Who Killed Our Middle Class?

Popular Economics Weekly

It’s becoming clear that our Middle Class—the midsection of U.S. earners and consumers—has shrunk alarmingly. And this is the main reason for the political polarization today that in the words of journalist Christopher Hedges, has driven the Republican Party “insane”.

Our society has become so polarized that Donald Trump needed the support of the Ku Klux Clan, white nationalists, and Vladimir Putin to become President-Elect. Whereas it has been the Middle Class values of probity, honesty and a belief in science, first satirized in Moliere’s Le Bourgeois Gentilhomme, (The Middle Class Gentleman), that has been the stabilizing influence in American politics since WWII.

The main difference between poverty and middle class and between middle class and wealthy, noted one researcher, “is belief in, and planning for, moving up as a working assumption.” A report from the Pew Research Center found that, for the first time since the 1970s, families defined as “middle income” are actually in a minority in the US – squeezed from both ends by an enlarged poverty-stricken group below them, and an enriched group above them.

Graph: Fortune Magazine

This graph shows the shrinkage of those defined as middle class from 1979 to 2014—from 38.8 percent (gray line) to 32.09 percent (blue line), according to a Pew research study. The shrinkage reads like a textbook example of the future that French economist Thomas Piketty predicts for the world in his best-selling, Capital in the Twenty-First Century.

In 1971, there were 80 million households in the US defined as middle income – compared with a combined 52 million in the groups above and below. Now, there are 120 million middle-class families, but 121 million rich and poor – “A demographic shift that could signal a tipping point,” says Pew.

So who or what is at fault for the result; record income inequality last reached in 1929 that led to the Great Depression? We can fault President Reagan, who was first to break the unions with his firing of all federally employed Air Traffic Controllers that belonged to PATCO, the traffic controllers union.

Or conservatives’ espousal of the Reagan motto, “government is the problem,” which caused massive downsizing of government regulation, as well as regulators, and the ensuing de-regulation of whole industries, such as the airlines, telecommunications, and financial markets.

But the truth may be much closer to the present—in fact, from the Presidency of Bill Clinton. For it was President Clinton who veered so far to the right in his 1966 reelection campaign (thanks to Republican strategist Dick Morris) that he preempted the Republican platform by continuing to deregulate the financial markets with the repeal of the Glass-Steagall Act that separated FDIC depositor-insured banking from higher risk investment banking, financing the addition of 100,000 more police to combat the drug epidemic, and downsizing poverty programs with welfare reforms that took tens of thousands off the welfare rolls, which required them to take low-paying menial jobs to receive even a limited amount of financial support.

The Republicans, as Chris Hedges said, were thus driven politically insane into the waiting arms of Trump's rascist, anti-immigrant voting block. President Clinton had preempted the bread and butter issues (such as law and order, smaller government, family) that were once their own, which led to formation of the Tea Party, and a new political civil war declared on Big Government ruled by the northern elite that had ruled for so long. It was our 150 year-old Civil War taking a new form, in other words, but with almost the same mix of combatants.

Hillary Clinton, unfortunately, wasn’t able to break away from the Clinton mix of conservative economics (e.g.,balancing the federal budget) and social liberalism that resulted. The culture wars against abortion, civil rights, and welfare (including Obamacare) were the only issues the Republican Party had left. The result was and is President-elect Trump, an ideologist of neither party. Trump is an advocate of no government, where possible, who can count on the loyalty of only his most trusted associates and family.

Sound familiar? It is politics of the tribe, the close=knit family, held by gangsters and oligarchs, with everyone else to be treated with obfuscation and outright deceptions.

Even more significant is the record inequality since 1979, resulting from the loss of those policies that built up the middle class after WWII, policies from the New Deal, such as social security and Medicare, entitlements, unionization of whole industries, leading to the unparalleled prosperity of the 1950s and 60s.

So let us hope a majority of our politicians realize, as a majority of Americans still do, that our prosperity and stability rest on a middle class that hasn't given up hope for a better life.

Harlan Green © 2016

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

What, Now A Trump Recession?

Popular Economics Weekly

Economists are already warning that if President-elect Trump’s policies are enacted, such as initiating trade wars, or the wrong tax cuts, or even cutting back on social security and Medicare benefits, we could see another recession, similar to the Great Recession that occurred during GW Bush’s term.

Whether his policies can be enacted depends on several things, including his unpredictable behavior, and perhaps the outcome of his November 28 RICO trial in San Diego for running Trump University as a criminal enterprise. Judge Gonzalo Curiel has just ruled that Trump’s inflammatory campaign statements can be admitted as evidence in his trial.

The Bush recession was caused by too lax regulations that caused the housing bubble (by allowing excessive bank leverage), tax cuts that increased the budget deficit while we were fighting two wars, and then Greenspan’s Federal Reserve decision to raise interest rates 16 consecutive times to bust the housing bubble.

It’s terrifying what President-elect Trump will be able to do when he controls all three branches of government (as soon as he appoints a ninth Supreme Court Justice) and carries out his campaign pledges.

Carrying out his pledge to deport all aliens when there is already an outflow of immigrants will devastate agriculture, construction, and any other industry that relies on low-cost labor, for instance.

His promise to ‘fix’ Obamacare (or abolish it outright) will endanger health benefits for the 20 million now covered by it. This makes healthcare much more expensive, since it puts the uncovered back in Emergency Room care for serious illnesses, which puts the cost of their care back on the hospitals.

And as the New York Times reports, “This is going to be a president who will be the biggest regulatory reformer since Ronald Reagan,” Stephen Moore, one of Mr. Trump’s economic advisers said in an interview on Wednesday. “There are just so many regulations that could be eased.”

It could be everything from repeal of Dodd-Frank, the successor to the Glass Steagall Act that protected federally insured depositors from risky investment banking, to repealing environmental regulations that combat global warming, and not only abolishing Obamacare, but the current Medicare system as House Speaker Paul Ryan is threatening to do.

Graph: Marketwatch

And we are reaching full employment levels, which will surely mean the Fed will begin to raise short term rates in December. This is happening already in the bond markets, as evidenced by rising longer term interest rates in anticipation of a soaring budget deficit, if Trump’s plan to increase both infrastructure and military spending while cutting taxes is implemented.

The central issue, though, maybe Trump’s misbehavior in dissing those elements that made American great. “Trump’s bigotry, dishonesty and promise-breaking will have to be denounced,” said David Brooks today. “We can’t go morally numb. But he needs to be replaced with a program that addresses the problems that fueled his ascent.
“After all, the guy will probably resign or be impeached within a year. The future is closer than you think.”

But President-elect Trump’s destruction of almost all decency in his grab for overwhelming power has let that Genie of discontent out of the bottle. We know what happened in the 1930s and even earlier when such ruthless tactics were used.

Harlan Green © 2016

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Goldman’s Defense--Innocent Fraud?

Financial FAQs

The U.S. Senate has finally begun debate on financial reform, but only after eye-opening testimony at Senator Carl Levin’s Permanent Subcommittee on Investigations by Goldman Sachs’ executives, who claimed that hedging their bets on subprime mortgages was perfectly legal, while not believing that telling clients what they thought of the securities or derivatives sold to them was relevant.

Why their belief that they were innocent of any fraud? This is when economic theory gets mixed up with ideological belief systems. Economist John Kenneth Galbraith labeled it “The Economics of Innocent Fraud” in his book of that title (2004, Houghton Mifflin, Boston). “Most progenitors of innocent fraud…are not deliberately in its service. They are unaware of how their views are shaped, how they are had. No clear legal question is involved. Response comes not from violations of law but from personal and social belief. There is no serious sense of guilt; more likely, there is self-approval.”

The inherent conflict in Goldman’s case was that of the classic inside trader, who believed that free, unregulated market forces should determine investor behavior. We now know that unregulated ‘free markets’ are a vehicle for manipulation by insiders. Goldman had inside information that their buyers didn’t—i.e., that there was a great likelihood the underlying subprime mortgages might have very high default rates. And as ‘market-makers’, their function as a pure trader was to find buyers for sellers and vice versa, without evaluating the underlying worth of the assets being traded.

Of course there were other conflicts of interest. Goldman was both an unregulated securities’ trader and an investment bank regulated by the Federal Reserve, which gave them a source of very cheap funds (i.e., because tax payer guaranteed). Until the Depression era Glass-Steagall Act was repealed in 2000, commercial banks regulated by the Fed could not also be securities’ traders. The reason was that stock, bond, and derivatives’ trading was a very risky business where caveat emptor prevailed—‘buyer beware’, in other words.

This was precisely why Senate members used the Las Vegas casino analogy at the Goldman hearings. Bets were being placed on which direction the subprime market would go, without the bettors having any ‘skin’ in the game—i.e., no equity or ownership interest in the underlying securities—just like placing a horse racing bet. It was gambling, in a word, but Las Vegas gamblers knew they were gambling as Nevada’s Senator John Ensign said at the hearings, whereas Wall Street investors did not at the time.

And, more importantly, because derivatives’ trading was unregulated, no one knew how much was bet for or against subprime mortgages at the time. It was being transacted through a shadow-banking system specifically set up to escape regulation. Whereas horse race bettors know exactly what the odds are, because regulations require the odds to be publicly posted.

The result was that traders’ profited, but those pension funds and foreign banks that had no real knowledge of the risks inherent in such trades did not. That is why this ‘last bastion of free enterprise’, as some traders call it has to become more transparent. Financial markets are now as interconnected as our environment. What happens in one part of the financial environment can affect other parts not directly involved.

The environmental analogy is apt here. Financial markets have become an internationally connected financial ecosystem subject to ‘pollution’ with toxic securities, just as our environment has become polluted with toxic chemicals. The world has become ‘flat’ and interconnected, said columnist and author Thomas Friedman, precisely because information is now transmitted at light speeds in our new digital world.

The Darwinian world’s survival of the fittest analogy was true 100 years ago when Capitalism was an infant struggling to survive in a post-feudal age world where ownership was still in the hands of the few—whether monarchs or military dictators. But once the Industrial Revolution prevailed over the feudal age, laws regulating private property rights and controlling predatory behavior became necessary.

In fact, markets only function well when there is transparency. Otherwise assets become mispriced, bubbles formed, and greater losses ensue. Nobelist George Akerlof knew this best when he did ground-breaking research on how asset markets really function. He studied the Lemon used-car market, of all things, which before it became regulated meant buyers had no knowledge whether a new or used car was a lemon—had some undetectable defect, in other words. And because buyers therefore discounted the price of those unguaranteed cars, it drove sellers with vehicles of better quality out of the market.

And that is why state vehicle Lemon Laws now require some guarantee or warranty of quality for each vehicle for sale. Professor Akerlof’s seemingly innocuous research, along with that of Joseph Stiglitz and Michael Spence won them the 2001 Nobel Prize in the Economic Sciences “for their analysis of markets with asymmetric information”, and proved that insider trading will always harm markets, if not regulated.

Professor Akerlof, also the co-author with behavioral economist Robert Shiller of “Animal Spirits”, has been very vocal about the need for regulations and laws to keep up with financial innovations. One of his favorite sayings first appeared in a New York Times editorial.

“If you let your toddler out of her playpen, you need to watch her more carefully. This wisdom is known by every American parent but has been systematically ignored in economic deregulation…Now is the time to remember the lessons of the playpen: increased scope for action must be accompanied by increased regulatory oversight.”

JK Galbraith’s innocent fraud is the reason ideology may trump economic reality. Those AAA ratings on subprime mortgage securities were an illusion, fostered by Goldman’s traders that generated tremendous profits. There is a ‘snake oil’ element in all financial markets that free market ideologues are loath to admit. “…those employed or self-employed who tell of the future financial performance of an industry or firm, given the unpredictable but controlling influence of the larger economy, do not know and normally don’t know they do not know.” Those predictions “are thought to reflect economic and financial expertise. And there is no easy denial of an expert’s foresight.”

Harlan Green © 2010