March 2009 Archives

The flap over bonus payments to executives and traders at the American International Group continues in full force, and looks set to dominate at least another news cycle or perhaps more. The focus of mainstream press reporting on the story has shifted to "how much did Obama and Geithner know about the bonuses, and when did they know it?" But while journalists are obsessing over the reactions of the Administration and Congress, the real import of the story lies in how it vented a deep current of almost violent anger among the people, who have been seething over taxpayer bailouts since Bear Stearns collapsed a year ago.

As I'll show you, that anger has opened the way for Congress and the Administration to take actions that will severely threaten the free exercise of contracts and agreements. And yet with all this, the actual impact of the AIG bonuses in financial terms is almost insignificant.

Every financial firm pays bonuses to its employees. In the former Wall Street investment banks, the annual bonuses (which are usually determined in November and paid out in January) can in fact comprise the majority of each individual's compensation. This goes beyond the holiday bonuses or sales commissions that are common in other industries. For firms whose only real business is handling money, the bonus system is a way of inducing cutthroat competition among their own people.

Three days ago, the redoubtable Tom Friedman wrote a column in the New York Times which called the stock market bottom in the time-honored manner of big-time journalism: he told us that the sky is falling. The market promptly started an 11% rally, which is going to continue later this morning as I write.

Mr. Friedman wasn't the only one. His Times colleague David Brooks also became alarmed by the fall in his 401(k) account and realized lately that this financial and economic crisis is the real thing. (I should have sent them links to my articles on the subject going back nearly two years now.)

Now that political and cultural commentators have realized they need to weigh in on the economic story, and in a way that considers more than just the evils of income inequality, we also have to deal with their prescriptions for how to handle the situation.

This is a problem because Mr. Friedman, while perceptive about the nature and dimensions of the crisis, reflexively locates the potential solutions in government action. And ultimately in the slender, graceful hands of Barack Obama.

To Friedman, Obama seems distracted by other things and is lacking in needed focus on the economic crisis. (It would be closer to true to say that Obama and his team are simply out of their depth, and flailing.)

But although there is some need for sustained government action, most of this crisis is impervious to what government can do. Government can help to create the conditions for an eventual recovery. But what's going on is something they can't fix.

It would actually be refreshing if someone big and important stood up to say that policymakers really haven't a clue how to improve the economic and banking crises. But no one in a position of political authority is willing to do so, least of all the New Masters of the Universe in Washington. So therefore, the task falls to me.

In the US, there's a growing sense that the Obama Administration just doesn't know what to do about the worsening economic and financial picture. Consumer demand continues to fall, jobs continue to be lost at a rate of more than half a million a month, the credit crisis is still as bad as ever, and housing is still far overpriced.

The bright spot, if it is one, is that Fed Chairman Bernanke has been doing more than anyone else in the world to get ahead of the deepening problems in the capital markets. The leaders of the world's other central banks are mostly watching him and waiting to see if anything works. So far, a lot has worked, but the economic problems that are of greatest concern haven't been touched.

Bernanke's academic specialty has been his studies of the Great Depression, particularly of the dynamics through which a long chain of bank runs and capital-market stresses turned into the worst episode of sustained high unemployment in our history. He also watched closely as Japanese authorities mismanaged their deflationary situation in the early Nineties.

What he concluded is that at a time like this, monetary authorities have to act as fast as possible, and in as much size as possible.

However, he concluded this not because he knows it will work, but rather because nothing else has been known to work. We're in totally uncharted territory, and so far nothing in the broad economy is looking any better.

I'm going to try to lay out the stresses pushing and pulling on the US economy in the medium term. I'm going to intentionally oversimplify some things in order to make the overall picture as clear as possible.

 

And I'm going to apply a bit of a curve to the analysis, to account for the uncertainty surrounding the banking sector. (By that, I mean that we don't know yet whether the private-sector crunch will abate, not abate, partially abate, or sectorally abate.)

 

In the medium term, the United States faces an unavoidable liability to fund healthcare for the baby-boomers.

 

As people age, they tend to consume more healthcare with each passing year. In the US, the next several decades will see steady increases in health spending, probably peaking around 2030 and declining thereafter.

 

This is mandated consumption. There is a firm expectation that rationing healthcare for the elderly is not an acceptable social outcome. Therefore we need to fund the spending.

 

There is also a firm expectation that no one may receive a level of care that far exceeds what is available to people without wealth. We may argue this point until we're blue in the face, but I won't waste my time. Social justice is non-negotiable. Therefore, some amount of income redistribution is inevitable.

I must admit to you that I was very surprised by the budget that Barack Obama announced on Thursday.

In the short time he's been President, we've seen a pattern of a man who talks big but passes the buck. Everything he wants to do is someone else's job -- responsibility is passed on to Congress, his own subordinates, or the future (as in, "today we're announcing a major initiative that will accomplish X, Y, and Z. You'll have the details in a few weeks").

Not so with the budget. This budget is something different. Whether anything like it actually becomes law is impossible to say at this point. But it does represent a radical change in its basic philosophy about the relationship between the American people and their government.

I'm one of the many people who have been throwing the phrase "New New Deal" around, although I claim some measure of paternity because I've been using it (and the companion phrase "Great Depression II") since late 2007, which is longer than anyone else I'm aware of.