GLASS-STEAGALL 101

We are entering the section on economic policy making in my Introduction to American Politics class. Last week we made it to the Great Depression and discussed the rationale behind the Glass-Steagall Act. For those of you who are not familiar with the Glass-Steagall Act (1933) you can read about it in my book, or you can get a broader history from PBS here.

In brief, the Glass-Steagall Act (also known as the Banking Act of 1933) was passed by Congress in 1933. It specifically prohibited local commercial banks from doing what Wall Street investment banks do. It was enacted in response to the failure of nearly 5,000 local banks who, you guessed it, were using the bank deposits of their customers to gamble on investments and other projects they knew little about.

While Glass-Steagall was made possible by the stellar investigations done by the Pecora Commission, Franklin D. Roosevelt made it a cornerstone of his New Deal program.

Ferdinand Pecora

The Glass-Steagall Act gave the federal government more control over national banks, created the Federal Deposit Insurance Corporation (FDIC), and prohibited bank sales of securities. It didn't keep Wall Street from gambling with money from their clients accounts (see here and here) but it did protect the little guy on Main Street, for over 50 years.

Here's MSNBC's Dylan Ratigan explaining how Glass Steagall actually worked:

Visit msnbc.com for breaking news, world news, and news about the economy

After being attacked by Wall Street for years Glass-Steagall was finally repealed in 1999 when President Bill Clinton signed the Financial Services Modernization Act (aka Gramm-Leach-Bliley). Commercial banks could now get into investment banking. Nice. This clip from 1999 reminds us that Senator Byron Dorgan (D-ND) saw a market collapse around the corner, even if he didn't know exactly when it was going to happen ...




The fact that we haven't done anything to bring back Glass-Steagall is just one of the reasons it's easy to argue that we're going to have another 2008 market collapse, again.

- Mark

HOW THE WORLD (REALLY) WORKS

One of the things that I regret from writing my first book is what I left out. Perhaps the biggest omission was leaving out Friedrich List. Who the hell is Friedrich List you ask? Good question.

In the pantheon of giant thinkers who studied and then tried to explain how our world works in the 19th and 20th centuries Friedrich List (1789-1846) ranks up there with Adam Smith and Karl Marx. We all know that the ideas that drove Adam Smith helped set the groundwork for the liberal revolution(s) that gave us our free market economies (and the American and French revolutions). We also know that Karl Marx's criticisms of market capitalism set the stage for the socialist revolutions of the 20th century.

Artwork from Artonfix.com

Unfortunately the ideas of Adam Smith have been used and abused to such a degree that the U.S. economy is currently dominated by reckless market players who treat the economy like a giant casino. For his part the writings of Marx were used to set up totalitarian states that got virtually everything wrong about incentives and the human condition.

The end result is that while the U.S. economy seems poised to collapse on its own debt and derivative-driven stupidity (again), the Soviet and Chinese experiments with "worker utopias" have been relegated to the dustbins of history.

The problem we have at the beginning of the 21st century is that adherents and zealots on both sides of the Smith-Marx continuum largely ignore key pieces of history and have not given much thought to how the world really works. Instead they blindly believe in misapplied theories of markets and people, as if the human condition is dominated by some kind of rational homo economicus man.

Those who claim some kind of intellectual bond with either Adam Smith or Karl Marx seem to believe that universal rules of profit and material production drive the human condition when this simply is not the case. Incredibly extremists on both sides ironically find common ground with one another because both see a shrinking (or "withering") state as ideal because of how a rational new man emerges to guide society (yes, they are much closer on this then either cares to admit).

I bring all of this up because a discussion on FB I had this morning got me thinking about what I should have mentioned in my first book.

Specifically, I should have been much more forceful explaining that how most people (especially market players) think the world works is not actually how it really works. Simply put, the state creates the conditions under which societies and markets prosper. If we understood this my guess is that we wouldn't be in the position we find ourselves in today: Praying that the Germans will save the day in Europe ... and hoping that Wall Street doesn't fall off an economic cliff (again) and then drag the rest of the world down with yet another "unforeseen" market collapse.

This article - "How the World Works" - from James Fallows goes a long way in explaining why politicians and market players in America are getting things so wrong. As you will see, it's not so much that they don't know as much as they never learned how the world really works.

- Mark

FOR MY STUDENTS ...

Click to enlarge.

- Mark

THE POLITICAL LESSON(S) OF THE BELL EXPERIMENT

The finger-pointing, scapegoating, jingoism and ideological aggression we're seeing during this presidential primary season is disheartening for many Americans. With so many problems confronting our nation I'm often asked why do politicians talk at each other instead of to each other? Why don't they take the time to understand and really discuss the challenges that confront us instead of trying to score political points by blaming each other?

The answer is actually quite simple, and can be tied to the swirl of our modern world. Simply put, the complexities of our modern world leave many Americans incapable of understanding or appreciating the things we should.

To help students understand what's happening, in my introduction to American Politics class I like to begin my discussion on American institutions by explaining why things don't get done the way many of us think they should ... i.e. with negotiation, compromise, civility, etc. Specifically I try to explain the roots of the ideological aggression and the bitter partisanship we see today.

To do so I discuss how our world has become so complex and fast paced that the vast majority of Americans are simply overwhelmed. The end result is that, in spite of living in the information age, large segments of American society have become disconnected and, ironically, uninformed citizens. Unfortunately, this leaves many susceptible to mindless bumper sticker answers to complex problems.

And, yes, it's happening on both the left and the right side of the political spectrum.

To deal with the complexity, increasingly many Americans are engaging in any number of "displacement activities." Displacement activities are viral forms of procrastination in that it involves doing something entirely disconnected to the task at hand. In the animal kingdom birds may peck at the grass instead of fleeing in the presence of a predator. Applied to the human condition it involves doing something to avoid confronting serious issues that everyone knows must be addressed. It becomes a lifestyle for many.

Among the displacement activities we see around us include mindless consumerism, reckless alcohol and drug use, self segregation through cultish or militia groups, the glorification of a mythical past, and the pursuit of superficial and self-indulgent relationships, among many other activities. Apathy, political tribalism, and faux movements are the result.

The worst of our displacement activities may be the return of religious fundamentalism because of how it helps absolve followers of responsibility for virtually anything. You don't have to listen to anyone because God's on your side. All you have to do is follow or elect the person who claims to be "Godly." Why learn anything if it's in God's hands and all you have to do is affirm what you already know? Lessons on tolerance and understanding are jumbled in the process.

All of these displacement activities have created a disconnected society full of disorders and aggressive ideologues. This, unfortunately, undermines our democracy and social cohesion on many levels. Worse, as long as we're engaged in these activities, it helps keep many Americans from understanding or appreciating the activities that help to make our world a better place.

This is why this story about a man playing the violin on a cold January morning is so revealing.

In 2007 a man played six classical Bach pieces for about 45 minutes. During that time, since it was rush hour, it was calculated that thousands of people went through the station, most of them on their way to work.

Three minutes went by and a middle aged man noticed there was musician playing. He slowed his pace and stopped for a few seconds and then hurried up to meet his schedule. A minute later, the violinist received his first dollar tip: a woman threw the money in the till and without stopping continued to walk.

A few minutes later, someone leaned against the wall to listen to him, but the man looked at his watch and started to walk again. Clearly he was late for work.

The one who paid the most attention was a 3 year old boy. His mother tagged him along, hurried but the kid stopped to look at the violinist.

Finally the mother pushed hard and the child continued to walk turning his head all the time. This action was repeated by several other children. All the parents, without exception, forced them to move on.

In the 45 minutes the musician played, only 6 people stopped and stayed for a while. About 20 gave him money but continued to walk their normal pace. He collected $32. When he finished playing and silence took over, no one noticed it. No one applauded, nor was there any recognition.

No one knew this but the violinist was Joshua Bell, one of the great violin players of the world. He played one of the most intricate pieces ever written,with a violin worth 3.5 million dollars.

Two days before his playing in the subway, Joshua Bell sold out at a theater in Boston and the seats averaged $100.

Joshua Bell playing incognito was organized by the Washington Post as part of a social experiment about perception, taste and priorities. But it also tells us how the pace of our lives can lead us to ignore excellence, truth, and even each other (you can read the Post's article on the experiment here). It tells us that we've conditioned ourselves not to care. The political implications abound.

The Bell experiment tells us that we're so wrapped up in trying to make our way through life that we don't have the time to stop and listen to one of the world's greatest musicians, playing the best music ever written. So how many other things are we missing? How many of us take the time to search for the truth instead of accepting empty slogans and embracing bankrupt ideologies?

There's a reason why many Americans embrace scapegoating, ideological aggression, and mindless single-issue politics. And it's not because the other side is necessarily evil. It's because it's easier to see them that way. It's easier to put ideology above the facts.

More to the point, it's easier to ignore the other side when we've convinced ourselves that they don't matter. The fact that we don't care is the political lesson of the Bell experiment.

- Mark

WHAT FREE MARKET? UNCLE SAM WANTS YOU TO SPEND ...

In my classes I always make the case that we don't have a free market. The very visible hand of the state is involved in subsidizing and encouraging purchases and other activities that many of us simply take for granted. Uncle Sam wants you to spend, and to spend on things that are supposed to make us all better off (at least that's the way the programs are sold to us).

Let's take employer provided health insurance, for example. I'm sure most of you look for jobs with employer provided health insurance, and are thankful when you find a job that can provide it, right? Well, guess what? Your employer doesn't actually pay for your health insurance. You do. And so does your neighbor.

Your employer might pay the insurance provider, but your employer then gets reimbursed by the federal government (i.e. the American taxpayer) for the expense. While the process is called a tax deduction, it's also the essence of fiscal policy; i.e. when congress creates legislation that encourages certain economic activities over others. Over the next four years the medical plan your employer "provides" will cost the U.S. taxpayer over $1 trillion. 

Below I've attached a brief list of several major tax deductions designed to encourage spending & investment, and what they will cost the U.S. taxpayer this year (over $600 billion) and a few years down the road.

One thing should be clear from this list. The federal government - at the request of industry lobbyists - is doing a lot to keep our "free market" afloat (just ask Mitt Romney). Whether you agree with the long list of write-offs and deductions is another matter.

- Mark

UPDATE: Click here for tax expenditure estimates for fiscal years 2014-2018.

CORPORATE PERSONHOOD ... STILL A FLAWED IDEA

Two years ago this week, on January 21, the Supreme Court lost it's head. Specifically, in Citizens United v. Federal Elections Commission a split Supreme Court ruled that corporations could dump as much money as they wanted on political campaigns. No joke. Five members of the Supreme Court think it's a good idea to give corporations unlimited voice in America's democratic experience.

Below is an op-ed article - "Corporate personhood: A flawed construct that undermines democracy" - that I penned for the Bakersfield Californian last month. It explains why the Citizens United decision is both flawed, and needs to be reversed. I'm posting it again not only because it's the anniversary week of Citizens United, but because it's one of the most important issues of our time.

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"If you can't vote, you can't contribute." This was part of a conversation I had about political campaigns awhile back. And it stopped me in my tracks. With this simple comment, my friend Larry Moxley summarized how to deal with the influence money has on our political system. And I agreed.

So you know -- and I want to be clear on this -- Larry Moxley and I are on opposite sides of the political spectrum. There's very little we agree on. We've had strong debates that literally have turned heads in restaurants over the years. But we're friends who can agree on the things that undermine our national priorities.

When it comes to the influence of money in our political system, Mr. Moxley and I agree on this: It's undermining our political system.

Most of us understand the influence money has on our politics. Simply put, to become legitimate candidates, office seekers spend so much time chasing large donations and corporate money that they lose sight of what's good for our communities and our nation.

This shouldn't be a surprise. When asked why he did what he did, famed bank robber Willie Sutton replied, "That's where the money is." Candidates go where the money is too. This means going to large corporations and groups with deep pockets. More on this later. But first, some background.

Candidates for office are forced to pursue money in part because of two legal developments. The most recent allows corporations to give almost unlimited amounts to political campaigns. The earlier, and most important, development granted corporations personhood status. GOP presidential candidate Mitt Romney acknowledged this when he shot back at a heckler: "Corporations are people, my friend."

What Romney didn't discuss was how corporations became people. If he had, he would've had to explain how corporate personhood came about.

The key here is an 1886 U.S. Supreme Court decision on taxes, Santa Clara County v. Southern Pacific Railroad Co. While the Supreme Court ruled in the railroad's favor -- arguing corporations are entitled to 14th Amendment protections -- it said nothing about corporate "personhood." A court reporter did.

Specifically, a court reporter -- not a Supreme Court justice -- wrote in the Santa Clara summary head notes that corporations enjoy the same rights as a U.S. citizen. Corporate America has been running with this ruling ever since (yes, I've deliberately oversimplified the primary issues here). And just like that -- and with no birth certificate -- corporations now have the same rights and protections as any U.S. citizen.

Later, the Supreme Court ruled in Buckley v. Valeo (1976) that spending money on elections is a form of constitutionally protected free speech.

This was followed with a 5-4 decision in Citizens United v. Federal Elections Commission (2010), which effectively allows corporations to spend what they want on political campaigns.

The result? Because of the functional equivalent of a typo (1886), corporations are considered people who can speak (1976) as loudly and brashly as they want (2010).

Conversely, citizens in the streets of America are given strict limits (time, place, voice) as to how they can exercise their constitutional rights. And it's distorting our political picture.

If you don't see the picture, here's what's wrong:

* Corporations are legal abstracts, created by the state. Per the Enlightenment, constitutional protections were designed for citizens whose rights were historically abused by large corporate entities and the state.

* Corporate "personhood" status was a legal accident. No claim to citizen rights should rest on the functional equivalent of a typo.

* If we can't yell "fire" in a crowded theater, corporations shouldn't be able to set fire to political campaigns. The Citizens United ruling went too far.

* Unlike most citizens, corporations can directly lobby and get favorable legislation, regular bailouts, subsidies, generous tax write-offs, legal exemptions, limited liability, and can live on indefinitely.

* Foreign subsidiaries can access Madison Avenue, which can distort and elevate their foreign "voice" above most U.S. citizens.

* Corporations find legal cover under proprietary rights (trade secrets) and legal settlements (or fines). This allows corporations to distort and hide their voice.

Our Constitution was created to protect citizens from corporate and state abuses. One way to address the trend of corporate money swamping broader national priorities is to consider what Mr. Moxley has suggested for some time now: "If you can't vote, you can't contribute."

It won't solve all our problems, but it's a start.

Mark A. Martinez, Ph.D., author of "The Myth of the Free Market," is a professor of political science at Cal State Bakersfield.

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Long story short? Citizens United needs to be reversed.
 
- Mark

SO, WHERE'S THE TEA PARTY ON THIS ONE?

Via Think Progress we learn that thirty big corporations in America actually spent more money lobbying Congress between 2008 and 2010 than they paid in taxes (hat tip to Tom for the link).

What has all that lobbying gotten corporate America over the long-term? In a few words corporate profits have soared (money once set aside for taxes suddenly becomes "revenue"). Just as importantly, corporations now pay a smaller share of taxes into our economy (as a percentage of GDP) than they did in the past. Check it out ...

All of this helps explain why middle America's income tax (what you earn) and payroll tax (social security, medicare, etc.) payments have remained relatively stable or grown (payroll). Middle America is told that they need to keep paying their share of the bills, while America's richest Americans have convinced most Americans that their tax load has to go down ... for the good of the nation. Trickle down, you know.

Long story short? Our debt problem is largely A REVENUE PROBLEM. And it's caused by a group of people who think shifting the responsibility of maintaining our great nation on to others (the middle class) is a good idea (and it is, for them).

Think about it. As I explained (or tried to explain) to Republican Mark Abernathy during one of our KGET 17 sparring matches, spending as a percentage of GDP has remained relatively stable over the years, and only started to surge under President Reagan's trickle down policies.

At the end of the day, by reducing their tax burden, while maintaining (or raising) the tax load on ordinary Americans, what we're seeing is one of the greatest wealth transfers in human history. Seriously.

Not only do the top 1% and those at the top of corporate America's food chain get to keep more, but someone's going to have to pay for the $14 trillion that's been added to our national debt since 1980 (when it was only $907 Billion). And you can bet your life that the top 1% don't think it should be them.

So, my question is, where's the Tea Party on this one?

- Mark

TRICKLE DOWN ECONOMICS, SOVIET STYLE ... STALIN'S AMERICA

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In spite of recent bailouts, favorable legislation, and regular money dumps from the Federal Reserve, we don't have socialism in America. Not even close. This is the case even if you count government safety nets, which don't cost anywhere near what we've committed or disbursed to Wall Street since 2008 (at least $13 trillion). But if you're going to make the "socialism in America" argument this is how you might want to start .... 
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In an effort to explain the logic behind market economics, in my book I tell the story of Russia's peasant economies after the October Revolution of 1917. One of the biggest problems Russia ran into was getting peasant farmers to produce. Things took a turn for the worse during Russia's Civil War (c. 1918-1922), when the nation was faced with frustrated revolutionaries and mass starvation. This was a critical moment since Russian revolutionaries wanted to sell surplus agricultural production to facilitate industrialization. But there were no surpluses.

While agriculture production increased with the introduction of the New Economic Policy in 1921, the program was abandoned by Josef Stalin and replaced with forced collectivization. Not surprisingly, agriculture production slipped, again.

To better understand why revolutionary peasants weren't producing surpluses - which were necessary to help fund industrialization - teams of anthropologists were sent to study peasants societies throughout Russia. This was a tremendous undertaking as it meant spending months, and even years, at a time in distant rural communities. But the findings were extraordinary.

PEASANT STUDIES & "UNCLE JOE"
Headed by researchers like Aleksander Chayanov, various institutes studied and learned about peasant societies throughout Russia. One key finding was that peasants would work until they had enough to feed their families, and not much beyond this point. As I point out in my book, they learned that subsistence peasant households didn't particularly care about wage or price incentives. Instead, for a variety of reasons (discussed in class), they focused primarily on the “use-value” of a good in the immediate term rather than its “exchange-value” in a market. Producing more than what they needed was viewed as “drudgery.”

Though the findings of Chayanov and others were instructive because they helped explain what was wrong with collectivization in the Russian countryside, they didn’t sit well with Stalin. He wanted to know how he could get peasants to produce. As a result, because of his own paranoia's and twisted world views, he saw the reports emerging from the countryside as an unwarranted defense of rich kulaks (productive peasant farmers). All he knew was that the revolutionary state demanded surpluses, and the peasants weren't producing.

Stalin saw traitors in his midst.

After Stalin took control of Russian agriculture the studies done by Chayanov and others were virtually ignored by the Soviet state, and many of the institutes were closed. But this was just the beginning. Repression and purges in the early 1930s were followed with large-scale disappearances of "non-revolutionaries."

Chayanov was among those branded a non-revolutionary. He was arrested, tried, and then shot on the same day in 1937 [photo below is not Chayanov].

In Stalin's world, the Russian revolution and the worker's paradise would be a success, even if he had to use the levers of the state to spin lies, send misfits to labor camps, or kill his political enemies (both real and imagined). This is where it gets interesting.

TRICKLE DOWN THEORY, SOVIET STYLE ...
While Chayanov's story is instructive for what it tells us about peasant economies (and capitalism; a topic for another day), it's also significant because of what it tells us about Russian revolutionaries and die-hard Bolsheviks like Stalin. They were so committed to their theories of socialism that they would use the state - which was supposed to wither away according to Karl Marx, mind you - to make sure that agriculture surpluses were created and transferred to the more productive industrial sector.

It was deemed unimportant that the state became increasingly repressive as it forced collectivization on peasants, suppressed living standards in the countryside, and then transferred resources from Russia's agriculture sector to industry and the city. The needs of backward peasants could be put off.

Part of the rationale for this line of thinking was that Stalin believed peasants would soon benefit from the availability of manufactured goods, agriculture equipment, and other products that would eventually reach the countryside. As Cambridge economist Ha-Joon Chang points out, this was trickle down theory, Soviet style.

I tell this story because, as Ha-Joon Chang suggests in 23 Things They Don't Tell You About Capitalism, policymakers today who claim to be die-hard capitalists and free marketeers are actively using the state - which is supposed to stay out of the marketplace, mind you - to bailout Wall Street, facilitate money dumps when markets fail, and to rewrite the rules to suit the needs of a specific class.

At the same time, by using the state to pursue union-busting trade agreements (while doing little for labor), winking at weak immigration laws (which helps suppress prices and wages), and then ignoring collapsing wage and living standards for America's middle class, America's policy makers are acting very much like Stalin's Politburo.

They're even promising that by transferring wealth to a designated productive class that the benefits will eventually reach those at the bottom. And they've been doing this for the better part of 30 years, in spite of a history of spectacular failures and budget deficits.

Like Stalin's planning authorities, today's proponents and willing recipients of bailouts, money dumps, and favorable legislation understand the importance of using the state to create and transfer wealth from one sector of the economy to another. With more than $4 trillion disbursed, and a total of 13 trillion in tax payer backed dollars committed to Wall Street's collapse, you can be sure of this.

But this is precisely the problem.

As I point out in my book (Ch. 11), by using the state to transfer wealth to achieve market results (profitability), America’s bailed out and subsidized market players are on no firmer intellectual ground than the Soviet Union's Vladimir Lenin and Joseph Stalin. Pushing for and accepting government favors, while speaking admiringly of the wonders of the market, imposes an Alice in Wonderland character on modern markets in America.

Seriously, at what point do we stop using the resources and authority of the state to prop up failed banks, wink at market busting Wall Street schemes, and continue to believe in the value of disastrous trickle down market ideology?

- Mark

SUPERCHARGING WALL STREET, AND AMERICA'S EVOLVING SYMBOLIC ECONOMY

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In my International Political Economy course today we spent a good deal of time talking about the interplay between economics and politics, and how both impact modern markets. Since some of it was a bit detailed, below is a brief outline of some of the topics we discussed in class. Those of you who are not in my class can read too  ;-)
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In International Political Economy class this Monday we briefly discussed what happened when Congress created the 401k (tax deferred incentives to invest), and then encouraged, or allowed, other novel financial instruments to arrive on our economic stage. In the process Congress supercharged Wall Street's numbers, but what we really saw was the evolution and consolidation of what Peter Drucker called the "symbolic" economy, and what Kevin Phillips referred to as the beginning of the "financialization" of the American economy.

What did this mean for America? In a few words the American economy became increasingly dominated by trade in money, interest rates, futures contracts, and other "derivative" instruments. Trade in durable or manufactured goods has taken a back seat to these financial products. In fact, the American economy has been trading in these "symbolic" financial instruments to such a degree that they now represent at least 20 times (and perhaps 40 times) what we will produce and trade in the "real" economy this year (about $15 trillion).

In plain speak - and as economist Joseph Schumpeter might have put it - we are now living in a world where America's economic mandarins are playing monopoly rather than building them. This is the biggest difference between the Robber Barons of the past and our Robber Barons of today.

The Carnegies, Morgans and Rockefellers of the 19th century built steel mills, railroads, and other real industries which created real wealth. If they went bust at least they left railroads, steel mills, and other industries of substance. Not so with today's financial wizards. The Robber Barons of the 21st century are financial zombies bent on extracting rather than creating wealth. It's really that simple.

We can see the impact of America's economic transformation because of the increased emphasis on the financial sector, and because how more and more of Americans are seeing their wages squeezed (see graph below). Unfortunately, this has forced many Americans out of the middle class.

At the same time Americans are watching their incomes collapse Wall Street has focused on safeguarding their empires of paper wealth, and finding new ways to pump up the market. This is one of the reasons we have seen a plethora of financial instruments created and traded. Not surprisingly, total volume traded on the NYSE has exploded since 1982 ...

As should be expected, with every fee-laden trade, and with every new expanded portfolio managed, Wall Street's financial mandarins have gotten increasingly wealthier. This explains, in part, the growing wealth gaps in America.

But volume isn't everything. There's also this. Every time Wall Street's financial wizards created new ways to trade and then collapse the economy, Congress and the Federal Reserve have stepped in with an assortment of bailouts, money dumps, and favorable legislation to save their bacon.

WHAT WE'RE GOING TO DO IN CLASS THIS QUARTER (in part)
While many Americans don't understand the details of any of this, one thing is clear: Our economy is increasingly built around, and dominated by, fuzzy financial instruments that take many shapes. The financialization of America's economy is part of what we'll be looking at in class this quarter. We'll be doing this at a global level too.

As an example of how the financialization of the economy works in the United States we can look at home mortgage loans and other debt contracts (student loan, credit card debt, etc.). Specifically, when we look at what's happened to mortgage contracts we find that they are no longer single documents holding all the information you need to know about a loan. Instead, home mortgages (and other debt contracts) are sold, bundled up with other mortgage contracts, and then resold as a collateralized debt obligation (CDO) security.

Today most mortgage contracts that are bundled into securities and sold can only be understood if you can decipher this ...

While these mortgage backed CDOs make money for market players the thing to understand is (1) how these CDOs created the environment for deregulation and shoddy lending standards, among others, and (2) how these CDOs pushed the financial industry, and our shadow banking system, to ask for more (shady) debt contracts.

These contracts lie at the heart of what brought the economy down in 2008.

The fact that we did little to fix the problems that caused the meltdown after 2008 help us understand how much power and influence the financial sector has in our economy, and why our next market collapse will happen. Also helping us understand how our new economy functions is that, while all of this has been going on, the vast majority of Main Street has seen their wages decline since 1980 while the financial sector has seen their compensation soar ...

Two key components of this new economy include the wonderful world of "derivative" markets and our extremely important "shadow banking" system (which GOP FCIC members pretended didn't exist in their 2010 report). If you can find the time, try and read the links.

These topics are among the many issues we're going to be looking at this fall. I'll have more to say about derivatives, our shadow banking system, and our symbolic economy as we move through the quarter.

- Mark

FIRST DAY OF CLASS ...

It's the first day of class at California State University Bakersfield today. I always begin my Introduction to International Relations Theory with a long discussion of the scientific method (followed by theory) ...

* Click to enlarge.

In my introduction to International Commerce class we begin by discussing the challenges posed by what we want to believe about markets, and the reality that's out there ...

* Click to enlarge.

While class lecture is a bit more detailed, you get the general idea.

- Mark

GET GOVERNMENT OFF MY BACK? HARDLY ...

We hear it all the time. Don't interfere with the marketplace. Deregulate. Get the government out of the market. Unfettered competition leads to the best possible outcome for everyone because people rationally pursuing profit will enhance both productivity and quality in the marketplace. Like an "invisible hand" the needs of society would be met. In the end consumers get better products. Producers get more money. Workers earn better wages. Everyone wins.

At least this was the message many believe that Adam Smith, the intellectual godfather of capitalism, told us in The Wealth of Nations (1776). It's this belief system that has fed the free market and deregulation push we've seen over the past 30 years. It's what's pushing us today. Unfortunately, much of what Adam Smith wrote was often misrepresented and taken out of context by many of his followers, including Milton Friedman. It's one of the reasons I wrote The Myth of the Free Market.

To be sure, Adam Smith argued that the state should stay out of the marketplace. But not because market players should be free to do what they wanted. Rather Smith believed that government should stay out of the market because it usually intervened on behalf of monopoly and privilege. Smith's message was that we shouldn't allow market players run herd over the rest of us.

Many of today's market players have no clue about any of this. And it shows. In fact, contrary to popular belief, market players today ignore - or don't recognize - how they have been pushing and benefiting from the very visible hand of government subsidies and supports, which Adam Smith feared would happen. Check it out:


A SERIES OF MARKET BAILOUTS: Talk about a lack of accountability. One of the cornerstones of a competitive market system is the idea that there would be retribution for stupid decision making. You would go bankrupt and/or lose your business. Guess what? Increasingly, for Wall Street's biggest players, it's simply not happening. Anyone who argues otherwise is either clueless or on crack.

Here's a short list of the bailouts Americans have yawned at or supported since Ronald Reagan's "free market" revolution began in 1980:

* Wall Street / Mexico in 1982.
* Continental Illinois in 1984.
* The Discount Window intervention to save floundering banks in the late 1980s.
* Market support after the October 1987 crash.
* The Savings & Loan debacle of 1989-1992.
* Intervention to save the Bank of New England and Citibank.
* The 1994-1995 Wall Street / Mexico rescue.
* The Asian Currency rescue in the late 1990s.
* The Fed-organized LTCM bailout.

Impressive, ain't it? But know one thing. This list is incomplete.

In virtually every case above we were told, in one way or another, by the Chicken Little's of the financial world (and Washington) that bailouts and subsidies were necessary or else "prosperity in our time" could end. Markets would collapse, and middle class Americans would be hurt. So we propped up the stupidity with bailouts, rather than "let the market work." We were saved.

Then 2008 came along. Oops.

THE GREENSPAN PUT:
Perhaps the greatest guaranteed money flood in human history. It all began when Alan Greenspan became chair of the Federal Reserve (1987-2006). Instead of letting market players pay for their market stupidity, Greenspan made the decision to push money into Wall Street - the Greenspan Put - every time they created a mess of things. And he did it by making money available at a cheap price (and he said he wasn't a Keynesian ...).

Coupled with deregulation, this fed market appetites for bigger and bigger market bets (it didn't matter to Greenspan that the vast majority of trading is not done by humans buying and selling a few hundred shares, but by computers and high frequency traders dealing in ever more complex instruments).

Accountability flies out the door when The House backs your bets in Vegas. So it is with Wall Street (though, to be fair, Vegas doesn't do what Washington does). The Greenspan Put has been continued under Ben Bernanke with QE I, QE II, and what we can expect to be QE III (yes, it's coming).

FAVORABLE LEGISLATION / MARKET INTERVENTIONS: If markets are logical, and market players are rational, why do free marketeers need the very visible hand of government for this ...

* You're not smart enough so ... The 401k was created in 1978 by Congress to encourage workers to invest in the market (by allowing employees to defer paying taxes on income they invest). The rules impose strict penalties for early withdrawal (why penalties if market players are rational?). The end result is that by enticing investors with tax breaks our financial markets have been given an artificial boost, which is good for portfolio and wealth managers who get paid based on fees and volume managed. Don't believe me? Check out what's happened to market activity and volume traded since the 401k and other "invisible hand" of the market tools were invented by Congress ...

- The Helmet Laws for brokers ... NYSE circuit breaks, which stop trading, are designed to maintain confidence when markets tank. Then we allow market players to suspend redemption's (not allowing clients to sell their investments) in order to stabilize markets in panic. Both make a travesty of market logic and the code of rationality that we're told dominates the market. It rewards gambling and stupidity by telling brokers "we'll control the panic, even if your incompetence starts it."

- The "socialize the losses" law (deduction) ... If you sell a stock at a loss you can deduct it (as a "capital loss") from your tax bill. Nice.

- The "carry it forward" tax law (deduction) ... Stock losses can be carried forward for tax purposes. Specifically, a banking stock that collapse can be used to offset gains from more successful ventures, or even a portion of your everyday income. So much for taking it on the chin when you make a stupid investment decision.

There are many more of these legislative and political gifts. The point is that it's hard to argue that the millionaire wunderkinds on Wall Street are rugged individualists going it alone in a jungle-like market environment when we look at all the government created, and taxpayer funded, market supports that are out there.

In fact, in many ways Wall Street has become a walled off, protected, ward of the state.

Still, today there are plenty of market players who are dumb and arrogant enough to believe they're actually market gurus, slaying market dragons. In reality, monkeys picking stocks randomly could have made money in this state subsidized market environment (and they have the tests to prove it).

At the end of the day, Wall Street and their financial mandarins are the beneficiaries of a massive legislative and regulatory group hug given by Washington over the past 25-30 years.

Get government off my back? What a joke. Worse, market players don't even know it.

- Mark

UPDATE: Here's an excellent article (9/26/11) explaining ETFs, or exchange-traded funds. It's written by Money Mornings Shah Gilani. ETFs are complex derivative products, which fit into the "complex instruments" noted above.

WHY WE KNOW THE STIMULUS WORKED

Did President Obama's economic stimulus program work? In my view it did. In fact, I know it did. The primary reason I know it did is because of what would have happened if we had not dumped hundreds of billions into the economy via the stimulus program. We could have ended up in another depression, or somewhere near those lines.

This is where problems begin for most people. I always get asked, "So, how do you know? Show me the evidence ... ", usually with some fine expletive worked in there. Follow me as I explain how I know (I'll get to the actual stimulus studies below).

The problem with pursuing "woulda-coulda-shoulda" scenarios or asking "what if" is that many people don't think these exercises bare fruit. They think there's no way to contemplate what never was, especially if the "what if" undermines what they desperately want to believe is true. Part of the reason for this mind set is that Joe Six Pack just doesn't understand how we study the "what ifs" of our lives, especially when it comes to the economy (or any similarly complex topic). What they don't understand is that our kids engage in these kind of activities every day.

How do kids do this, you ask?  Here's an example.

When my son was five he would consistently ask questions like, "Who do you think would win in a fight, Superman or Spiderman?" or some similar question. It really didn't matter who my son was asking about. What he was engaged in was a creative mind exercise that allowed him to contemplate the "what ifs" of his world.

As my son replaced Spiderman with Batman, or some other super hero team, he was considering different outcomes under different conditions. Sometimes he would consider what would happen if Spiderman had kryponite, or some other outcome changing variable. It didn't matter. He was engaged in a mind exercise that social scientists also engage in. And while it may not be as simple or as fun as when kids do it, social scientists have gotten pretty good at studying the "what ifs" of our lives.

In the social sciences the "what ifs" we study are are referred to as counter factual activities. Wait, don't leave. I won't use that word more than once. What's a counter factual? (OK, twice). It's a mind exercise that allows us to think about alternative or other possible scenarios. Today we might watch programs like Spike's Deadliest Warrior, among others, which help us understand the science behind counter factual thinking. While the process behind using counter factuals for the social scientist is a bit more complex than what our kids do (it involves the scientific method), you get the point.

Unfortunately, apart from professional social scientists, most adults don't engage in stimulative mind exercises that force us to ask questions about things that make us uncomfortable. This is one of the reasons many are inclined to reject studies that respected social scientists put out. There are a number of reasons for this.

Many people get set in their ways, for example. Others fear the "What if I'm wrong?" moment. They don't want to entertain anything that might disturb their world view. This explains, in part, why Galileo's contemporaries didn't want to look into his telescope ...

Others fear disappointment and regret, especially if their lives or partners don't meet their expectations. It can lead to depression. Whatever it is, the end result is that many adults don't engage in (or accept) the free flowing creative mind activities that most kids do almost every day (which probably explains why adults don't skip, and children do; but I digress ...).

I bring all of this up because the Washington Post's Ezra Klein has done an excellent job of explaining why we know that President Obama's stimulus program worked. Or, to put it in terms that my then five-year old son would recognize, we now know for sure that Superman would beat Spiderman ;-) ...

For those of you who don't have the time to read the piece (or who find it a bit too technical), just know that Ezra Klein has broken down nine of the best studies on the effects of the economic stimulus program. What Klein presents is a lesson in how we study and understand counter factuals, like whether the economic stimulus program worked or not.

In this case, Klein explains why we know that the economic stimulus program worked.

- Mark

PRESIDENTS AND THEIR DEBTS

The NY Times has an excellent collection of essays that discusses U.S. presidents and their debts. Richard Reeves' "Reagan's Deficit Dreamscape" is wonderfully written, easy to understand and, more importantly, reminds everyone that Reagan started the "borrow and spend" policies that have put us in a hole today. But my favorite is David Kennedy's "FDR, Budget Hawk." It's short, to the point, and dispels any notion that conservatives have about FDR being a spend thrift. 

They're all excellent, so I hope you can find the time to read some of them.

- Mark