is capital itself.”

Using the findings of another report we see much the same trend.
Thomas Palley (Financialization: What It Is, Why It Matters, PERI, U.Mass/Amherst, 2007) shows that financial corporation profits as a percentage of all corporate profits grew from 20% to 43% between 1973 to 2005 (Palley, page 37). Financial corporation debt as a percentage of GDP grew, 1973 to 2007, from 9.7% to 31.5%, increasing by a factor of 2.4 times (Palley, page 38) . Non-financial corporate debt decreased from 90.3% of GDP to 68.5% (Palley). Mortgage debt, 1973 to 2005 increased from 48.7% of GDP to 97.5% (Palley).

Palley's findings show a rapid growth of financial corporation debt (by a factor of 2.4), but not as rapid as the findings reported by Rasmus or by Magdoff and Yates (showing an increase by a factor of 6) in The ABCs of the Economic Crisis, page 77. The Magdoff and Yates figures align with the Rasmus figures. Perhaps Palley's definition of a financial corporation was more restricted, not including the 'shadow' banking corporations. (See also Palley's 2009 paper, America's Exhausted Growth Paradigm: Macroeconomic Causes of the Great Recession, for more analysis along this line.)

So, why ?, I ask myself, is the Treasury exempting “swaps” from regulation?

My suggestion comes from another book, The Keynes Solution by Paul Davidson. He proposes an International Monetary Clearing Union (IMCU). “All international payments, whether for imports or financial funds crossing national borders, would go through this clearing union.” (page 136) You can read the rest of the chapter for yourself. But I’ll shortly quote his three objectives:
1. Prevent a lack of global effective market demand for the products of industry from occurring due to liquidity problems whenever any nation holds excessive idle reserves by saving too much of its internationally earned income. . . .
2. Provide an automatic mechanism for placing a major burden of correcting international trade imbalances on the nation running persistent export surpluses.
3. Provide each nation with the ability to monitor and, if desired, to control movements out of the nation of:
a. Financial funds ... moved .. to avoid paying taxes on such funds.
b. Earnings from illegal activities leaving the nation.
c. Funds that cross borders to finance terrorist operations.

I want to remind you of a few uncomfortable facts: since Nov. 2009 one in four children in the U.S. get their food by way of food stamps, and now it is about 29% of all children, one in seven of all citizens, over 44 million. 24.1% of all households have “zero or negative” wealth or savings, probably almost one in three have less than $5,000. Our nation produces a GDP/capita of over $47,000. We have tremendous inequality. The top one percent now own 225 times more than the median household, an all time high. The median household has just lost over $40,000 (or 40%) in savings. (These figures come from Sylvia Allegretto’s report State of Working America, Wealth, published by Economic Policy Institute, March 2011.)

Inequality is widening, opportunities are shrinking, precarious security is infecting more and more. Various forces could tip the balance in catastrophic ways, which would really be tragic (food prices, gas prices, housing prices, more unemployment, disruptions). The people at the Treasury should have a bigger outlook than what I presently see. They seem to be protecting the private holders of financial assets, the status quo, the wealthiest people on the face of the earth who themselves created a monumental mess. The arrogance of the mighty creates suffering for those who did least to create the problem.

In addition to Foster and Magdoff, and Paul Davidson, and Sylvia Allegretto, I recommend you read the facts at inequality.org, see the side-bar links to income and wealth inequality. I also have a blog, http://benL8.blogspot.com, in Feb. 2011 I posted a 6 point program. Raise wages, increase minimum wage, increase EITC, create public jobs, impose tariffs and quotas, emplace a values added tax on multi-national corporation’s imports. I just collected ideas from scholars and writers, it’s not my own creation. I will add a 7th proposal, drawing from Rep. Jan Schakowsky’s deficit reduction plan, eliminate the interest payment deduction enjoyed by financial corporations, a savings of $77 billion a year. Raise capital gains tax to normal marginal tax levels, and if sold before 12 months raise that rate to 70%.

Lawrence Mitchell wrote The Speculation Economy, a financial history centered around the 1900s when the stock market began to overshadow productive industry. Perhaps it is time to reel-in speculation. The world lost between 2007-2009 about $35 trillion (17% of all value) because incentives were poisonous, incentives that U.S. government officials nurtured. It’s time to think deeply.

I hope this gives you a glimpse of a new world of prosperity, justice, endeavor, and growing enjoyment of life. We should all be working less, doing art, visiting friends, but not worrying that the foundation is about to crack and sink into the Ocean of Chaos. The German worker works 9 weeks less per year, the Gini level in Germany is 25, not the 41 in the U.S. Time to humanize the system.

Yours, Ben Leet, I live in San Leandro, CA, May 12, 2011
I am a retired public school teacher, not an economist.

Why the Economy Must Have Public Jobs
or Suffer a Lengthy Slump

--------The Problem-----
One in four American children get their food by way of food stamps, and among the total population one in seven or over 44 million Americans. In fact, the use of food stamps has increased by over 30% since the official end of the recession in July 2009. The rate of children getting food from charity coupons is approaching one in three. Yet, on the other hand, our economy creates over $47,000 of value each year per person. We are a very wealthy nation. These two snapshots provide a concise picture of an economy with extreme inequality. This inequality threatens our core values of personal opportunity, and it threatens the overall prosperity of our country. We are all victims of this inequality, and the economy performs far below its potential.

As the economy shrunk since January 2008, so did government revenues from taxes. Some say the government services must shrink. “We have a spending problem, not a revenue problem,” is heard. “We don’t need new taxes, we need to cut our spending.” I disagree. The problem lies in the greater economy that is shrinking because of inequality. If we attack unemployment and inequality we can have an economy that self-expands and a government that expands in tandem. To simplify my position, “Create public jobs and raise wages.” We need a spending solution.

Today if the nation embraced public job creation and made the political choice to add between 8 to 18 million more public workers, the economy would create a self-sustaining expansion, which is one way of saying “Recovery.” The purchasing power of those additional workers would inspire private employers to add more non-supervisory workers, also known as employees. This is Robin Hood economics, we “steal” from the rich to create jobs for the poor, and the economy recovers its ability to self-sustain employment and expand. Those who insist that we have a spending problem, not a revenue problem, are wrong. We have a problem with the greater economy to self-sustain.

The perfect illustration is that ten years ago, in December, 2000, there were more private sector jobs than there are today. Between 1980 and 2000 38 million private sector jobs were added to the economy; between 2000 and 2010 7 million jobs were lost. The economy has shrunk in terms of private jobs since 2000 when there were 110 million private sector jobs; today we have less than 105 million private sector jobs. So we have a ditch out of which to dig. Maybe in five, ten, or twenty years the economy by its own power will self-motivate and resume hiring and restore former employment levels --- or we could jump start it with public jobs.

There is total confusion about government spending in Congress. The Speaker of the House, John Boehner, gives speeches about cutting trillions, not billions, from the budget. He erroneously states that the “wealthy” do not have enough money to balance the budget, so thoughts of raising their taxes are futile. Wrong. The top one percent of households, as he probably knows, own 35.6% of all private property, are worth about $20 trillion, much more than $1.4 trillion needed to close the budget shortfall. The wealth of the top 10% exceeds $38 trillion, 75% of the total. (The bottom 4/5ths of U.S. households own only 12% of the nation’s wealth.) Boehner and his allies threaten to close down the government by refusing to raise taxes or the debt ceiling. These are rhetorical flourishes that just add hysteria and confusion to the atmosphere.

In 1933 Franklin Roosevelt faced a nationwide “bank holiday” -- which is a euphemism for total financial system collapse -- in the first days of his administration, the economy was on the brink of freezing up. John Maynard Keynes published an open letter in the New York Times in which he advised the President to seek recovery before he sought reform. And the method to achieve recovery was by massive government spending to re-employ the unemployed. Keynes advised, “Broadly speaking, therefore, an increase of output cannot occur unless by the operation of one or other of three factors. Individuals must be induced to spend more out of their existing incomes; or the business world must be induced, either by increased confidence in the prospects or by a lower rate of interest, to create additional current incomes in the hands of their employees...; or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money... It is, therefore, only from the third factor that we can expect the initial major impulse.”

Roosevelt took this advice, he created the Civil Works Administration that lasted only five months but, creating 4 million jobs, is to date the largest government public employment project in our nation’s history. And then he created the Works Progress Administration (WPA) and the Public Works Administration (PWA).

This is how the nation recovered from the Great Depression. Marshall Auerback, writing in New Deal 2.0, claims (and he is seconded by Paul Davidson, prolific Keynesian scholar and author of The Keynes Solution, and by Jeff Madrick, editor of Challenge Magazine, writing in his deficit reduction report for Campaign for America’s Future, January 2011) that between 1933 and 1937 the unemployment rate decreased from 25% to 9.6%. Prematurely in 1938 Roosevelt drastically reduced government spending on jobs creation, and unemployment shot up to 13%, so he reapplied his previous policy. Again between 1939 to 1946 the federal government spent like a nation at war, creating public jobs, and unemployment dropped from 13% in 1938 to below 2% for three consecutive years during the war, 1943, 1944, and 1945. Afterwards the result was an economic expansion unheard of before. It worked. This is not socialist history, it is the history of the most productive period of economic growth in American history, bar none.
It’s a case study in a “spending solution” not a “cut spending solution.”

After hiring millions and reducing the rate of unemployment to below 2%, the national distribution of personal income held steady for about 40 years. Distribution for the years 1940 to 1980 restrained the amount received by the top 10% of households to under 35% of all personal income. Marginal tax rates in the highest brackets, that is taxes on income over and above a very high level, exceeded 90%. That lasted until 1980, when high bracket marginal tax rates dropped dramatically, and when the share of the top earning households grew and grew, and recently, 2007, the top 10% received 49.7% of all pre-tax income, in 2007 the top one percent received 23.5%, nearly 1 or every 4 dollars of income.

As a nation we can now sadly boast of having the worst, most unequal distribution of income among advanced nations. And to match that achievement, we do the worst job of transferring income to those who are in need. Chuck Marr at the Center for Budget and Policy Priorities recently reported that an OECD report “shows that the disparity in income [inequality] in the United States is more pronounced than any other country (squeaking past Poland). At the same time, U.S. tax and spending policy [social transfers] (i.e., the whole budget) does less to diminish this inequality than the policies in any other country in the OECD except South Korea.” We have the most inequality, we do the least to reduce it. Quite a record! Robin Hood had a good idea. In France, before social transfers, their childhood poverty is approximately the same as the U.S. rate, 27%. After transfers they reduce childhood poverty to 7%, we reduce it to 20%, which is about double the average in Europe.

The value of our economy, the GDP, divided equally among children, adults, and retired elders, is over $47,000 a year per person. A family of four could have an income of $186,000. Divided equally among all workers it comes to $100,000 a year. Yet more than half of U.S. workers earn less than $29,775 a year, according to the U.S.Census. The bottom 40% of households own a mere 0.03% of all private savings.

The Republicans argue that the wealthy need more money (tax cuts) to create more jobs. It didn’t work out that way 2000 to 2007, despite the enormous tax cuts to the wealthy afforded by the Bush administration and the Republican dominated Congress. Those years were called the “jobless recovery.” The top one percent, according to U.C. Berkeley economics professor Emmanuel Saez, took in two-thirds of the economic gain of that period.

Marriner Eccles, the Chairman of the Federal Reserve during the Great Depression described in 1951 the causes of the Depression in these words:

"As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery. [Emphasis in original.]

Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped. . . . Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy.”

President Kennedy described the economy in nautical terms, “A rising tide lifts all boats.” That was when we had a balanced income distribution. This apt description was to be replaced in the 1980s with “When there is more for me, there is less for you.” The top one percent of households now earns more pre-tax income than the combined income of the bottom sixty percent. Soon it will be the case that Scrooge McDuck, or Daddy Warbucks, or whoever, will own everything once and for all, and we’ll be living in feudal times again, the Dark Ages will have returned. (I have my own hysterical flourishes too, if you don’t mind.)

_________________________________________________________________

-----The Solution-----
Unfortunately, we as a society do not believe in public job creation for the purpose of balancing income distribution and repairing the economy.

Demos, a left-leaning political advocacy group, published recently a proposal “Back to Work, A Pubic Jobs Proposal for Economic Recovery” by Rutgers University professor Philip Harvey. For a net cost of $162 billion a year this plan would create 8 million new jobs, at a cost of $20,226 per new job.

Compare that cost with the cost of the Great Recession. After the financial system collapsed $11 trillion, or 17% of the nation’s private wealth evaporated, the typical or median household savings dropped from $109,000 to $65,000, a 40% drop to levels below the 1983 level.

Compare the cost of Harvey’s program with other big ticket costs to tax payers.
Economists Mark Zandi and Alan Blinder state the entire cost to the public of just the financial system bailout will be approximately $1.6 trillion, ten times the yearly cost of the Harvey proposal. Other government expenses:
--$2.5 trillion over ten years for the Bush tax cuts benefiting the wealthy
--$700 billion to bailout the too-big-to-fail banks
--$152 billion for the Bush stimulus of 2008
--$787 billion for the Obama stimulus in 2009
--$800 billion for the tax compromise of December 2010
--$150 billion to bailout AGI insurance company
---$70 billion, the replacement cost of the trident missile submarine fleet
--$664 billion, the yearly military budget costs
-- $1.2 trillion, the actual but unofficial cost of the military

Additional social costs are not included in the cost of the debacle: the cost of 10 million (or 22% of all) home mortgage foreclosures over a six year period, resulting in family and community disruption, the cost in terms of severe unemployment in the private sector, the costs to local and state government resulting in government employee (police, fire, education) unemployment --- none are included in the $1.6 trillion estimate of just bailing out the banks and other financial corporations who after self-destructing still managed to make enormous profits.

We should ask, where’s the money for workers? The bailout left 17% of the workforce in the lurch --- unemployed. If we spent $162 billion on public jobs each year, a minute fraction of the cost and damage caused by the financial system collapse, 8 million new workers would contribute to the economy, pay taxes, enjoy a steady income with security and predictability. And most importantly the private sector could regain its usual hiring practices and achieve a self-sustaining expansion. Then the misery would begin to end.

There are other proposals fully developed and painstakingly thought out to create public jobs. These jobs could be targeted to create a solar/wind renewable-energy based system for the nation’s electricity grid and transportation system -- both enormous projects; and this would reduce our foreign oil dependency, improve our trade deficit and improve our national security resulting in lower military expenses. Public workers could insulate the nation’s homes and government buildings, renew our decrepit infrastructure, and improve and enhance our childcare services, and enlarge the number of home health-care providers for the elderly.

We suffer from a failure to analyze and execute. It’s time to lift a page from our historical past. “Happy Days” would be here again if we could break through the barrier that prohibits direct government created jobs as an economic remedy when the private sector is not up to the task.