How Economists (and Pundits and Politicians) Helped Steer America Off a Cliff
As the economy crashes around us, Dean Baker's star has been on the rise, and for good reason.
While most of his colleagues were following the herd, swept up in the irrational exuberance of an economy fueled by the growth of a massive housing bubble, Baker, co-director of the Center for Economic and Policy Research, was one of the few voices warning of the housing market's impending crash.
When AlterNet interviewed Baker in mid-2006, there was no talk of "subprime" loans and "toxic securities," yet he warned that the crash of America's "debt bubble" -- mortgages, consumer debt and all the rest -- could decrease Americans' average wealth by as much as 40 percent.
At the time, he said that he hoped he was wrong, but unfortunately he wasn't.
In his new book, Plunder and Blunder: The Rise and Fall of the Bubble Economy, Baker explains the rise of the speculation-fueled bubble economy following the relative prosperity of the New Deal era, offers insight into how so many of his colleagues could have gotten the situation so wrong, and calls out politicians, pundits and corporate America for getting us into a mess that's threatening the entire global economy.
AlterNet caught up with Baker recently to discuss his new book, and to find out where he thinks we should be going from here.
Joshua Holland: You describe this virtuous cycle of prosperity following World War II, where productivity growth was widely distributed in wage gains, which increased consumption, which increased corporate investment and expansion, which led to increased productivity growth, etc., etc. And, you point out that the bubble economy grew in the mid-'90s, after two decades in which that cycle was broken and wages were flat for most Americans. Briefly, how did that fundamental shift occur, and how did it fuel the creation of the bubble economy?
Dean Baker: Well, I'd say what happened was, we had a period -- and this is highly debated, and you'll get different people give you different answers on this -- we had a period in the '70s where things weren't working, that we saw an end to that virtuous cycle. Several things went on, which I think explain the shift.
We had extraordinary shocks to the system in the form of much higher food prices and much higher oil prices. There was a lot of inflation. Now, my view is that if we had kept the same policies, we might have gotten back to somewhere like where we were in the '60s, but we didn't keep the same policies. Reagan got into office, and he quite deliberately set about weakening the power of workers, the power of unions.
He broke the air traffic controllers' strike, which really changed labor relations. Before that, companies negotiated with their workers when they went on strike. They didn't fire them. But suddenly, following the lead of the president, it became common practice in the private sector to start firing workers. So, there were many instances where you had workers fired when they went on strike, and that hugely weakened their bargaining power. Suddenly, if they went on strike they had to fear that they'd be fired.
Also, the National Labor Relations Board became much more hostile to unions. Then there was the trade policy. We had a high-dollar policy that made it difficult for workers in sectors that are open to competition, most importantly manufacturing, and made it difficult for them to keep their wages up.
At the same time, you had deregulation of many major sectors. The airlines, trucking … telecommunications. Several major sectors, employing millions of people with good-paying jobs, were all deregulated. And this was quite consciously an effort to reduce the power of workers and lower their wages.
So, I'd say that's really what changed in the '80s. And, as a result of that, we stopped seeing wage growth for most workers. And, it wasn't until the '90s, late '90s, where we did get low rates of unemployment, where we began again to see some wage growth for workers.
But basically, that was brought about by the stock bubble, which led to strong growth and low rates of unemployment, so finally workers were in a position to share in some of the wage gains from productivity growth. But, that was after a long period of time in a very different environment.
JH: And what, if any, is the connection between that long period of stagnating wages and the emergence, in the mid-'90s, of this kind of bubble economy that started, obviously, with the tech sector?
DB: Well, I think that because you didn't have wage growth, because you didn't have strong unions, workers had less bargaining power, and there was less fear of inflation. This might sound a little perverse, but [Alan] Greenspan quite openly said this. He was prepared to have very low interest rates, let the economy keep growing. Because, he said, workers don't have any bargaining power. You don't have to worry about inflation. He wouldn't have done that if we'd been back in the '70s world. So, it was only because you had broken down that pattern of wage growth that Greenspan allowed for the sort of low interest rates that are conducive to the growth of a bubble.
Just to be clear, I don't have a problem with low interest rates. I think they're great. I think it was great the economy did have good growth in the late '90s. But on the other hand, I do have a problem associated with the bubble, because that's not going to last. It's not going to be enduring, and it has very bad consequences, as we see.
JH: Now, we've heard that all of this was impossible to see. And of course, you saw during the run-up of the stock market bubble, the price-to-earnings ratios of some of these companies were just absolutely ridiculous.
And then, the stock market bubble burst and you saw a run to the housing market, because people thought, 'Well, OK, we can live in our houses.' You mention in the book that there was this kind of idea that as there was less security in the stock markets, people ran to the housing market. And again, you saw this huge bubble rise up.
When I interviewed you several years ago, this was something you were talking about. And yet, at the same time, virtually no economists -- none who have a bully pulpit in our media, who get a lot of attention in the press -- were talking about this. Why is that?
DB: Well, I think economists have very little incentive to really think for themselves. If you just say the exact same thing as everyone else, there's not really a downside to it. So just think of the incentives. Think about economists the way economists would think about economists -- or should think about economists. People respond to incentives. And, in this scenario, their incentives are all just to repeat, say the same exact same stuff as Alan Greenspan and everyone else is saying, and don't think about it.
Because, if you step out of line, if you get out there and say, "There's a real big bubble. It's going to be real bad news. It's going to wreck the economy, and we're going to have the worst recession since the Great Depression," well, you're taking a real big risk. Because obviously you don't know for sure that you're right. You might think you're right, but you don't know for sure. And if you're wrong, well, everyone's going to laugh at you. You'll be humiliated. You'll be ignored. No one's going to take you seriously. You won't get promoted. Who knows? You could even get fired.
So, economists shouldn't be trusted to ever step out of line, they shouldn't be trusted to think originally, creatively, because there's no reason for them to. It's all risk and very little upside. So, what we should expect is that all these economists, including many highly paid economists, are going to say exactly what every other economist will say, whether they agree with it or not. It doesn't even matter, because that's the incentive structure.
JH: At the same time, you had the raw data. I mean, home prices rose with wages and inflation for 100 years, essentially. And then, between 2002 and 2006, you point out in your book, real home prices rose by 70 percent. And, at the same time, you pointed out years ago -- when we spoke about your last book -- that there had always been a close relationship between rental prices and purchase prices, but that relationship got totally blown up in the early 2000s.
And it's just very difficult to grasp how it is that not only the media and economists, but also policymakers, could have ignored this. It's almost like there was this institutional desire to stick one's head in the sand.
DB: Well, I would certainly agree with that. You know, whenever I suggest that some people from the Clinton administration who are very much associated with these policies that brought us this disaster, who thought bubbles were fine back in the '90s. They thought the stock bubble was cool. You know, if you say that those people shouldn't have gotten top positions in the Obama administration, people think you're being vindictive. To my mind, though, well, you messed up in a really big way. That should affect your career. It's a reasonable thing. But, that's not the way it works. It's more like a fraternity. Once you're a member, you're a member, and it really doesn't matter what you do. And, that's the story.
JH: OK, let's move on to the current debates that are going on. We hear an enormous amount about a credit crunch. And this is supposedly a problem -- articulated by George Bush and Hank Paulson and many others -- where even qualified individuals and qualified firms are unable to access capital. And, you have been pointing out repeatedly that the real story here is quite different. Tell me what's going on today, in terms of the credit markets.
DB: Well, you know, I have to be careful there. I wouldn't say that there's no issue of firms not being able or having difficulty getting credit. Obviously, some are. And some of them are relatively healthy firms.
But the point I've made is, first off, that that's not the big problem. The big problem is that we have a lack of demand because we've lost on the order of $6 trillion in housing wealth and perhaps $8 trillion in stock wealth. And you'd expect, even if our banking system was totally capitalized, totally solvent, that that would cause big problems. That's what happens when you lose many trillions of dollars of wealth. People stop consuming. And that's really where our big problem is.
But the second point is that there are issues where people can't get credit. But in many cases, that's because they're a bad credit risk. They weren't bad credit risks two years ago, but they are today. And, this shows up very clearly in housing. If you look at the number of applications for home mortgages it's, again, one of these simple statistics that just tells you about everything you need to know. If you look at the number of applications for home mortgages -- new mortgages -- those haven't risen.
The reason why that's so important is, if we believe the credit crunch story ... let's, for a moment, imagine that there's all these good credit risks out there who simply can't get credit because banks are holding on, hoarding their money, and they're sending everyone away. OK, so if we believe that, then we have a lot of people who go to the bank to get a mortgage, and they're turned down. Even though they've got a solid credit rating, put down a reasonable deposit and they're paying a reasonable price on a home, the bank's turning them down. So they go to a second mortgage company. They go to a third, a fourth.
So, if we believe the credit crunch story, there's real simple test. There should be a huge rise in the ratio of mortgage applications to mortgage issuances, which correspond roughly to the homes sold. Well, there isn't. There's no perceptible rise at all. I mean, I haven't done the arithmetic, but I could eyeball it. There's no uptick at all. In fact, the mortgage applications index has been trending downward, and it's pretty much been following the rate of house sales. So, there's no evidence at all that people [who are creditworthy] are having difficulty getting mortgages.
Now, there's lots of people who owe $300,000 on a home that today is worth $200,000. They go to the bank and they say, "I want to refinance." They can't get it. No. No bank in its right mind's going to lend someone $300,000 on a home that's worth $200,000. That's not a credit crunch. They'd never do that even if they were stuffed to their gills with capital.
But that really has nothing to do with the strength of the banking and the financial system. Banks, as a general rule -- we had an exception a couple years ago -- don't like to make loans to people they don't think are creditworthy.
JH: Now, this seems to me a crucial question, in terms of policy ramifications, right? I mean, if we have this credit crunch, where banks are not loaning to otherwise-qualified individuals, but showering billions and billions and billions of dollars onto the financial system, makes a certain amount of sense, doesn't it?
But, is there another approach that might seem more obviously effective, if this credit crunch story is not the primary issue, but rather a secondary issue to this massive loss in wealth and the fact that people are sitting in homes that are worth significantly less than their loans?
DB: Well, I think first off, in terms of how we look to boost the economy, it's going to have to be primarily through fiscal policy. We're going to have to spend a lot of money, and we're going to have a big stimulus. I think the one that President Obama worked through with Congress is a good start. It should give the economy a boost, but we'll need more than that.
But the other problem, when we come to the banking sector, we do have to fix it. I mean, you do have a situation where you have a large number of banks that are insolvent -- they're bankrupt.
But the fact that there's not this imminent credit crunch does mean two things: One, we have more time. And two, we could think this through. We could structure this in a way so that we don't just end up giving money to the shareholders who took a bet and lost. In a market economy, if you take a bet and lose, you're out of luck. That's the way it's supposed to be.
So, one, we don't want our money going to the shareholders. And two, perhaps more importantly, we don't want it to go to the bank executives. And, we have the time to sit down and work this out to make sure that what we do doesn't reward the people who got us here.
In any case, we certainly have the time today, and there's absolutely no reason on earth to be designing new plans that are going to end up rewarding the banks, rather than simply sustaining the financial system. Which again, that's what we care about. There's no reason on earth that taxpayers should be coughing up their tax dollars to help out the shareholders and the executives at these banks.
JH: Now, you talk about moving beyond the bubble economy, and you lay out a number of things that you think need to be done. Dean Baker, you're president for life, without a Congress to worry about. You're a dictator. What are you going to do to keep the next bubble from rising?
DB: And I thought we just inaugurated Barack Obama.
DB: Anyhow. Several things. First off, I'd rein in the financial sector. We have to understand, the financial sector is a drain on the economy. That's not a moral statement; it's an intermediate good. This isn't like recreational activities or health care, goods that make us better off as an end in itself. It's an intermediate good, like trucking.
So, if we suddenly saw that more and more of the economy's resources were being used up by the trucking sector, we'd be inclined to say, well, what's going on there? Why do we have 10 percent of the economy in trucking? Of course, we have about 1 percent, but suppose it jumped to 10 percent. We'd think, "we have a really inefficient trucking sector." And that would be the same way we should look at the financial sector.
We need the financial sector so that we can get the money to buy a house, to start a business, to borrow money to send our kids through school, or so they can borrow it themselves. There's all sorts of reasons that we need, and we want a good, working financial sector.
But, when you see it growing exponentially, as it had over the last three decades, well, that should have set off all sorts of warning lights. That's a real problem.
So we want to rein in that sector, and I think the best way to do that is with a modest financial transactions tax. You have one in England. They tax stock trades a quarter of 1 percent per trade. I think we should have something like that. You could raise a ton of revenue. I did some calculation with [University of Massachusetts economist] Robert Pollin, a friend of mine, a few years back, and we found it could easily raise over [$]100 billion a year in revenue. That's real money.
And, it does that by reducing the size of the financial sector. If we want to regulate the financial sector effectively, I think we have to have it be smaller, because part of the story that we saw during the bubble years was that the financial sector used its political power to prevent effective regulation. So there were people at different points, in different places, who wanted to rein in some of the abuses that we saw. But they were prevented from doing so by politically connected people who were tied to the financial industry.
There are other issues. We're way behind the rest of the world in several areas, health care first and foremost. Our health care system's just incredibly dysfunctional. We spend more than twice as much per person as the average of the other wealthy countries, all of whom have longer life expectancies than us. So, we have to get our health care system in order.
You have all these people running around there with these projections, how we have this deficit of $60 trillion. Real scary numbers. And, that whole story is health care. If we had our health care fixed, we wouldn't have a deficit problem, or at least not a serious one. We may have to raise some taxes here or there, but no one would be running around the country talking about this nightmare story if we had our health care system fixed.
We also have to improve the bargaining position of workers. One of the bills that will be before Congress in this session is the Employee Free Choice Act that will allow workers who want to organize unions the opportunity to do so without the fear of being fired.
If we could do things that will increase the bargaining power of workers so they're better able to ensure themselves a share of productivity growth, and that would help to restore the sort of virtuous cycle that we had in years past.
JH: Now, let me ask you. You discuss in the book these hedge funds, the massive kind of house of cards of derivatives that sprang up, you know, actually as a result of deregulation, and other unregulated tools of capital that are out there. How would you address that issue?
DB: I mean, the transactions tax would take a lot of the profit out of [speculation]. Part of the story with the transactions tax, and one of the reasons why I think it's so nice is that it basically directly discourages the activity you want to discourage.
If we're looking to save up money for our retirement, we're going to buy shares of a stock, or buy a mutual fund, whatever it might be, and we'll pay the tax when we buy in, and we'll pay the tax when we sell. A quarter of a percent. We'll be happy about it. It's just not going to be that big a deal.
On the other hand, if we're talking about people who buy at 1 o'clock and sell at 2 o'clock, well, a quarter of one percent on each side, it's going to end up being a big deal. Because, if you make a one percent gain, buying at 1 o'clock and selling at 2 o'clock, you're golden. I mean, that's great. You know, you made 1 percent in an hour. I mean, that's fantastic.
On the other hand, if you have to give up a half percentage point in taxes, well, your gain's cut in half. And of course, no one was promising you a gain of 1 percent. A lot of those deals don't give you a gain of 1 percent. So, it suddenly becomes a really big-risk proposition to buy at 1 o'clock and sell at 2 o'clock, which means you have many fewer people doing it.
It's not going to put the hedge funds out of business. It's not going to shut down the speculators. I don't know we'd want to do that -- but you certainly would reduce the amount of money that's going to that sort of speculation very substantially.
JH: Let me ask you, one of the things that I think is so important about your contributions to all of these debates is that you take really complex issues and make them rather accessible. Tell me a little bit about high-dollar policy, trade and how that has played into the development of the bubble economy.
DB: Well, the high-dollar policy has been a really important part of this story, and it's unfortunate that its implications are rarely talked about. We have a very large trade deficit. It's come down last year. But we had, until very recently, a trade deficit that was close to 6 percent of GDP. It peaked out at over [$]800 billion in 2006. And that was a direct outgrowth of the high dollar. Because that's what determines whether someone buys an imported good or not.
And, what we want to do, at least to my mind, is bring the dollar down a lot so that we could get the trade deficit down somewhere closer to balance.
Now, the reason why this fits in with the bubble story is that when we start importing a lot, and we export less, we run the big trade deficit, there's less demand in the economy.
We used to produce cars, steel, whatever it might be. All these goods we used to produce domestically, creating jobs domestically. Now we're no longer doing that. We're buying the goods from abroad. So we end up with much more unemployment, much more slack in the economy, and that's a scenario in which you end up lowering interest rates to try and fill that gap.
And that's exactly what the Federal Reserve Board did, certainly in the late '90s, and again in this decade. They kept interest rates very low, with the idea of letting the economy expand. Low interest rates encourage housing, of course, encourage other forms of consumption.
So, to a very large extent, you could say that the bubble economy ... or I should say, the conditions for the bubble economy ... were created, were an outgrowth of the trade deficit, which was in turn the direct result of the high-dollar policy. If we had had a lower dollar, we wouldn't have had so much excess labor, so much unemployment. And, there wouldn't have been an environment in which Greenspan and the Fed would have looked to lower interest rates to try to boost the economy in the same way.
JH: What should be done with the banking system going forward?
DB: I'm very concerned right now that there's a lot of talk about creating a ... a bad bank that would buy up all these bad loans.
People should understand what's going on there, because what that would almost certainly mean is we'd be paying too much money for bad assets, taking them off the bank's books. But it's just misleading the public about what's at issue.
Because when we're buying bad assets at an inflated price, we're handing money to the banks. If you have a car that's worth $5,000, and we give you $10,000, well, that's a way of handing you $5,000. And that's, in effect, what these proposals are doing. We'd be talking about paying too much money for the bank's bad assets.
And, people have used the analogy ... they've been comparing this to the savings and loan [collapse] in the '80s. The key point in savings and loans is we put them out of business. We put them into bankruptcy. We took over their assets, and we sold them off in a separate pool to recover money for the taxpayers, and we then took the banks themselves, stripped of their bad assets, and sold them back off to the private sector.
And that makes perfect sense, but that's not what they're talking about right now. What they're talking about right now is, you leave the banks operating. You leave Citibank there. You leave Bank of America, Wells Fargo, all the others who have hundreds of billions of dollars of bad assets, perhaps trillions of dollars between them, and we just take their bad assets, pay them more than they're worth, and then we let them keep operating as though nothing had happened.
And that's just a huge handout to the shareholders of these companies, as well as to executives, because they're able to keep their high-paying jobs.
So, people should be aware of that and they should be screaming bloody murder if anyone tries to go through with those plans.
JH: Should we be thinking about nationalizing these banks?
DB: Well, in effect, that's right. I mean, and again, understand what's going on. They would be going into bankruptcy. This isn't a communist takeover. They would be in bankruptcy. That would be the market outcome. But we don't want the market outcome, because these [institutions] are too big to fail. We don't want Citigroup going into bankruptcy and having a judge have to sort through, you know, trillions of dollars of loans and assets. I mean, it would just be a nightmare.
Now, at least to my mind, I really don't want the government to own the banks. But they put themselves in that situation, where they're effectively bankrupt. So, for a period of time, yeah. I think we do have to nationalize them until we could get them reorganized and sold off again to the private sector.