Demand Side Exposed: The Confessions of an Unreconstructed Progressive Economist

One of the questions that appears in my e-mail at Demand Side is, "Who are you?" When this does not send me into a period of morbid introspection, it produces a resistance and defensiveness most often characterized by the response, "I am the person writing this material. If it doesn't make sense, move on."

Today all that is changed. As the introduction to Demand Side, the book, 2nd ed. I have drafted the following characterization of who I am and what I'm about.

Look, I wanted to study economics. But even as an undergraduate I could see that Academic economics, at least at the large state university I attended, was ill-suited to the real world. It seemed to be a place people went to study things nobody else could understand so they would have job security. In four years I heard the name Keynes mentioned only twice in lecture, and then it was mispronounced.

Perhaps I was convinced they were hiding something, so I persevered with good results on the GPA scorecard. But when it came time to make a decision for graduate school, I came up against a personal reality. I was already in my forties with family.

The Neoclassical main line was not difficult to reject. The assumptions of perfectly competitive markets and perfect information plainly did not correspond to even one real world situation. Monopoly and oligopoly ruled. Even restaurants were rewarded more for location and less for quality of food or service. Prices in the real world were not supply and demand, except in limited circumstances, but manipulated by market power or government regulation and subsidy.

The mathematics and statistics I learned were useful in themselvs, but economics I could see even then was a science of human behavior. The mathematics was suited for thermodynamics, but plainly in a system that was not closed and where there were no independent variables unless by assumption, applying math meant results that worked only in a hypothetical world. And for all the precision of the econometric models, the results in terms of forecasting were not good. Perhaps I should say they were very good when applied to the past, but very poor when applied to the future.

The economic lions of the day were at the University of Chicago. Milton Friedman and Robert Lucas and the others. Friedman advocated a policy of increasing the stock of money at a steady pace to control prices. But it was back in Macro 101 we looked at the equation PQ = MV, and Friedman was plainly ignoring the V. The great experiment of Paul Volcker in bringing down inflation in the late 1970s and early 1980s was premised on Friedman's assurances that constraining the quantity of money would certainly move prices quickly and painlessly down. The severe recession of 1981 was not quick and was very painful for people I knew. Plus it was relieved only when oil prices fell and the money stock came out from under the Fed's thumb by way of credit cards.

Robert Lucas described a scheme called Rational Expectations. Here, too, the fallacy was right up front. Rational Expectations requires economic actors who are prescient beyond possibility and certainly beyond any historical evidence.

Efficient Markets and the claims for them by their Chicago School advocates were belied by the results. "Efficiency" needed a very narrow definition to make the theory work. Agriculture, for example, had all the elements of perfect competition -- homogenous products and a multitude of producers, low barriers to entry and the rest -- yet the efficient market impoverished everyone. Admittedly, my "efficiency" was a social outcome, while that of the Chicago School was a price outcome. Still, the assumption that the two converged was implicit and was contradicted every time I looked out the window.

Perhaps it was my experience in the real world, where I had a list of jobs longer than yours, from cabs, to restaurants, to mines, to forestry, to municipal government. I was keenly aware that these theories were flowers appropriate only in hothouses and other controlled environments.

I am not claiming any special insights. It is my firm belief that many if not most of my fellow students found them equally invalid, or at least dreadfully uninteresting. Certainly the Business School and the Economics Department did not cross-pollinate.

So in terms of graduate school I was hard up against the orthodoxy. I had done well in the undergraduate curriculum by granting it the benefit of the doubt. I think I was convinced that once we got through the fundamentals and the weak in spirit were weeded out, the elect would emerge into a realm where the absurd assumptions were removed and the tools became applicable. Never happened.

And as I said, I was personally up against being forty-something with a family. I did not have the time or patience to continue down a road without some more sound assumptions being made explicit. My particular school did not have a parallel course for heretics. There were no other schools in our region. Nothing in economics. Some in business applications, but a cursory look at that showed it to be more than a little contrived. It would be math and facile theory or nothing.

The choice I made was to take my high grades and new degree to work with me on the bus. (To be completely candid, I did have the opportunity to become a budget analyst for the County, but declined in preference for purity of macro purpose, a purpose probably misplaced.)

In any event, in order to study Keynesian or even the successes of the economy during and following World War II, I needed to study on my own.  John Kenneth Galbraith, John Maynard Keynes, an early chair of the Council of Economic Advisers and prominent New Dealer named Leon Keyserling, Joseph Stiglitz, James K. Galbraith, George Soros, and now Hyman Minsky.  There is a lineage of economic thought that has progressed and become more useful.  Fortunately, some of it survived in the U.S. House of Representatives and had some access to policy.  But Demand Side became confused with the success of the New Keynesians such as Paul Samuelson and James Tobin.  (What Joan Robinson referred to as "Bastard Keynesianism."  And it was dominated later by the rise of the Monetarist, Rational Expectations, Supply Side and Efficient Market nonsense.  But it exists.  And it informs very well what is going on now.

My studies quickly began to pay off.  I was able to predict -- following closely the work of others -- the end of the Clinton New Economy.  I was able to identify bubbles when we were inside them -- a feat much less remarkable than those at the Fed would have you believe.  And I came to know what questions to ask, who to listen to, and who to discount.

It is much more surprising to me that the decline of U.S. industry and the stagnation of median incomes, the decline of social infrastructure and the rise of a parasitic financial sector, has been considered a golden period, the Great Moderation, by most economists.  High Academia and the halls of Wall Street seemed to become the repository for self-serving ignorance, not for workable economics.  This was perhaps as surprising to me as my claim of knowledge is to you.

Nevertheless, I recently returned to my alma mater in hopes that the housing bust, financial meltdown, socialization of the financial sector and bleak prospects going forward would have opened a parallel path for at least a few heretics.  In response to a description of my success in forecasting, my work on state tax policy and my interest in the theory of multipliers and productivity (which appear later in this volume), the reply was pointed:

Dear Mr. Harvey,

Thank you for your email, it is always good to hear from former students, especially ones who have retained a deep interest in Economics.

But I regret that the answer to your question about fitting into the Ph.D. program is almost certainly negative.  Like most other Economics departments, our Ph.D. program has become increasingly theoretical and mathematical over time.  As a result, we generally accept only individuals who have taken a heavy dose of calculus, linear algebra, and mathematical statistics in the recent past, because a solid foundation in all three is necessary to master the first-year core courses.

One presumes the theory is not Keynesian.  Certainly the mathematics has been disgraced by the absence of results, and indeed the creation of loss, in the real world.  While I have good skills in all three areas, this response clearly indicated the department, having started down the road of irrelevance, would not be detouring any time soon. 

On one hand, it would be logical to be discouraged and frustrated.  So I am.  On the other hand, How much more to learn and trust these fallacies and then be forced to the choice of either admitting a life spent in error or denying  reality.  At least my forecasts work and my studies build on each other to a more complete understanding.

We see around us the rubble of an intellectual conceit, yet at the highest points still standing the debate is dominated by the architects who built the structure and claimed it would last forever.  Here I hope to offer the views of those not favored by academic elites or corporate subsidies.  I hope to consolidate the views of those who make sense, display the evidence that proves them right, and do it in a way that is accessible and useful to the reader's own understanding.

It is not simply that we must escape the errors of the past, no matter how great.  We must also move aggressively into a productive and sustainable future.  Standing around waiting will only serve the interests of the entrenched interests and increase the damage of the collapse now in progress.

Bill Black suggests that in saving the banks, we have saved the vampires

The inability and unwillingness to correct the corruption and decay in the financial sector led to the current economic decline.  Continued unwillingness and delay will certainly bring a return of the same fruits.  But beyond passive enabling, the Fed and Treasury have actively and substantially enriched the authors of the debacle because of the delusion that these practices are similar to legitimate banking because they are carried out behind the same august facades.

Bill Black here outlines the scope and severity of the ongoing crisis, and points to the ultimate access to levers of power. The ability of the financial sector to block meaningful reform after bringing the world to the brink of a second great depression proves how exceptional its powers are to corrupt nearly every critical sector of American public and economic life. The five largest U.S. banks control roughly half of all bank assets. They use their political and financial power to provide themselves with competitive advantages that allow them to dominate smaller banks.

How the Servant Became a Predator: Finance’s Five Fatal Flaws
by Bill Black
October 13, 2009
New Deal 2.0

What exactly is the function of the financial sector in our society? Simply this: Its sole function is supplying capital efficiently to aid the real economy. The financial sector is a tool to help those that make real tools, not an end in itself. But five fatal flaws in the financial sector’s current structure have created a monster that drains the real economy, promotes fraud and corruption, threatens democracy, and causes recurrent, intensifying crises.

1. The financial sector harms the real economy.

Even when not in crisis, the financial sector harms the real economy. First, it is vastly too large. The finance sector is an intermediary — essentially a “middleman”. Like all middlemen, it should be as small as possible, while still being capable of accomplishing its mission. Otherwise it is inherently parasitical. Unfortunately, it is now vastly larger than necessary, dwarfing the real economy it is supposed to serve. Forty years ago, our real economy grew better with a financial sector that received one-twentieth as large a percentage of total profits (2%) than does the current financial sector (40%). The minimum measure of how much damage the bloated, grossly over-compensated finance sector causes to the real economy is this massive increase in the share of total national income wasted through the finance sector’s parasitism.

Second, the finance sector is worse than parasitic. In the title of his recent book, The Predator State, James Galbraith aptly names the problem. The financial sector functions as the sharp canines that the predator state uses to rend the nation. In addition to siphoning off capital for its own benefit, the finance sector misallocates the remaining capital in ways that harm the real economy in order to reward already-rich financial elites harming the nation. The facts are alarming:

• Corporate stock repurchases and grants of stock to officers have exceeded new capital raised by the U.S. capital markets this decade. That means that the capital markets decapitalize the real economy. Too often, they do so in order to enrich corrupt corporate insiders through accounting fraud or backdated stock options.

• The U.S. real economy suffers from critical shortages of employees with strong mathematical, engineering, and scientific backgrounds. Graduates in these three fields all too frequently choose careers in finance rather than the real economy because the financial sector provides far greater executive compensation. Individuals with these quantitative backgrounds work overwhelmingly in devising the kinds of financial models that were important contributors to the financial crisis. We take people that could be conducting the research & development work essential to the success of our real economy (including its success in becoming sustainable) and put them instead in financial sector activities where, because of that sector’s perverse incentives, they further damage both the financial sector and the real economy. Michael Moore makes this point in his latest film, Capitalism: A Love Story.

• The financial sector’s fixation on accounting earnings leads it to pressure U.S manufacturing and service firms to export jobs abroad, to deny capital to firms that are unionized, and to encourage firms to use foreign tax havens to evade paying U.S. taxes.

• It misallocates capital by creating recurrent financial bubbles. Instead of flowing to the places where it will be most useful to the real economy, capital gets directed to the investments that create the greatest fraudulent accounting gains. The financial sector is particularly prone to providing exceptional amounts of funds to what I call accounting “control frauds“.  Control frauds are seemingly-legitimate entities used by the people that control them as a fraud “weapons.” In the financial sector, accounting frauds are the weapons of choice. Accounting control frauds are so attractive to lenders and investors because they produce record, guaranteed short-term accounting “profits.” They optimize by growing rapidly like other Ponzi schemes, making loans to borrowers unlikely to be able to repay them (once the bubble bursts), and engaging in extreme leverage. Unless there is effective regulation and prosecution, this misallocation creates an epidemic of accounting control fraud that hyper-inflates financial bubbles. The FBI began warning of an “epidemic” of mortgage fraud in its congressional testimony in September 2004. It also reports that 80% of mortgage fraud losses come when lender personnel are involved in the fraud. (The other 20% of the fraud would have been impossible had these fraudulent lenders not suborned their underwriting systems and their internal and external controls in order to maximize their growth of bad loans.)

• Because the financial sector cares almost exclusively about high accounting yields and “profits”, it misallocates capital away from firms and entrepreneurs that could best improve the real economy (e.g., by reducing short-term profits through funding the expensive research & development that can produce innovative goods and superior sustainability) and could best reduce poverty and inequality (e.g., through microcredit finance that would put the “Payday lenders” and predatory mortgage lenders out of business).

• It misallocates capital by securing enormous governmental subsidies for financial firms, particularly those that have the greatest political power and would otherwise fail due to incompetence and fraud.

2. The financial sector produces recurrent, intensifying economic crises here and abroad.

The current crisis is only the latest in a long list of economic crises caused by the financial sector. When it is not regulated and policed effectively, the financial sector produces and hyper-inflates bubbles that cause severe economic crises. The current crisis, absent massive, global governmental bailouts, would have caused the catastrophic failure of the global economy. The financial sector has become far more unstable since this crisis began and its members used their lobbying power to convince Congress to gimmick the accounting rules to hide their massive losses. Secretary Geithner has exacerbated the problem by declaring that the largest financial institutions are exempt from receivership regardless of their insolvency. These factors greatly increase the likelihood that these systemically dangerous institutions (SDIs) will cause a global financial crisis.

3. The financial sector’s predation is so extraordinary that it now drives the upper one percent of our nation’s income distribution and has driven much of the increase in our grotesque income inequality.

4. The financial sector’s predation and its leading role in committing and aiding and abetting accounting control fraud combine to:

• Corrupt financial elites and professionals, and

• Spur a rise in Social Darwinism in an attempt to justify the elites’ power and wealth. Accounting control frauds suborn accountants, attorneys, and appraisers and create what is known as a “Gresham’s dynamic” — a system in which bad money drives out good.  When this dynamic occurs,  honest professionals are pushed out and cheaters are allowed to prosper. Executive compensation has become so massive, so divorced from performance, and so perverse that it, too, creates a Gresham’s dynamic that encourages widespread accounting fraud by both financial firms and firms in the real economy.

As financial sector elites became obscenely wealthy through predation and fraud, their psychological incentives to embrace unhealthy, anti-democratic Social Darwinism surged. While they were, by any objective measure, the worst elements of the public, their sycophants in the media and the recipients of their political and charitable contributions worshiped them as heroic. Finance CEOs adopted and spread the myth that they were smarter, harder working, and more innovative than the rest of us. They repeated the story of how they rose to the top entirely through their own brilliance and willingness to embrace risk. All of their employees weren’t simply above average, they told us, but exceptional. They hated collectivism and adored Ayn Rand.

5. The CEO’s of the largest financial firms are so powerful that they pose a critical risk to the financial sector, the real economy, and our democracy.

The CEOs can directly, through the firm, and by “bundling” contributions of its officers and employees, easily make enormous political contributions and use their PR firms and lobbyists to manipulate the media and public officials. The ability of the financial sector to block meaningful reform after bringing the world to the brink of a second great depression proves how exceptional its powers are to corrupt nearly every critical sector of American public and economic life. The five largest U.S. banks control roughly half of all bank assets. They use their political and financial power to provide themselves with competitive advantages that allow them to dominate smaller banks.

This excessive power was a major contributor to the ongoing crisis. Effective financial and securities regulation was anathema to the CEOs’ ideology (and the greatest danger to their frauds, wealth, and power) and they successfully set out to destroy it. That produced what criminologists refer to as a “criminogenic environment” (an atmosphere that breeds criminal activity) that prompted the epidemic of accounting control fraud that hyper-inflated the housing bubble.

The financial industry’s power and progressive corruption combined to produce the perfect white-collar crimes. They successfully lobbied politicians, for example,  to legalize the obscenity of “dead peasants’ insurance“(in which an employer secretly takes out insurance on an employee and receives a windfall in the event of that person’s untimely death) that Michael Moore exposes in chilling detail. State legislatures changed the law to allow a pure tax scam to subsidize large corporations at the expense of their taxpayers.

Caution: Never Forget the Need to Fix the Real Economy

 Economic reform efforts are focused almost entirely on fixing finance because the finance sector is so badly broken that it produces recurrent, intensifying crises. The latest crisis brought us to the point of global catastrophe, so the focus on finance is obviously rational. But the focus on finance carries a grave risk. Remember, the sole purpose of finance is to aid the real economy. Our ultimate focus needs to be on the real economy, which creates goods and services, our jobs, and our incomes.  The real economy came off the rails at least three decades ago for the great majority of Americans.

We need to commit to fixing the real economy by guaranteeing that everyone willing to work can work and making the real economy sustainable rather than recurrently causing global environmental crises. We must not spend virtually all of our reform efforts on the finance sector and assume that if we solve its defects we will have solved the other fundamental reasons why the real economy has remained so dysfunctional for decades. We need to be work simultaneously to fix finance and the real economy.

William K. Black is an Associate Professor of Economics and Law at the University of Missouri-Kansas City. He is a white-collar criminologist and was a senior financial regulator. He is the author of The Best Way to Rob a Bank is to Own One.

Modern economics is mathematical and theoretical. Too bad it is not more real. But the real world is inconveniently asymetric. It resists modeling.

Here, from Brad DeLong, a request that the real world again enter the cognitive sphere of economists.

The Anti-History Boys
J. Bradford DeLong
Project Syndicate
October 6, 2009

BERKELEY – If you asked a modern economic historian like me why the world is currently in the grips of a financial crisis and a deep economic downturn, I would tell you that this is the latest episode in a long history of similar bubbles, crashes, crises, and recessions that date back at least to the canal-building bubble of the early 1820’s, the 1825-1826 failure of Pole, Thornton & Co, and the subsequent first industrial recession in Britain. We have seen this process at work in many other historical episodes as well – in 1870, 1890, 1929, and 2000.

For some reason, asset prices get way out of whack and rise to unsustainable levels. Sometimes the culprit is lousy internal controls in financial firms that over-reward subordinates for taking risk. Sometimes the cause is government guarantees. And sometimes it is simply a long run of good fortune, which leaves the market dominated by unrealistic optimists.

Then the crash comes. And when it does, risk tolerance collapses: everybody knows that there are immense unrealized losses in financial assets and nobody is sure that they know where they are. The crash is followed by a flight to safety, which is followed by a steep fall in the velocity of money as investors hoard cash. And that fall in monetary velocity brings on a recession.

I will not say that this is the pattern of all recessions; it isn’t. But I will say that this is the pattern of this recession, and that we have been here before.

But if you ask the same question of a modern macroeconomist – for example, the extremely bright Narayana Kocherlakota of the University of Minnesota – you will find that he says that he does not know, and that macroeconomic models attribute economic downturns to various causes. Most, he points out, “rely on some form of large quarterly movements in the technological frontier. Some have collective shocks to the marginal utility of leisure. Other models have large quarterly shocks to the depreciation rate in the capital stock (in order to generate high asset price volatilities)...”

That is, downturns are either the result of a great forgetting of technological and organizational knowledge, a great vacation as workers suddenly develop a taste for extra leisure, or a great rusting as the speed at which oxygen corrodes accelerates, reducing the value of large things made out of metal.

But modern macroeconomists will also say that all these models strike them as implausible stories that are not to be taken seriously. Indeed, according to Kocherlakota, nobody really believes them.: “Macroeconomists use them only as convenient short-cuts to generate the requisite levels of volatility” in their mathematical models.

This leads me to ask two questions:

First, is it really true that nobody believes these stories? Ed Prescott of Arizona State University really does believe that large-scale recessions are caused by economy-wide episodes of forgetting the technological and organizational knowledge that underpin total factor productivity. One exception is the Great Depression, which Prescott says was caused by real wages far exceeding equilibrium values, owing to President Herbert Hoover’s extraordinary pro-labor, pro-union policies.

Likewise, Casey Mulligan of the University of Chicago really does appear to believe that large falls in the employment-to-population ratio are best seen as “great vacations” – and as the side-effect of destructive government policies like those in place today, which lead workers to quit their jobs so they can get higher government subsidies to refinance their mortgages. (I know; I find it incredible, too.)

Second, regardless of whether modern macroeconomists attribute our current difficulties to causes that are “patently unrealistic” or simply confess ignorance, why do they have such a different view than we economic historians do? Regardless of whether they have rejected our interpretations and understandings or simply have built or failed to build their own in ignorance of what we have done, why have they not used our work?

The second question is particularly disturbing. After all, economic theory should be grappling with economic history. Theory is crystallized history – it can be nothing more. Someone observes some instructive case or some anecdotal or empirical regularity, and says, “This is interesting; let’s build a model of this.” After the initial crystallization, theory does, of course, develop according to its own intellectual imperatives and processes, but the seed of history is still there. What happened to the seed?

This is not to say that the macroeconomic model-building of the past generation has been pointless. But I do think that modern macroeconomists need to be rounded up, on pain of loss of tenure, and sent to a year-long boot camp with the assembled monetary historians of the world as their drill sergeants. They need to listen to and learn from Dick Sylla about Alexander Hamilton’s bank rescue of 1825; from Charlie Calomiris about the Overend, Gurney crisis; from Michael Bordo about the first bankruptcy of Baring brothers; and from Barry Eichengreen, Christy Romer, and Ben Bernanke about the Great Depression.

If modern macroeconomists do not reconnect with history – if they do not realize just what their theories are crystallized out of and what the point of the enterprise is – then their profession will wither and die.

Yesterday's podcast carried Barack Obama's full statement on the Financial Products Safety Commission. Here is another take from Richard Wolf

Why is this country so hostile to users of consumer financial products?
from New Deal 2.0
by Richard Wolf
October 11, 2009

This country’s economy is predicated on individual consumerism. Indeed, with America’s 217 million adults and 116 million households, individual consumption represents as much as 70% of this country’s economy. Consumerism creates jobs. Individual households thrive when jobs are aplenty, and the country prospers when households thrive.

Much of that consumption is supported by consumer loans in the form of home mortgages, home equity lines of credit, auto loans, student loans, and of course, ubiquitous credit card loans. There is nothing intrinsically bad or dangerous about credit as long as it is used wisely and prudently. People would not want to return to the ‘good old days’ when one could only purchase a big ticket item like a house or car after saving a satchel full of cash to pay for it. Consumer credit facilitates the modern economy. (In fact, in the past bankers used to even call consumer loans ‘credit facilities’.)


Unfortunately, the market for consumer credit products is broken. It is broken because consumers lack trust and confidence. The system is unnecessarily complex and opaque. Loan agreements now consist of incomprehensible fine print and legalese burying a wide assortment of potential tricks and traps. While lenders offer low teaser rates to win more market share, they hide the numerous fees and practices, their real profit-makers, in the fine print — where the consumer can’t find or understand them. Consumers are unable to easily compare products or choose the ones with the lowest cost or lowest risk. “Financial innovation” now centers around the invention of new incomprehensible fees rather than better serving consumer preferences.

Because the true cost of credit is now so badly distorted, consumers use too much credit. And the government’s approach to oversight is presently unwieldy, complex, costly, and ineffective. This has resulted in a consumer credit market that is broken, dangerous, and, because left unchecked, has greatly contributed to the current economic meltdown.

Fortunately, this situation may be about to change. There is an initiative being debated in Congress to establish a Consumer Financial Protection Agency (CFPA). The CFPA would be a dedicated advocate for users of financial products in this country. Its scope would encompass consumer financial products and services including selling practices, advertising and underwriting. It would establish minimum federal standards by product, so consumers could compare various offerings more easily and have confidence in their decisions. Lenders would all face the same set of guidelines and disclosure rules. They wouldn’t be able to escape regulation by changing their corporate charters, geographic location, or regulatory supervisor as is the case now.

America’s Consumer Product Safety Commission has long been established and has the authority to develop uniform safety standards for physical products, order the recall of unsafe products, and ban products that pose unreasonable risks. This is similar to the FDA’s authority over food and pharmaceuticals. It is long overdue for John Q. Public to have uniform protection and standards for financial products.

A CFPA would concentrate the review of financial products in a single location but would not limit competition among lenders. Lenders would still evaluate risk, set prices, and design marketing campaigns and activities. However, a CFPA would focus primarily on expanding consumer safety rather than corporate profitability.

Unfortunately, there is an oft unstated fact that financial transactions are far riskier for consumers today than even a mere ten years ago. As complexity and opacity have increased with these financial products, with the advent of practices like immediate cross default, penalties with no notice, myriad nuisance fees, and the devilish practices of double-cycle billing, and with the evolution of a much smaller safety net, consumers are much less secure than they once were. Consumers need — and deserve — an advocate and a level playing field.

Our forecast has not changed over the past six months, so we have not drawn too much attention to it. Today we will, along with an explicit description of the current state of the economy and the obstacles to a complete recovery. Forecast: Stagnation. Currrent State: Failing. Obstacles: Continued Fed Obtusess, Unwillingness to pay bills in cash, and the Meanness that arises from a general Me-ness.

We will expand from these brief descriptions in the forecast section of today's podcast.

Later we will dig a bit deeper into the Fed on Idiot of the Week, and we have comment on the Taylor Rule and other nonsense, taking off from Paul Krugman.

First, though, complete and unedited, the statement by Barack Obama on the Financial Products Safety Commission. We view this new regulatory body as essential to moving out of the current case of market domination by big banks and bad practice.

As we've said before, this is a non-intrusive means of regulation. This has nothing to do with audits, pay restrictions, capital requirements, or any of your back rooms. One must ask Why the big banks have marshaled their money and purchased representatives in opposition to such a bill. As I said, it is not intrusive. One is examining products, not producers. Legitimate real economy firms welcome such consumer safety regulation as a way of weeding out the less competent and presumably less well-funded and at the same time increasing confidence among purchasers.

We suspect that it is precisely because such a financial products safety commission would bring order to the market and prevent exploitation by the well-positioned that it is being resisted by those well-positioned. And we are extremely pleased that Obama has invested political capital in this venture. Here he is, beginning with a calling of the roll.

OBAMA

Barack Obama

If nothing else, the current crisis has demonstrated how thoroughly the financial sector has captured its main regulator, the Fed. This new agency is an important escape from that corrupt arrangement.

Now. The Forecast.

First let's line up the opposition.

The consensus of economists suggests recovery proceed before too long into an equilibrium of high unemployment and lower trend growth, what I will a recovery, that is, slight improvement, into stagnation. Not a V-shaped, not a W-shaped, but a square root shaped -- down, up and out at a lower level.

This is mistaken because of the stable tail.

Another camp, primarily at the Fed, predicts a somewhat stronger rebound and posits a danger, even mortal danger, from an inflation arising from the need to unwind the Fed's injections of liquidity with a fire hose.

These guys have long been clueless and serve only as powerfully placed voices standing ready to sabotage any real recovery in the real economy.

The true context for policy is an economy that is highly fragile and posed for another leg down. The financial sector is a millstone, the zombie banks are hardly rowing, and the prospect of further weakness in residential and commercial real estate and continued negative contributions from derivative and commodity speculation are already on the charts.

Specifically, zombie banks are profitable because they are gouging consumer credit users, playing in commodity and futures casinos, and eating the interest payments from the toxic securities which are still on their balance sheets. The financial sector is not enabling productive investment activity because they don't have to. They have the government. Besides, the prospect of profit from new investment in the context of overcapacity and a retreating consumer is very low.

Aside from propping up the zombie banks and other formerly private sector markets, the Fed's policy has done nothing. There are no more bubbles to blow up, even at zero percent, that will generate private investment. No more high tech booms, no more residential housing booms, no more commercial real estate booms. There are only financial market casinos to play in. Fine if you have the zero percent chips and are playing with the house, but for people looking for productivity in the real economy. Not so much.

The only route to real recovery and a return to strong growth is through the Demand Side. Only with a renewed job market and a recovery of incomes can we escape the blunders of the past few decades. As we've said, this demand side recovery does not need a return to the consumer economy. The consumer economy, after all, was premised on borrowing and the idea of selling houses back and forth to each other. Consumer baubles large and small were the end point of this economy.

The public goods of infrastructure, education, public health and climate change mitigation are ample and productive occupations that can support prosperity. As incomes grow, the overcapacity of the private sector will shrink. But more to the point for private investment, a new emphasis on public goods opens new industries where there is currently NO overcapacity and where new investment would not be redundant. (To be clear for the simple, spending on public goods is income to private economic actors, whether employees or contractors.) These types of industries are very much not currently dominated by foreign industry. Health care, education, domestic infrastructure, energy retrofitting, reengineering transportation and energy and information infrastructure. All domestic activities. All productive activities, in that they generate improvements in the productive framework. These are not BMW's or flat screen tvs or perfume in one hundred dollar bottles.

Three main obstacles are likely overwhelming, however.

1. Fed intransigence in its error.
2. Political opposition to paying cash for public goods, and
3. A social psychology which believes the good of the whole is code for taking away from me.


The Demand Side way out is really the only way out. And that's why we've outlined it here in the context section. Insofar as the path diverges from this prescription, and by the same dimension, it will be a reduction from the optimal outcome.

The three main obstacles are likely overwhelming, however.

Demand Side is not revolutionary in the sense it is new or complicated, but only because it is fundamentally separate from these errors.

Oh, and four, such a solution likely means inflation in non-core commodities like energy and food. That is because any investment-led growth would mean inflation, as we read Minsky. No less investment-led growth tied to public goods. In the early stages, such inflation would be very mild. In every stage it could be controlled by tax policy -- by reducing inflationary demand via increases in taxes. (This would make sense in that we have bills to pay, but see below.)

But lets go back to one through three.

One, the Fed stands ready to kill any recovery with monetary policy. We have hammered the Fed elsewhere and we have debunked the effectiveness of monetary policy relentlessly. We will do it again next week, but soon we will begin to leave them alone, not because they are unimportant or are gaining a new comprehension, but because they are hopelessly wedded to their doctrines.

Two, Consumer and mortgage credit inflated the housing bubble. It may take public borrowing to create the public goods that can lead us forward. But not because it is necessary or advisable, only because it has been one of the signal successes of the Rovian or Reagan Right to turn the word "taxes" into a synonym for "incest." Since taxes are the way we pay for public goods in the absence of deficit spending, the prospect of paying outright is diminished. One of the continuing marvels of this age is that the non-results from tax cutting fevers have been ignored. The rhetoric continues that cutting taxes will lead us to water even as we go further into the desert.

Three. The Me culture. To some extent "Don't tax me" is a function of this broader "Me" culture. The focus on consumerism and the consumer is also a function of this "Me." And the resistance, as before, to strengthening the whole is very often an affirmation that what is mine is what is most important.

In previous generations, the influence of and dependence on family was felt strongly. Community was essential. "Me" was impolite, at best. The religeon of primitive economics is 180 degrees divergent. Greed is good. Getting what I can is not only all right, it is of positive benefit to everyone. Beliefe that strong community, stable environments, planning, and public goods produce a positive sum game is viewed as dangerously naive. So we keep digging.


All Right. All right. Forecast.

Yes, if you've noticed, we've drawn back in from DemandSide dot net to get more proprietorial. We've decided if we're going to be right, we should look into getting paid for it. Nevertheless, we'll be dropping those charts back onto another vehicle soon, for those of you who have been cribbing off our work.

Forecast continued recession.

The happy talk on Wall Street of recovery is based on a definition of recovery as two successive quarters of positive GDP growth. This is, of course, not a very sophisticated description of the economy, and it is not the formula used by the NBER when they make their official determination. If it were, they wouldn't need twelve months. It is our belief that even considering the strong political winds now blowing in favor of quote recovery unquote and the flimsy increase in activity that is needed to justify such a determination, the NBER will not be persuaded to declare recovery in the same quarter as rising unemployment and continued industrial stagnation.

Our Demand Side descriptions are not recovery and recession, which have peculiar and not well understood technical definitions, but on the three levels of failing, weak and strong economies. The current situation is failing.

We have the stimulus and recovery potential of the Recovery Act on one hand. On the other, we have the negative stimulus of no private investment and contracting state and local governments.

Specifically, real GDP growth will be somewhat volatile around zero. Nominal GDP volatile around 1.5. Unemployment in the narrow measure will continue to trend upward into 2010. Unemployment in the broad U-6 measure will go up less quickly than it has over the past 18 months, but at a steeper slope than the narrow measure.

We have a idiosyncratic measure called Net Real GDP, which is essentially GDP minus the federal deficit needed to make it happen, that will continue to decline. That will likely be our first chart up on the new site.

Demand Side does not see forecasts as a crap shoot, which is the consensus view, but as the evidence of understanding. Neither do we put stock in precision. Better to be approximately right than precisely wrong, as John Maynard Keynes said. Nor do we see economic outcomes as independent of policy choices. All of which creates a different platform than the typical statistical model based forecasts.

(We notice Ellen Zentner, a chief advocate of "The recovery began in June" camp, reserves the right to tweak forecasts up to the day before the next official data come out. This displays sensitivity to statistical trends, but not really forecasts.)

So, having been right, we will continue to tell you about it until we are wrong. Not a V. Not a W. Not a square root. There is upside, but not until the employment situation has been fully addressed and the drag from the financial sector's systemic meltdown is cut away. There are upturns on the charts, and strong ones, but these depend on policy choices not yet made. Until then, it is the Great Stagnation, with a distinct risk of another leg down.

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From the beginning, the New Deal's Home Owners Loan Corporation (HOLC) was the appropriate model for dealing with teh fall in home values. Share the problem of bubble purchases between borrowers and lenders rather than force borrowers into foreclosure.

Protecting the lenders has been the preferred approach. Of course, the appropriate solution is fouled to some extent by the securitization of mortgages, which constructs legal Rubic cubes out of straightforward mortgages. But returning to the one-on-one coordination that will keep borrowers in their homes, their mortgages close to market prices, and the flow of payments continuing is the only effective way to keep the housing collapse from dragging down the economy for the next decade.

Here from the New York Times is an assessment of the latest attempt to finesse the essential write-down of principle.

Panel Says Obama Plan Won’t Slow Foreclosures
October 10, 2009
New York Times

By PETER S. GOODMAN

A day after the Obama administration proclaimed significant progress in its effort to spare troubled homeowners from foreclosure, an oversight panel on Friday sharply criticized the program and declared it would leave millions of Americans vulnerable to losing their homes.
In a report mild in language but pointed in substance, the Congressional Oversight Panel — a watchdog created last year to keep tabs on taxpayer bailout funds — said the administration’s program would, “in the best case,” prevent “fewer than half of the predicted foreclosures.”
The report rebuked the administration for failing to shape a program that addressed the most significant engines of the foreclosure crisis — soaring joblessness and exotic mortgages with low introductory interest rates that give way to sharply higher payments over the next three years. Many of those mortgages are too large to qualify for modification under the administration’s plan. People who lose their jobs often lack enough income to qualify for relief.
The administration’s plan appears “targeted at the housing crisis as it existed six months ago, rather than as it exists now,” asserted the oversight panel in its report. “The panel urges Treasury to reconsider the scope, scalability and permanence of the programs designed to minimize the economic impact of foreclosures and consider whether new programs or program enhancements could be adopted.”
In a telephone briefing with reporters, the oversight panel’s chairwoman, Elizabeth Warren, said the administration’s housing program was so limited that it was unlikely to keep pace with the growing wave of foreclosures.
“Even when Treasury’s programs are running at full speed, foreclosures are estimated to outpace modifications by about two to one,” Ms. Warren said. “It simply isn’t clear that the programs in place will do enough to tame the crisis and have a significant impact on the broader economy.”
The Treasury acknowledged that its anti-foreclosure program was limited, with the effect of rising unemployment not fully checked. But the department said other relief efforts, like extended jobless benefits and continued health insurance for people who lose work, were better suited to alleviating economic distress than the housing program.
“In developing this program, it was critical that we address challenges that could be solved quickly with the tools available to us to ensure the most effective use of taxpayer money,” said Meg Reilly, a Treasury spokeswoman.
The administration’s decision to limit the cost of its one program aimed at helping homeowners could become more contentious as the foreclosure crisis grinds on. Populist anger has flashed over the rescues of major institutions including Citigroup and the American International Group — the most prominent components of a $700 billion taxpayer-financed bailout — while homeowners struggle.
“These Treasury people are all from Wall Street, and they’re not doing anything but protecting Wall Street,” said Melissa A. Huelsman, a Seattle lawyer who represents homeowners fighting foreclosure. “They don’t care in the least about protecting homeowners.”
When the Obama administration began its $75 billion Making Home Affordable program in March, it said the plan would spare as many as four million households from foreclosure. On Thursday, Treasury announced that 500,000 homeowners had since had their payments lowered on a trial basis, celebrating this as a milestone.
But the report from the oversight panel directly challenged the administration’s characterizations.
Most prominently, the panel had grave uncertainty about whether large numbers of the trial loan modifications — which typically run for three months — would successfully be converted to permanent terms.
As of the beginning of September, only 1.26 percent of trial modifications that had made it through the three-month trial period had become permanent, the report found. Of course, very few of those trial loans had reached their three-month expiration because the program only recently began processing large numbers of applications. As of Sept. 1, the Obama plan had produced 1,711 permanent loan modifications.
Some homeowners complain they have received trial modifications only to have them canceled for what seem dubious reasons — checks sent but supposedly never received, documents once in the file but suddenly missing.
“We’re on the phone arguing with mortgage companies every day,” said Dan Harris, chief executive of Home Retention Group, a company that negotiates with mortgage companies for loan modifications on behalf of homeowners, adding that trial modifications for four of his clients had been canceled over the last month. “It’s incredible.”
Major mortgage companies say they have significantly increased staffing to better manage the flow of paperwork, while notifying customers of the need to send in fresh documents to make their trial modifications permanent. But the companies offer no assurances that a large number of trial modifications will indeed become permanent.
“The process is too new,” said Dan Frahm, a spokesman for Bank of America. “We don’t know the number.” He estimated that 15 percent to half of all trial modifications would fail to become permanent.
The Treasury expressed hopes that a newly streamlined process that allowed borrowers to submit documents to mortgage companies more easily would help make large numbers of trial modifications permanent.
“We are intent on working with servicers to ensure that eligible borrowers receive permanent modifications,” said the department spokesperson, Ms. Reilly.
The oversight panel’s report expressed chagrin that the vast majority of loan modifications did not lower loan balances, leaving many homeowners still “under water,” or owing more than their homes were worth.
This tends to lower all property values, the report noted, because underwater borrowers have less incentive to care for their homes, and greater reason to stop making payments and default.
An Obama administration official who spoke on condition of anonymity, citing a lack of authorization to speak publicly, said the Treasury would have preferred that the program focused more on writing down principal balances but ultimately opted against it because “that would make it significantly more expensive to the taxpayer.”
In Wauwatosa, Wis., Theresa Lutz, 47, has been seeking to lower the payments on her home for several months. She is a graphic designer whose working hours were cut last summer. In September, her employer cut her salary by 6 percent. That has made it difficult for her to pay her monthly mortgage of $1,307.
As Ms. Lutz described it, her mortgage company, Wells Fargo, initially agreed to lower her payments. But then, last week, the bank informed her that she would have to come up with a fresh $3,000 to compensate the investor who owned her loan.
A Wells Fargo spokesman, Kevin Waetke, said that information had been conveyed “in error” and “the customer has been notified that payment does not need to be made.”
As Ms. Lutz struggled to clarify her agreement with Wells Fargo, she expressed dismay at news of the oversight panel’s report, and its finding that not enough help seemed to be on the way.
“It looks to me like Wall Street is too invested in our government,” she said. “Big business is winning out over the average person.”

Economists make themselves almost as ridiculous when they suggest recovery in the middle of the recession as when they fail predict a recession or bubble when it is already in progress. The recession is not abating. As described by standard economics, perhaps it is, since these numbers concentrate on monetized activity, which surely is increased artificially by government spending. But fundamentally, the economy has stabilized in a "failing" stage. Stabilized by the Recovery Act, but not having escaped the gravitational pull of the financial system's collapse.

This piece from EPI demonstrates the current bad state. Until this number is cut in half, the economy has not recovered.

Number of job seekers per available job continues steep climb

By Heidi Shierholz
October 9, 2009
Economic Policy Institute
While the gradual moderating of job loss is a very welcome sign, it is nevertheless getting harder every month for job seekers to find a job as more people continue to become unemployed and openings for new jobs continue to drop.
This morning, the Bureau of Labor Statistics released the August report from the Job Openings and Labor Turnover Survey (JOLTS), which showed that job openings decreased by 21,000 to 2.4 million in August. At the same time, the number of unemployed workers increased by 466,000 to 14.9 million. Thus there were 12.5 million more unemployed workers than job openings in August, or 6.3 job seekers per available job (see Figure). This was up from 6.0 in July. Importantly, the ratio of job seekers to job openings does not include job seekers who are currently employed but looking for work due to a lack of job security in their current position, so the ratio actually understates the number of job seekers who are competing for each job opening.



Between December 2007 and August 2009, the number of job openings declined by 2 million, or 45.5%. However, thanks to the American Recovery and Reinvestment Act, the declines are slowing—from September 2008 to March 2009, the losses averaged 156,000 per month, but from June 2009 to August 2009, the losses averaged less than a third of that, at 45,000 per month.
Although unemployment numbers for September became available last Friday, JOLTS data are released with a one-month lag. However, given last Friday’s announcement that unemployment increased by 214,000 in September, the number of job seekers per job opening was almost certainly at least 6.3 in September. While layoffs are abating, until employers start posting jobs and hiring again, finding employment will continue to be very difficult for the millions of jobless workers in this country.