Robert J. Shapiro's blog

Years of reckless mismanagement by the self-styled masters of the financial universe and senior economic policy officials now leave us with no alternatives but major action – but the Administration’s proposals are neither the only alternative nor anywhere close to the best one.

The Treasury says we need its plan to address a liquidity crisis, with banks unable to secure the funds to lend to sound businesses that need to invest or just need to meet their payrolls. There is evidence that overnight lending to banks by other banks or other financial institutions is way down. But there’s no evidence of sound companies unable to get funds to meet operating requirements. Moreover, the Federal Reserve has opened its "discount" window and is prepared to lend funds to any financial institution and at below-market rates. The Bush Administration seems to be trying to steamroll Congress and the public: we have to conclude that there is no liquidity emergency that could conceivably justify the steps they propose.

The Treasury also says Americans have to be prepared to bankroll their plan, because more financial institutions are on the verge of insolvency, which would trigger serious problems for the economy. The insolvency or capital problem is self-evident, since these institutions created it. They borrowed hundreds of billions of dollars to buy mortgage-backed securities and to sell the default-protecting derivatives of those securities, all of which were patently speculative: they bought and sold them precisely because they produced very large streams of monthly income, and since financial markets trade off risk and return, their initial high returns signaled that they were very risky.

Now that the securities have fallen sharply in value, these institutions owe much more on the debt they took on to buy them than the securities themselves are worth. That means capital losses that come out of their equity and leave many of them technically insolvent or close to it. So there is a real capital or equity problem across much of our financial system. The Treasury plan won’t solve it, however, not at least on terms that any sensible legislator, regulator or taxpayer should consider.

The Treasury plan originally contemplated providing that capital by paying financial institutions more than their securities are currently worth – since it’s the current market value of those securities that threatens these institutions with insolvency. So that means ordinary taxpayers would have to overpay for the assets of institutions owned and operated by the richest people in America. That’s the Bush economic doctrine, but it’s not mine – is it yours?

At a minimum, if taxpayers are to overpay rich people for their risky investments, they should get a big equity stake in all the institutions in return. That would make it a version of a debt-equity swap – but if that’s what it is, we alternatively could use regulation to require debt-equity swaps between the institutions and those they actually owe to debt to. That would be cleaner, less intrusive over the long run, and create no taxpayer exposure.

Alternatively, Congress could mandate that these institutions halt dividend payments and raise more capital, since we’re in this fix because they haven’t been subject to capital/equity requirements. Anything can find a buyer at the right price, and as a result of these institutions’ mismanagement, they’ll have to trade more of their equity for the capital -- as Goldman Sachs is doing now with Warren Buffet.

That still leaves the most serious business. Congress needs to take serious steps to address the underlying cause of the crisis by stabilizing the underlying assets: provide a new loan facility for homeowners facing foreclosure or new mechanisms to renegotiate the terms of the mortgages of people facing foreclosure. It also leaves one more thing: the stark and unhappy recognition that the Treasury, the Federal Reserve and the White House have produced an unworkable, inequitable and inefficient plan that Congress need not and should not accept.

The price of what are called “credit default swaps” for U.S. Treasury debt is rising sharply. Credit default swaps are financial instruments by which one investor holding debt pays another investor to guarantee that if that debt defaults, he will make the first investor whole. 

This week, the Treasury assumed responsibility for $5.2 trillion in outstanding debts held by Fannie Mae and Freddie Mac. A modest but significant share of that is headed for default, and the Treasury will have to absorb the losses. And the result is a rising price for credit default swaps on the U.S. Government: It now costs $18,000 to insure $10 million of U.S. Treasury debt. The market sees a very small - but not negligible - prospect that the U.S. Government would actually default on its debt, which would be, well, the end of the American and global economies as we know them. That’s how bad it is.

Credit default swaps for subprime mortgage based securities, of course, have played a significant role in the current unraveling in the financial markets. But conservative/Republican disdain for normal regulation of those markets has played the larger, underlying role.  Such regulation isn’t intended to “manage” those markets, but to ensure that the rest of us are protected from serious repercussions when problematic choices by financial market players (for example, to double down on subprime mortgages or their derivatives) collide with adverse conditions that make those problematic choices very reckless.

That’s the essential meaning of the Fannie Mae and Freddie Mac regulatory bailouts. Setting aside the many years of astonishingly reckless and self-interested management at Fannie Mae and Freddie Mac, the mortgage market would freeze up if these two institutions suddenly couldn’t operate. Here’s a brief course in why that’s so: there’s always plenty of credit for new mortgages, because those creating the mortgages promptly sell them, in bundles, to investors, so that the credit can cycle back to finance more mortgages. 

Fannie Mae and Freddie Mac both create and buy trillions of dollars in these mortgage-backed securities, and there’s no financial institution that could step in if they were taken out of the picture. That’s why we need to keep them operating, even if it requires a bailout. By the way, the other major holders of these securities include U.S. banks – expect a line of them to go belly-up in the next six months – and foreign central banks. 

The potential unpleasant fallout for our relations with other countries if their holdings went bust is the other reason that the Bush Administration has taken the largest interventionist step in U.S. financial markets since the Great Depression. Once again, the Bush Administration is moved to act not by what’s happening to Americans, but by the implications for our relations with other countries

Déjà vu. In 1992, while managing economic policy for Bill Clinton's campaign, I recall watching the Republican Convention in happy disbelief. For days, the gabfest had veered sharply and angrily to the right; and then, when George H.W. Bush accepted his renomination, it took him 26 minutes to get to the economy, the central issue of that campaign, which he talked about for perhaps five minutes. He didn't get it, and neither did John McCain last night. It took him even longer to get to the deep, economic concerns of a majority of Americans, and then devoted about three minutes to jobs, wages, the housing bust, globalization, trade, debt, and the rest. He doesn't get it either.

Another aging, career politician out of touch is hardly news. But another president who doesn't understand or much care about what's happening to most people in our economy would have serious long-term consequences for the real prospects of tens of millions of American families. And deteriorating conditions for most could well undermine public support for the measures that a responsible president will have to take over the next generation - including broad based IT training for all workers; universal access to post-secondary education; a major national commitment to 21st century infrastructure, including universal broadband and climate-friendly light rail system in most major metropolitan areas; a national commitment to aggressively support and promote R&D in climate friendly technologies and fuels, and support to broadly deploy the new technologies and alternative fuels; new cost-control provisions to slow rising health care costs as we provide universal access to health care insurance; and more.

Somehow, none of this made its way into John McCain's acceptance speech, which is only the most recent evidence that he doesn't have what we need in our next president.

My advice while you're watching the coverage of China that will start this weekend is, prepare to be dazzled, and prepare to be skeptical. Beijing and Shanghai are probably the most modern cities in the world, especially in their city centers, and they appear to bespeak a country as prosperous and advanced as our own, or nearly so. That's not the case. The national average income in China today is less than $150 per-month, and more than half of Chinese live on less than half that. No more than 20 percent have any health care coverage, and in a system that many Chinese call "pay or die," those that don't have coverage have to fend for themselves. (That's the main reason Chinese families save 30 percent of their small incomes.) China's economic progress since 1990 is truly stunning, with GDP and incomes more than doubling each decade, and exports growing an astonishing 20 to 25 percent a year for a generation. A new model of development has driven this extraordinary progress, in which China invited the world's advanced corporations to transfer entire business operations to a country that promised to soon be one of the world's biggest markets and is already home to the world's largest, low-cost skilled workforce. The result, in less than a generation, is that China has gone from being an economic backwater to one of the world's leading production and assembly platforms. That also means that while the spectacular architecture on display in the Olympics is all made in China, most of what's modern in the Chinese economy is still either foreign-owned or clones of foreign operations. It will be another decade or more before native Chinese companies can compete with their Western counterparts.

There's also a big "if" hanging over China's future. Everywhere else in the world, great economic progress has spurred demands for more political rights by those making the progress. China's leadership has always responded harshly to such demands - Tiananmen is only the best-known instance in which the government harshly put down political protests, with large losses of life.(Human rights groups estimate that China executes 10,000 to 15,000 people each year, and a significant share have likely been convicted of political crimes.) China also acknowledges that every year, at least 70,000 protests of more than 100 people occur, and the real incidence is probably quite a bit higher than that. The quandary for China is the almost certain collision sometime in the next decade of large scale popular demands for more political rights, and very small circle of leaders determined to maintain their monopoly on political authority. Thus far, the leadership's strategy has avoided such a collision: Preserve central authority by delivering extraordinary economic growth and progress. But since China shifted to market-based policies in the 1980s-with wrenching dislocations for hundreds of millions of people- it has never experienced an economic downturn. China may be facing at least a moderate slowdown this year and next: With high oil prices and financial problems here and in Europe, manufacturing orders and export growth have both fallen sharply for the first time. A serious slowdown may not happen this year or next, but it will happen - and the world will watch to see if the Chinese leadership will permit at last initial moves towards greater liberty and democracy.

To learn more about China's development and economy, read Futurecast: How Superpowers, Populations, and Globalization Will Change the Way You Live and Work, by Robert Shapiro (St. Martins, 2008).

When there’s a dispute in sports, we go to the videotape; in politics, we go to the facts – and the facts show that for all of John McCain’s righteous wrath over federal spending, he has been an active supporter of its enormous increases in recent years.

It’s fine to talk about pork barrel spending, but let’s look at his actual votes on all Senate appropriations bills for domestic spending since he started running for president. 

New research shows that since 2006, the self-appointed guardian against wasteful spending from Arizona actually opposed less than six-tenths of one percent of the discretionary spending approved by the Senate. Counting only those appropriations during which Mr. McCain was actually present and voted for or against, he opposed eight-tenths of one percent and voted for 99.2 percent. And counting only the last two years, while Mr. McCain has been most actively campaigning for president, the self-proclaimed arbiter of fiscal restraint actually voted against not one dollar of the more than $2 trillion in appropriations approved by the Senate.

Senator McCain’s record seems to refute his own campaign promises to balance the budget and pay for the new tax cuts he wants to give business and high-income Americans – and for his new spending – by cutting existing programs.

Here are the particulars as verified by the Senate’s records. For FY 2006, Senator McCain opposed one appropriation bill, $17 billion for discretionary spending in agriculture, out of a total of $940 billion in discretionary spending approved for that fiscal year, or 0.56 percent. For FY 2007, the Senate approved nearly $1.1 trillion in discretionary appropriations, and Senator McCain voted for all of it. For the current fiscal year, 2008, the Senate has approved, again, a little under $1.1 trillion; and again, Senator McCain opposed none of it, at least not by actually voting against any of it.

The economic benefits of restraining spending are sometimes exaggerated in our political discourse, especially when economic conditions are weak. However, the value of actually behaving in ways that correspond to your own “straight talk” cannot be overstated. On this basis, Senator McCain’s record falls painfully short.

Ooops ... The Financial Times reports today that China and India once again have rejected a cap on CO2 emissions -- and without these countries and the other large developing nations that will follow their lead, the world cannot seriously address the threat of climate change. China and India's response should be no surprise: as fast growing developing economies, their appetite for the energy that produces most of the CO2 increases sharply every year. Moreover, their modernization programs are concentrated in the most energy-intensive industries around - basic manufacturing and energy-intensive agriculture - while most of their own domestic energy supplies lie in coal, the most climate-damaging fuel. One way to move forward is to give them an alternative to a CO2 cap. Carbon-based taxes should be more appealing, since China and other fast-growing developing countries need more revenues to support the basic public goods of modernization -- infrastructure programs and greater access to education and health care. But that won't be enough: we will have to make it worth their while economically to join us, Europe and Japan in a global campaign to address climate change. That will mean offering them better and cheaper alternatives to the hundreds of coal-burning electricity plants they plan to build every year into the indefinite future. Better alternatives for the climate are widely available, for example, in hydropower or natural gas-fueled generating system, and perhaps soon, in solar and wind as well.

In the end, however, the United States, along with Europe and Japan, probably also will have to make those alternatives cheaper by providing large technology transfers at cut rates. And the United States is the only country that can make any of this happen, at least regarding China. As the largest foreign direct investor in China, its largest export market, and the guarantor of the sea and air lanes across which all of China's trade and oil supplies travel, China's leaders recognize America as the indispensable economic and military power for China's own progress. All we need is a president and administration prepared to use that position to advance the global agenda on climate change.

As the United States files a major case at the World Trade Organization charging China with wholesale piracy of U.S. intellectual property, especially copyrights covering books, music and videos, let’s pause and think about our trade deficit with China.  The administration is entirely right to file the case – though a little late, given that it’s only our third complaint with the WTO over intellectual property violations since George W. Bush took office, compared to fifteen cases filed at the WTO by the Clinton administration in its second term alone.  We’ll get to why those violations matter economically, but first let’s look at an even bigger picture.

It may not be politically satisfying, but the truth is, we cannot blame any other country’s trade practices for the size of our trade deficit.  We run trade deficits for one reason: We consume more than we produce and then purchase the difference from abroad.  When China sells paper or t-shirts for less than they cost to produce and ship them here, it increases our imports of Chinese paper and t-shirts, hurting American workers and companies that still produce them here. But if China charged three times as much, and we bought more paper and t-shirts from American or other foreign suppliers, it could affect the composition of our trade deficit, but not its overall size: That’s because the size is locked in by how much we consume of everything, relative to how much we produce of everything.  The only way to reduce the trade deficit is to either consume less – which is what economists mean when they say that the answer is to save more – or to produce more. It’s used to be the case that the two were closely linked: In order to produce more, you had to invest more, and to invest more, you had to save more (and so consume less).  Global capital markets have changed that for the United States, where everyone wants to invest: Now, we can invest more even without consuming less – we just have to borrow the investment funds from foreign savers. There’s a big cost down the road, since foreigners end up owning more of our companies and real estate, and then taking home their profits and rent – but at least we get to invest.

Force China to play fair with her trade policies (if we can, which is often doubtful), and we’ll end up importing a little less from China and exporting a little more to China. But unless we also begin to consume less overall or to produce more overall, it won’t affect the total trade deficit at all.  There is one, possible way it could do so -- if demand for our exports to China goes up, it may lead to greater production at home to fill the need (after it had led to greater investment to expand production) -- and the increase in our production can bring down the trade deficit.

The one exception to all this is what the administration is finally focusing on -- foreign violations of the intellectual property rights of American producers.  If we could get China, India, Russia and Brazil (the four biggest offenders) to stop appropriating or pirating our pharmaceuticals, software or music and films, it would directly reduce our trade deficit. Our own consumption wouldn’t change, but foreign payments back to U.S. companies would increase, just as if our production had increased and all been exported. Stealing our intellectual property, in short, has the effect of reducing our production (more precisely, taking part of our production and pricing it at nothing), which in turn drives up the trade deficit.

So, now there are two reasons to crack down on intellectual property violations by our trading partners.  It’s the only cost-free way to reduce our trade deficit, and it should increase the returns and incentives for producing more of it, at a time when globalization and technology make intellectual property a central factor in U.S. economic growth and progress.

One more word on our trade deficit with China: Half of it comes from U.S. companies bringing back products they’ve produced in China by their Chinese subsidiaries. China’s currency is undervalued by all the standard economic measures. But if China does revalues its’ currency, so its exports become more expensive, it will raise the price of products produced by American companies there for sale here – and by itself can’t affect the overall trade deficit.

For the last several years, with the economy growing more than 3 percent a year, job creation has been slow and most people’s wages and incomes have hardly gained at all.  So, what can we expect now, with the overall economy slowing down?  Industrial production is falling, so business investment is likely to lag; retail sales are flat, so consumer demand and spending will also slow; and home construction has plummeted.  It looks like we’re in for a spell of much slower overall growth -- 1.5 to 2 percent growth is a good guess. And that will mean even slower job gains and, in all likelihood, lower real incomes for average families.  What does the administration propose to do about it?  In a word, nothing.

A second shoe is also dropping: Inflation is up, even with energy prices generally behaving themselves.  A lot of it is fast-rising health-care costs, which again this administration has ignored for six years.  Some of it is the impact of last year’s higher energy prices now making their way through the economy – for which, again, this administration has no answer.  Some of it is food prices, driven up by bad weather and the unintended effect of government-directed demand for ethanol, which drives up the price of corn that goes into animal feeds and sweeteners, as well as the price of other gains as farm businesses shift from them to corn.  And some of it is higher import prices from last year’s weakening dollar.

The upshot of this inflation that even as growth slows, the Fed can’t cut interest rates – which means no relief from the slowing growth.

If the administration won’t take this seriously, Congress can do so.  Let’s not wait for the next election to see those who would be president submit real plans to contain rising health care costs, reduce our economy’s fossil-fuel dependence, and increase opportunities for average workers to improve their IT skills. 

George Bush has managed to set another record – Our trade deficit hit a record high in 2006 of $763.6 billion.  That’s up about 7 percent from the previous year and up 25 percent from 2004.  The country’s 2006 deficit in manufactured goods was actually $836 billion, but some of that was offset by a $72.5 billion surplus in services.

 A number like $836 billion, especially written in red ink, can be daunting, so let’s take it apart and see in what exact ways it matters.  It’s certainly not good for the overall economy to purchase $836 billion more in goods from other countries than we sell to other countries, but it’s also not necessarily bad.  It’s hard to posit that it reflects a collapse in the competitiveness of U.S. manufacturing companies, since manufacturing accounts for about the share of our GDP as it did 20 years ago, and America’s global market share in manufacturing actually rose over the last 10 years from 20 to 22 percent – while Europe and Japan’s global market shares feel sharply.  And our companies’ global market share in high-tech manufacturing went up even more. The critical issue here is that we measure trade flows by the value of what passes across our border in either direction, and American manufacturers are more highly globalized than Europe’s.  So one-third or more of our manufacturing imports are actually shipments from the foreign subsidiaries and affiliates of U.S. manufacturers.

 That makes the $836 billion number less troubling from the perspective of the competitiveness of U.S. companies.  But it leaves U.S. manufacturing workers in the lurch.  The number of manufacturing workers is way down – down 3 million since 2000.  But that’s also more complicated than it may seem.  Some of those losses reflect technology, with the workers that have remained earning more, because the technology makes them more productive.  A lot of it is also probably domestic outsourcing designed to cut the costs of health care and pension benefits, shifting a whole range of services from cleaning crews to lawyers from in-house to sub-contractors.

 There are more manufacturing jobs in America’s future, and it’s mainly in the technologically-based aspects of overall manufacturing and the manufacture of the most advanced, high-technology products.  It’s time for serious, progressive efforts to provide American workers the training and skills to fill those jobs, so five years from now we don’t have to import them from India and other places under special visas.   Let’s also focus on the service surpluses, a good share of which comes from royalty and licensing payments for America’s most highly-competitive export, our intellectual property.   So it’s also time for serious, progressive efforts to expand the access of lower and middle-income workers and their children to the scientific and technical education that can equip to take part in creating and applying new ideas.

 There is one unequivocally scary aspect of the huge trade deficits that have emerged under this administration: We finance them by borrowing that much from other countries, especially China, Japan and the Gulf states. That means that every year, our lenders get to take home the profits, interest and dividends earned on their new holdings in the United States. If this administration were running $100 or $200 billion budget surpluses, as the last Democratic administration did, instead of $200 or $300 billion budget deficits, we could finance $300 to $500 billion of our trade imbalance ourselves.  And that ultimately would make America a lot richer, since the returns, interest or dividends which all that money earns year after year would stay here instead of flowing to Beijing, Tokyo and Riyadh.

But that would require that the Bush administration know what it’s doing in economic affairs, something that has been consistently beyond their capacity since they took office.

President Bush has never shown much understanding of the American economy or its global environment, but yesterday he at least acknowledged that all is not as it could be: Income inequality has been rising, he said, for more than 25 years.   Actually, that’s not true: The distribution of incomes and wealth is less equal today than it was 25 years ago; but the record is that those distributions deteriorated in the 1980s during the Reagan and first Bush administrations, improved significantly in the 1990s during the Clinton years, and then turned much less equal under this President’s watch.

The President is correct that the rising return on higher education and skills plays a role – but he apparently missed the point that the Clinton administration did something about it by expanding government assistance and tax benefits for higher education and skills training.  He cut back that assistance, and now he’s surprised that inequality in up?

Clinton and the Congress during his terms also used government to ameliorate inequality, by expanding the Earned Income Tax Credit and raising the minimum wage.  George W. Bush let the value of both decline with inflation, and now he’s surprised that inequality is up?

Clinton also recognized that American prosperity requires full engagement in the global economy, so he successfully completed negotiations on the most important trade-expansion agreement in 50 years – the Uruguay Round that gave rise to the World Trade Organization – and won its approval in Congress.  Bush offered piecemeal protectionism and let the next major round of global trade talks collapse.  Clinton also recognized that in a global economy, rising health insurance costs would erode the ability of American business to create jobs and raise wages.  He failed to pass his overall reforms but succeeded in a number of smaller ways, including extending health coverage for children and promoting the expansion of HMOs.  Bush ignored the problem entirely – and now he’s surprised that inequality is up?

Finally, President Clinton saw that globalization raises the returns on capital—he took the stock market boom seriously—and responded by making the tax code more progressive.  He raised rates on the wealthy while cutting tax burdens on everyone else.  Bush surveyed the same forces driving greater inequality and decided to accentuate them by cutting taxes much more sharply for the very wealthy then for anyone else.  So, no, he cannot be surprised that inequality is now up.

If President Bush expects his comments about inequality to pass the laugh test of the American people, he’ll have to take steps that could actually do something about it – which in his case would mean reversing most of his economic program.