1950. How a Debt Crisis Is Drowning Puerto Rico

By Daniel Orsini, socialistworker.org, July 22, 2015

PUERTO RICO'S Gov. Alejandro García Padilla has declared the island's $72 billion debt "unpayable" and is calling on the U.S. government and Puerto Rico's creditors to negotiate debt relief and other measures to restore Puerto Rico's economic viability.

In a Western Hemisphere replay of the debt crisis strangling the Greek economy, attempts by Puerto Rico's government to stabilize its economy through a combination of harsh austerity measures and further borrowing has created a vicious circle that chokes off economic growth, which only makes the debt overhang bigger.

Among the cutbacks and other measures imposed by Garcia's Popular Democratic Party (PPD), which is aligned with the Democratic Party in the U.S., are massive closures in the public school system; a sales tax increase from 7 to 11.5 percent; the rollback or elimination of public-sector pensions; cuts in teachers' health care benefits; an increase in the tax on a barrel of oil from $9.25 to $15.50; and steep increases in water and electricity bills.

Puerto Rico's gross national product has fallen on average by 2 percent each year for the last eight years. Some 270,000 jobs have been eliminated. The rapid deterioration in Puerto Rico's economic climate led 140,000 residents to flee the island in 2014 alone.

The government's austerity measures amount to an all-out offensive in the war against all working class people in Puerto Rico. But make no mistake: the colonial government is merely a "front man" for Corporate America and the wolves of Wall Street, which have been extraordinarily successful at compelling a string of governors to implement various neoliberal packages during the past two decades.

Puerto Rico's Shock Doctrine

The year was 1993, and the pro-statehood New Progressive Party (PNP), which is aligned with the U.S. Republican Party, was in power. The governor, Pedro Rosselló González, was the most extreme neoliberal voice the island had ever experienced. He was our native Ronald Reagan, our Margaret Thatcher. With an iron fist, he implemented dramatic changes in the colonial government and society.

One of his first laws, known as "Mano dura contra el crimen" ("Strong hand against crime")--led to the occupation of poor and working-class barrios and projects by the National Guard and militarized police. Cops set up checkpoints at the entrances and exits of targeted communities and, from these strategic strongholds, directed a campaign of brutality, harassment and intimidation against thousands of individuals and families throughout the island. The government's decapitation of the chief organized crime syndicate in Puerto Rico created one of the bloodiest gang wars ever seen, as various players vied for control over the suddenly headless drug trafficking business.

Puerto Rico used to have a relatively robust public-health system that depended on infrastructure all across the island. It was fairly accessible and affordable. If a person got sick, he or her could simply go to the hospital and get treated--no insurance card needed. But Gov. Rosselló privatized the whole system.

He did that by selling off hospitals at almost half their market value and issuing the island's residents private insurance coverage paid for out of public revenue (something like Obamacare). Nowadays, the Puerto Rican health system is on the edge of collapse. Doctors are fleeing the island, which is further raising the cost of health care, and the government's constant scramble to keep up with its health care bills has the entire system sinking in quicksand.

In 1998, the PNP government privatized what used to be one of the island's wealthiest public corporations: Telefónica de Puerto Rico (Puerto Rico Telephone). Telefónica's militant unions waged a fierce battle to maintain the company as a public asset, enjoying active solidarity from many unions in both the public and private sectors, as well as university students and the public generally.

The telephone workers organized a 41-day strike that became known as "La Huelga del Pueblo" (The People's Strike) because it inspired the participation of thousands of people across the island and beyond, including a two-day general strike and dozens of direct actions and work stoppages at various strategic workplaces. But it still wasn't enough. A heavily repressive governmental response defeated the strike and paved the way for privatization of the Telefónica.

In 1999, Rosselló cut $40 million from the University of Puerto Rico's budget. He was now on the offensive, and no social movement seemed capable of stopping him.

His administration also passed "Ley 40" (Law 40), which represented a broad attack on the rights of public-sector workers. In 2008, the governor used the provisions of that law, which made it illegal for teachers to go on strike, to decertify the grassroots Federación de Maestros teachers union after a 10-day strike.

Rosselló wasn't the first or the only governor to implement neoliberal policies, but until he took power, no one had done it so effectively or widely. Rosselló's neoliberal "reforms" contributed $10 billion of debt to the current $72 billion debt crisis.

After Rosselló's rule, the PPD won the next two gubernatorial elections, and continued to advance the neoliberal agenda, but in a more populist fashion. During the first two weeks of May 2006, the island government shut down because the executive branch controlled by the PPD and the House and Senate dominated by the PNP couldn't agree on which form of regressive taxation to implement in order to balance the budget.

The PPD preferred a value-added tax, which is a common form of taxation in Latin America, while the PNP preferred a U.S.-style sales tax. The successive PPD administrations of Sila María Calderón Serra, the first woman elected governor of Puerto Rico, and Aníbal Acevedo Vilá added to Puerto Rico's debt by $13.3 billion and $10.1 billion, respectively.

When the PNP returned to power in 2009, Gov. Luis Fortuño Burset quickly became a contender for Pedro Rossello's legacy as the island's foremost neoliberal heavyweight. Fortuño was a card-carrying member of the U.S. Republican Party and public admirer of Milton Friedman. He held up Ronald Reagan as the best president in American history. With that pedigree, it wasn't difficult to envisage his plans for Puerto Rico.

During his four-year term, a two-month-long student strike shook the island to its roots. An $800 increase in student fees was the detonator for this historic struggle that led to the student occupation of all 11 campuses of the University of Puerto Rico. While public and private police forces meted out violence and repression, the students fought back--with street art, political strategy, ingenious solidarity campaigns and, of course, self-defense.

But Fortuño's greatest neoliberal legacy was the "Special Law Declaring a Fiscal State Emergency and the Establishment of an Integral Plan of Fiscal Stabilization to Save Puerto Rico's Credit." No one in Puerto Rico knew the law by this ridiculous name--we just called it "La ley 7" (Law 7).

Law 7 resulted in the dismissal of 30,000 public employees, the freezing of all collective bargaining agreements in the public sector, massive tax credits for corporations, and on and on. Law 7's shock waves still reverberate in the collective consciousness of the people of Puerto Rico.

Fortuño's contribution to the debt was the most generous of all--he added as much to the debt as the previous two PPD governors combined: $23.4 billion. By the time he left office, the debt of Puerto Rico stood at $70 billion.

Last but not least, the current neoliberal in the Fortaleza (the governor's mansion) is Alejandro García Padilla. He represents the PPD's most conservative wing and has distinguished himself through his poor leadership, his marriage of the interests of national and international capital, and his shameful acceptance of the notion of Puerto Rican "democratic self-government" under the terms of U.S. military occupation.

His victory in the 2012 election was based on the logic of "lesser evilism." A lot of independentistas (people who support Puerto Rico's political independence), nonpartisans and even the PNP's working-class militants joined together to defeat Fortuño's bid for reelection. But the honeymoon with García Padilla was short-lived. A few weeks after his inauguration, García Padilla consummated Fortuño's efforts to privatize the island's international airport.

The Greece of the Caribbean

Alejandro García Padilla's rule has coincided with the worst economic crisis in Puerto Rican history. For good reason, Puerto Rico is now known internationally as "The Greece of the Caribbean." Puerto Rico's debt is roughly $72 billion, which amounts to nearly 70 percent of GDP. Greece's debt stands at 177 percent of GDP.

Besides the difference in their debt proportions, there are other significant factors to take into account. Since 1898, the year that the U.S. Navy bombarded Puerto Rico and began the occupation that continues to the present day, the island's economy has existed to serve the military, political and economic interests of the North American empire. For example, Puerto Rico's imports more than 80 percent of its consumer goods. Want to guess where they come from? That's right: the United States of America.

And that's not all. The Jones Act passed by the U.S. Congress in 1920 requires that all shipping to and from U.S. ports be conveyed by U.S. vessels and crews. As Nelson Denis, author of War Against All Puerto Ricans: Revolution and Terror in America's Colony, explains in a recent blog post:

This includes cars from Japan, engines from Germany, food from South America, medicine from Canada--any product from anywhere. In order to comply with the Jones Act, all this merchandise must be off-loaded from the original carrier, reloaded onto a U.S. ship and then delivered to Puerto Rico. It all makes as much sense as digging a hole and filling it up again. This is not a business model. It is a shakedown. It's the maritime version of the "protection" racket.

As a result, Puerto Rico's imports cost at least twice as much as neighboring islands.

Added to this burden, Puerto Rico can't establish trade relations with other countries without U.S. permission. A few years ago, for example, former Venezuelan President Hugo Chávez offered Puerto Rico a generous deal that would have brought a steady flow of Bolivarian crude oil to the island on very favorable terms. It didn't take long for the U.S. Congress to forbid such an arrangement.

The structure of the debt itself also distinguishes Puerto Rico from Greece. Puerto Rico's lack of sovereignty means that it cannot secure loans from the International Monetary Fund or World Bank. As a result, its debt takes the form of lines of credit and bond issues traded on the open market. In June 2015, Fortune magazine reported that more than 50 percent of the island's debt is owned by the infamous vulture funds. According to the hedge fund watchdog site Hedgeclippers.org, the debt vultures have a take-no-prisoners strategy for the island:

Hedge funds and billionaire hedge fund managers have swooped into Puerto Rico during a fast-moving economic crisis to prey on the vulnerable island. Several groups of hedge funds and billionaire hedge fund managers have bought up large chunks of Puerto Rican debt at discounts, pushed the island to borrow more, and are driving towards devastating austerity measures. At the same time, they are also using the island as a tax haven...They are fueling inequality by demanding low taxes on wealthy investors, higher taxes on working people, lower wages, harsh service cuts and privatization of public schools...The spoils they ultimately seek are not just bond payments, but structural reforms and privatization schemes that give them extraordinary wealth and power--at the expense of everyone else.

But perhaps the starkest difference between Greece and Puerto Rico at the moment is the character of the ruling political party. The agreement of Greek Prime Minister Alexis Tsipras to a new round of austerity measures has left the people of Greece and the international left with a bitter taste of betrayal after the historic July 5 referendum against austerity. Yet trying to compare Tsipras' left-wing SYRIZA government with García Padilla's PPD government would be like comparing Chile's former President Salvador Allende with the general who overthrew him in a coup, Augusto Pinochet.

While SYRIZA members are arguing in workplaces and communities for social revolt against austerity, García Padilla commissioned former IMF official Anne Krueger to issue a report on the island's economic situation as well as to propose solutions to the debt crisis. In keeping with the IMF's record of further impoverishing poor countries around the world with its program of "structural adjustment," the Krueger report prescribes the same bitter medicine to "improve" Puerto Rico's health:

-- Restore competitiveness by lowering labor costs, including eliminating the federal minimum wage and other deregulation of labor markets;

-- Cut federal welfare payments because they are "too generous" relative to Puerto Rico's low wages;

-- Allow private companies to compete with the public sector in generating electricity while keeping public electrical transmission and distribution, which are the least cost-effective sectors of the energy industry;

-- Reduce subsidies for the University of Puerto Rico;

-- Cut Medicaid benefits in excess of minimum standards on the U.S. mainland.

If Puerto Rico decides to impose the utterly predictable economic policy proposals of an IMF veteran like Anne Krueger, the island will most definitely follow Greece's path toward an ever-greater debt crisis.

Fight Like a Greek

If the people of Puerto Rico, including those who have recently fled in search of a better life, don't want the island's destiny placed in the hands of vulture-fund managers, transnational corporations, the U.S. and its colonial puppet government, we must fight--as the Greek people have been for some years now.

The Puerto Rican left has been evolving and transforming itself in recent years, but it still has yet to congeal into any semblance of a coherent social force. At this juncture, different groups have been organizing assemblies to assess the current situation and call for the development of a social movement capable of reaching beyond the organized labor and student movements in order to challenge the austerity regime.

At the beginning of June, more than 100 young activists from across the island participated in a youth assembly. In July, there was a progressive artists assembly as well as a women's assembly. These meetings are taking place in the run-up to a rally outside the island's Capitol on July 24.

The Puerto Rican nation is made up of roughly 8 million Puerto Ricans; only 3 million currently live on the island, while a majority of the rest lives in the U.S. Any serious political contribution to challenging U.S. imperialism and neoliberalism and to fighting for independence and socialism on the island must base itself not only on Puerto Ricans living in the colony, but also those living in the belly of the beast.

1622. U.S. Oil Prices Fall Below $80 a Barrel

By Clifford Kraus, The New York Times, November 2, 2014 

Recent prices at the pump in
Chattanooga, Tennessee, Photo:
John Rawlston, NYT, via AP

HOUSTON — The benchmark American oil price fell below the symbolic $80-a-barrel threshold on Monday, swooning to two-year lows, after Saudi Arabia aimed to shore up its dwindling exports to the United States by cutting its selling price for the American market.

The Saudi move and the deepening fall in oil prices are both symptoms of the oil-drilling boom in the United States, which has lifted production by more than 70 percent over the last six years and reduced the nation’s imports from OPEC producers to roughly half of what they once were.

The lower oil prices are bringing relief to consumers at the pump in time for the holiday shopping season. The national average price for regular gasoline has fallen below $3 a gallon for the first time in four years, and experts say it could easily drop 25 cents more over the next month.

A sustained drop in oil prices could also eventually affect investments in domestic drilling. Most analysts do not think the rise in domestic oil production — an increase totaling more than a million barrels a day over the last year alone — will be interrupted anytime soon unless the American benchmark drops to $70 a barrel and stays there for several months. Then less efficient or highly indebted smaller producers would probably have to slow drilling in at least some fields.

1618. How the Housing Crisis Originated and Why Another Crisis Is in the Making: The Mainstream Views

By Eduardo Porter, The New York Times, October 28, 2014

Is it time to temper the American dream of homeownership?

If you want to curb the power of Wall Street and reduce the risk that the financial system will bring the rest of the economy tumbling down again, there may be no other choice.

Consider what happened last week, when regulators pretty much threw in the towel on new rules requiring mortgage bankers to keep on their books a minimum share of all but the safest loans.

The idea was perfectly reasonable — a way to keep bankers’ “skin in the game” to encourage prudence. In the end, however, officials decided that just about all mortgages were supersafe. No need for banks to keep a chunk.

“The loophole has eaten the rule,” Barney Frank, the former chairman of the House Financial Services Committee and co-author of the Dodd-Frank financial overhaul, told my fellow columnist Floyd Norris last week. “There is no residential mortgage risk retention.”

Phillip L. Swagel, an economist at the University of Maryland who was an assistant secretary of the Treasury under George W. Bush, called the decision simply “perplexing.”

The reason for the about-face, though, is not exclusively, or even mainly, the formidable power of the Wall Street lobby. The ability of the financial industry to fend off attempts to hem it in also relies on an argument that is difficult for outsiders to refute: We cannot live without it.

Unable to determine the risk that finance imposes on the broader economy, voters — and the politicians they put in office — have a strong incentive to give the industry a pass.

“What is the cost of a crisis I don’t prevent against what is the cost to tame finance?” asked Alan M. Taylor, an economist at the University of California, Davis. “We’ve only been thinking about this for a short time.”

Mortgage lenders dodged the proposed rule by joining homebuilders and advocates of low-income homeownership to convince hundreds of lawmakers that defining supersafe mortgages as those with significant down payments would curtail mortgage lending to the struggling middle class and poor.

That argument, while only partly related to the notion of requiring lenders to have skin in the game, pretty much stopped a central tenet of financial reform.

The breakneck growth of our modern banking system closely tracks the rise of the long-term home mortgage. A recent study by Professor Taylor, Òscar Jordà of the Federal Reserve Bank of San Francisco and Moritz Schularick of the University of Bonn found that mortgage lending across the industrialized world rose from the equivalent of 20 percent of annual economic activity at the start of the 20th century to about 69 percent in 2010.

In 1928, mortgages accounted for 39 percent of American banks’ lending to nonfinancial private companies. By 2007, on the eve of the financial crisis, the share was 68 percent.

“The changing nature of financial intermediation has shifted the locus of crisis risk towards mortgage lending booms,” the authors wrote. Financial reform that gives mortgages a pass is not going to cut it.

Most Americans have an interest in being able to obtain a reasonably priced mortgage. But there is a fundamental tension between Wall Street’s interests and those of the rest of us.

Financial institutions will naturally prefer to take more risks. After all, for them risk-taking has historically carried a lot of upside and, with taxpayer funds as the ultimate backstop, only a limited downside. Ordinary people have a very different experience.

“Financial deregulation is similar to relaxing rules on nuclear power plants,” argue Anton Korinek of Johns Hopkins University and Jonathan Kreamer of the University of Maryland in a working paper for the Bank for International Settlements. It makes it easier and more profitable for the utilities, their shareholders and executives. It might also help ordinary Americans get cheaper electricity. “However, it comes at a heightened risk of nuclear meltdowns that impose massive negative externalities on the rest of society.”

Tightening mortgage rules would no doubt make it more difficult to buy and sell homes. It would lead to more renters and fewer homeowners.

That might be worth it, though. Germany is doing fine with a homeownership rate of 45 percent, compared with about 65 percent in the United States, which is actually down from a peak of near 70 percent in 2004.

The Explosion of Mortgage Finance

Mortgage lending has led the growth of the financial system since World War II, according to a new study of 17 industrialized nations, including the United States and most of Western Europe.

Sheila C. Bair, who ran the Federal Deposit Insurance Corporation throughout the buildup of the mortgage bubble and its implosion, argues that a policy of pushing mortgages for every American family is hardly ideal.

“There is this religion about homeownership being the primary path to wealth accumulation — notwithstanding the bad experience we’ve had with it,” she said.

Indeed, in an uncertain economy with so little job security, it makes less sense for policy to encourage workers to lock themselves into mortgages. Even when homeownership is the right call, “I don’t think low-income people should be in private-label subprime mortgages,” she added. That is what the Federal Housing Administration is for.

Yet this is a Rubicon that our elected officials are afraid to cross. “On the margin, regulation does increase the cost of credit in the good times,” Ms. Bair said. “Regulators are battling a political system that wants to let the good times roll.”

Still, many experts say Washington is at least moving in the right direction. “Regulations are putting the system in much better shape than it was,” said Douglas J. Elliott, a former banker at J. P. Morgan who is now at the Brookings Institution in Washington.

This is not merely a self-serving, American view. Across the Atlantic, John Vickers, a professor at Oxford and the former head of Britain’s Independent Commission on Banking, agrees. “I wish there had been greater steps,” he said. “But major steps have been made toward a less fragile system.”

Is this enough to close the gap between Wall Street’s unbridled appetite for risk and the broader public interest?

Recent research suggests the growth of credit increases the odds of a financial crisis. Researchers have also found little evidence that more finance brings faster growth to industrialized nations.

The problem is, as long as we can’t precisely measure the cost of financial excess, we will be prone to believe that the financial industry is simply too fragile to be meddled with.

And with growth disappointing in just about every developed country, many people may be willing, even eager, to roll the dice again.

Despite all the new efforts at regulation, Ariell Reshef of the University of Virginia noted, “there’s maybe a slowdown in the growth of finance, but not a reversal.”

In a study published last year, Professor Reshef and Thomas Philippon of New York University concluded, “If finding more growth opportunities becomes ever harder with development, then a larger financial output and a larger share of income may be needed to sustain growth.”

Professor Vickers cited another paradox. “Ironically, the macroeconomic damage done by the crisis shows how important a well-functioning banking sector is,” he said.

The question is whether our banking sector is well functioning.

*     *     *

By Peter J. Wallison, The New York Times, October 30, 2014

WASHINGTON — SEVEN years after the housing bubble burst, federal regulators backed away this month from the tougher mortgage-underwriting standards that the Dodd-Frank Act of 2010 had directed them to develop. New standards were supposed to raise the quality of the “prime” mortgages that get packaged and sold to investors; instead, they will have the opposite effect.

Responding to the law, federal regulators proposed tough new standards in 2011, but after bipartisan outcries from Congress and fierce lobbying by interested parties, including community activists, the Obama administration and the real estate and banking industries — all eager to increase home sales — the standards have been watered down. The regulators had wanted a down payment of 20 percent, a good credit record and a maximum debt-to-income ratio of 36 percent. But under pressure, they dropped the down payment and good-credit requirements and agreed to a debt-to-income limit as high as 43 percent.

The regulators believe that lower underwriting standards promote homeownership and make mortgages and homes more affordable. The facts, however, show that the opposite is true.

In the late ’80s and early ’90s, down payments were 10 to 20 percent. The homeownership rate was 64 percent — about where it is now — and nearly 90 percent of housing markets were considered affordable (that is, home prices were no more than three times family income). By 2011 only 50 percent were considered affordable, and by 2014, just 36 percent — even though down payments as low as 5 percent are now common.

How could this be? Consider this: If the required down payment for a mortgage is 10 percent, a potential home buyer with $10,000 can purchase a $100,000 home. But if the down payment is dropped to 5 percent, the same buyer can purchase a $200,000 home. The buyer is taking more risk by borrowing more, but can afford to bid more.

In other words, low underwriting standards — especially low down payments — drive housing prices up, making them less affordable for low- and moderate-income buyers, while also inducing would-be homeowners to take more risk.

That’s why homes were more affordable before the 1990s than they are today. Back then, when traditional standards for “prime” mortgages prevailed, homes were smaller; they had fewer bathrooms, and the kitchens were not appointed by Martha Stewart. A family could buy and live in a “starter home” for several years before selling it and using the accumulated equity to buy a bigger or better appointed home.

In a competitive housing market not subsidized by lax standards, home builders would similarly adjust by reducing the size and amenities of new homes to meet the financial resources of home buyers entering the market. Home prices would stabilize and not rise faster than incomes. Low- and moderate-income families and millennials might have to wait to save for a first home, but they would be able to afford it.

If the government got out of the way, would sound underwriting standards come back? History suggests yes. Although Fannie Mae and Freddie Mac were government-backed, they were shareholder-owned, profit-making firms. They adopted strong underwriting standards to avoid the credit risk of subprime and other high-risk mortgages. But after Congress enacted affordable-housing goals, administered by the Department of Housing and Urban Development, in 1992, underwriting standards declined.

Republicans generally favor eliminating the government’s role in housing finance, while Democrats worry that without government support, mortgages would be too expensive for low- and moderate-income families. Although it runs counter to the current Washington view, good underwriting standards can satisfy the objectives of both parties.

It’s clear that today’s policies create winners and losers. The winners include real estate agents and home builders, who want to increase borrowing and sell ever-larger and more expensive homes. The losers, as we saw in the financial crisis, are borrowers of modest means who are lured into financing arrangements they can’t afford. When the result is foreclosure and eviction, one of the central goals of homeownership — building equity — is undone.

After the financial crisis, Representative Barney Frank — the Massachusetts Democrat who led the House Financial Services Committee during the crisis, and a champion of credit programs for low-income buyers — admitted, “It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.” Policy makers who support homeownership would be wise to consider who is hurt and who is helped when we abandon traditional underwriting standards.

Peter J. Wallison, a senior fellow at the American Enterprise Institute, is the author of the forthcoming book “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again.”

1587. Book Review: The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis

By Paul Krugman, The New York Times, October 11, 2014 

Almost nobody predicted the immense economic crisis that overtook the United States and Europe in 2008. If someone claims that he did, ask how many other crises he predicted that didn’t end up happening. Stopped clocks are right twice a day, and chronic doomsayers sometimes find themselves living through doomsday.

But while prediction is hard, especially about the future, this doesn’t let our economic policy elite off the hook. On the eve of crisis in 2007 the officials, analysts, and pundits who shape economic policy were deeply, wrongly complacent. They didn’t see 2008 coming; but what is more important is the fact that they even didn’t believe in the possibility of such a catastrophe. As Martin Wolf says in The Shifts and the Shocks, academics and policymakers displayed “ignorance and arrogance” in the runup to crisis, and “the crisis became so severe largely because so many people thought it impossible.”

Did supposed experts really think that nothing like what did happen could happen? Yes. In his 2003 presidential speech to the American Economic Association, Robert Lucas of the University of Chicago, the most influential macroeconomist of the late twentieth century, asserted that “the central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.” What he meant was that modern policymakers wouldn’t repeat the mistakes that, according to the prevailing wisdom, made the Great Depression possible.

In particular, Milton Friedman had convinced many economists that depression prevention is actually a fairly simple task, which can be carried out by technocrats at the central banks that control national money supplies. According to Friedman, the Great Depression occurred only because the Federal Reserve failed to do its job in the 1930s; if it had acted to rescue troubled banks and prevent a fall in the money supply, catastrophe would have been avoided.

At a celebration of Friedman’s ninetieth birthday, Ben Bernanke, an eminent monetary economist and Depression scholar who would become Fed chairman a few years later, accepted this verdict: “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

Then crisis struck, and major central banks—the Fed under Bernanke’s leadership, the European Central Bank, the Bank of England—did everything Friedman said they should have done in the 1930s. Troubled banks were rescued; money supplies were sustained. And we got a depression all the same.

True, in the United States we can comfort ourselves slightly with the observation that, bad as our experience has been, it hasn’t been as bad as the 1930s; but in Europe, where a weak recovery stalled in 2011, and growth between 2007 and 2014 was slower than between 1929 and 1936, they can’t even say that.

How could such a thing happen? If you try to follow the economic debate by listening to the talking heads on TV, or even from press reports, it can seem like a cacophony of voices with no clear theme. That impression isn’t entirely wrong: the crisis has revealed deep cleavages over economic doctrine that were papered over during the good years. But many economists and financial officials (although not as many politicians) have converged on a broadly consistent view about what went wrong—a sort of Standard Model, to make an analogy with physics—that seems to make sense of the mess we’re in. The Shifts and the Shocks is, I’d argue, best viewed as an extended, learned, and well-informed exposition of this Standard Model and what it implies about where we should go from here. Since the new sort-of consensus is clearly much more realistic than the pre-crisis complacency, Wolf, the chief economics commentator of the Financial Times, has performed a very useful service by putting it all together in one readable book.

But is the sort-of consensus the whole story? And are policy recommendations based on this consensus likely to solve our problems? My answers would be “No, not entirely” and “Doubtful.” Before I get there, however, let’s talk about Wolf’s vision of what happened.

2.

The Shifts and the Shocks opens with a long quotation from the late Hyman Minsky, a heterodox economist who had little influence on mainstream economists and policymakers during his lifetime, but whose analysis is now central to the Standard Model. Minsky’s ideas have been cited by monetary officials including Janet Yellen, by business economists like Pimco’s Paul McCulley, and by many academics, myself included. You could say that we are all Minskyites now.

What did Minsky bring to economics? In part, he argued that conventional views of financial crisis were too narrowly focused on the specific issue of bank runs. In Minsky’s vision, excessive leverage—too much reliance on borrowed money—creates a risk of crisis whoever the borrower. Banks, which in effect borrow money short-term from their depositors but invest in assets that can’t easily be converted to cash, may be especially vulnerable. But business and household debt also expose the economy to the possibility of a self-reinforcing downward spiral.

Minsky was not, of course, the first to make this observation; during the Great Depression the great American economist Irving Fisher, in a paper that reads remarkably well to this day, argued that the economy was suffering from “debt deflation,” in which borrowers of all kinds were trying to pay down their debts at the same time, which led to plunging prices of assets and a severe economic slump, which made their debts even less supportable and led to further pullbacks.

What Minsky added, however, was the notion that deflation as a result of excessive debt is fated to happen every once in a while, that periodic financial crises are a more or less unavoidable feature of capitalism. According to his “financial instability hypothesis,” eras of economic stability carry within themselves the seeds of their own down- fall. If there hasn’t been a financial crisis for many years, both borrowers and lenders will become complacent, underestimating the risks of high levels of debt. Leverage will rise, year after year. Inevitably, however, there will come a point when something goes wrong—a financial bubble bursts, a major financial institution fails, whatever—and people will start worrying about debt again. This is the “Minsky moment” (a term coined by Pimco’s McCulley), and it is followed by a nasty case of debt deflation that is very hard for policymakers to fight.

Mapping this story onto the past few decades of US economic history is easy and persuasive. From the mid-1980s to 2007 the US economy did indeed experience an era of relative economic calm, and this in turn induced a very bad case of complacency, not least among policymakers. In 2004 Ben Bernanke gave an influential speech lauding the economy’s “great moderation,” which he argued was likely to be a lasting phenomenon, in part because it reflected the excellence of modern macroeconomic policy. “This now seems quaint,” remarks Wolf; I would have used a stronger word.

What we now know, and should have been obvious even at the time, was that the surface stability of the US economy rested on an unsustainable rise in debt. The graph below, which reproduces one of Wolf’s charts, tells the tale: private-sector debt grew and grew, making the economy ever more vulnerable to a Minsky moment. And the moment came.

In retrospect, the complacency of both policymakers and investors in the face of the trend visible in this chart is remarkable. Why weren’t alarm bells ringing?

One answer was a fallacy of misplaced concreteness: the economics establishment, to use Wolf’s term, identified financial crisis with old-fashioned bank runs by depositors—and such bank runs are a thing of the past thanks to deposit insurance. Yet by 2008 depository institutions were no longer the dominant form of banking. Instead, finance increasingly relied on “shadow banking” (another Paul McCulley coinage): institutions like money market funds and investment banks that are reliant on overnight loans had come to make up more than half the US banking system. And these institutions were both unsecured and unregulated, making them highly vulnerable to panic.

Another answer was vastly excessive faith in the wisdom of the financial industry. Major policymakers convinced themselves and the rest of the world that “financial innovation” was making the system more stable as well as more efficient. Far from opposing or seeking to limit the rapid growth of finance, they sought to promote it; the most important reason instability like that of the 1930s returned to markets, says Wolf, “was simply financial liberalization.”

Finally, policymakers convinced themselves that they could easily contain any major economic fallout from financial disruption, as Milton Friedman claimed the Fed could have done in the 1930s. Indeed, over the course of 2007–2008 official assurances that troubles in the mortgage market had been “contained” were made so frequently that they became a joke. As it turned out, containing the effects of financial crisis is very hard indeed.

This, then, is the Standard Model of the crisis. A long period of relative economic stability fueled complacency in both the private and public sectors, leading to an unsustainable rise in debt. Meanwhile, free-market ideology blinded policymakers to the dangers of growing financial debt, as with the vast number of underfunded mortgages, and in fact led them to dismantle many of the protections we had. And there was, inevitably in retrospect, a day of reckoning, in which the bubble of complacency burst and the fragility of our financial system turned that bursting bubble into catastrophe.

Now, the story I’ve just told is somewhat US-centric, and Wolf argues rightly that a fuller picture requires paying attention to the wider world. This complicates his account in a couple of important ways.

First, as Wolf says, developments in emerging markets, especially in Asia, have in some ways been a mirror image of developments in advanced economies. While the United States was experiencing its “great moderation,” emerging markets were being whipsawed by huge inflows and outflows of capital (made possible by the widespread dismantling of capital controls). It’s interesting to ask why the Asian financial crisis of the late 1990s, which brought Great Depression–level slumps to several economies and pushed Japan into prolonged stagnation and deflation, didn’t shake the policy complacency of Western economists. But it didn’t. (Full disclosure: I did indeed see that crisis as an omen, and published a book to that effect, The Return of Depression Economics, in 1999.)

What it did do was convince emerging markets that they needed huge foreign currency reserves as insurance against future crises. And the enormous accumulation of overseas assets meant that the Chinese and many others were, in effect, lending large sums at very low interest to advanced economies, the United States in particular. In another influential speech, Ben Bernanke dubbed this phenomenon the “global savings glut.” At the time (2005), this analysis was meant to be reassuring: Bernanke was telling his audience not to worry too much about large-scale US borrowing from abroad. But Wolf argues that the savings glut interacted with unsound finance to make America even more vulnerable to crisis.

If the 1990s were an era of crisis in developing countries, the years since 2010 have been an era of crisis in Europe. In a general sense the euro crisis follows the Minsky schema. There was a complacency-fueled rise in debt, followed by a severe slump as many debtors were forced to retrench at the same time. In the European case, however, complacency came not so much from the experience of stability as from the false belief that a shared currency, the euro, eliminated lending risks. Borrowing costs in Spain, for example, plunged in the late 1990s, as it became clear that Spain would indeed share a currency with Germany. Low interest rates, in turn, helped inflate an enormous housing bubble. And when this bubble burst, Spain and other borrowers—with no currencies of their own—found themselves with no room for maneuver, forced into fiscal austerity that deepened their slumps.

While the special circumstances of emerging markets and the euro area complicate the narrative, however, Wolf’s essential story remains that of Minsky’s financial instability hypothesis: stability begets complacency, complacency begets carelessness and hence fragility, and fragility sets the stage for crisis. It’s a good story. But is it good enough?

3.

One of the great temptations one faces in writing about financial crises is the urge to turn it all into a morality play—to emphasize the lurid excesses of the boom, and accept the painful slump that follows as the necessary wages of sin. Liquidationism, the doctrine that policymakers should let a depression run its course, had powerful advocates in the 1930s. Friedrich Hayek, for example, warned against the use of “artificial stimulants” to boost a depressed economy, arguing that policymakers should “leave it to time to effect a permanent cure.”

Wolf is no liquidationist. In fact, he decries the reemergence of “liquidationist folly” at some major international institutions, notably the Bank for International Settlements. Yet I don’t think I’m being unfair if I suggest that in his book, at least, he shows more energy and passion in discussing lax regulation and misplaced worship of the invisible hand than he does in lamenting the inadequacy of post-crisis policies and the damage wrought by austerity. He addresses, briefly, the case for debt relief in economies that, according to his own account, are being dragged down by excess debt, but it almost seems like an afterthought. Or if that wasn’t his intention, it is nonetheless how I suspect the book will be read—mainly as a plea for reining in runaway finance, overshadowing the case for more monetary and fiscal stimulus and more relief for struggling debtors when the economy is depressed.

Emphasizing the need to reduce financial fragility makes sense if you believe that the legacy of past financial excess is the reason we’re in so much trouble now. But are we sure about that? Let me offer two reasons to be skeptical.

First, while the depression that overtook the Western world in 2008 clearly came after the collapse of a vast financial bubble, that doesn’t mean that the bubble caused the depression. Late in The Shifts and the Shocks Wolf mentions the reemergence of the “secular stagnation” hypothesis, most famously in the speeches and writing of Lawrence Summers (Lord Adair Turner independently made similar points, as did I). But I’m not sure whether readers will grasp the full implications. If the secular stagnationists are right, advanced economies now suffer from persistently inadequate demand, so that depression is their normal state, except when spending is supported by bubbles. If that’s true, bubbles aren’t the root of the problem; they’re actually a good thing while they last, because they prop up demand. Unfortunately, they’re not sustainable—so what we need urgently are policies to support demand on a continuing basis, which is an issue very different from questions of financial regulation.

Wolf actually does address this issue briefly, suggesting that the answer might lie in deficit spending financed by the government’s printing press. But this radical suggestion is, as I said, overshadowed by his calls for more financial regulation. It’s the morality play aspect again: the idea that we need to don a hairshirt and repent our sins resonates with many people, while the idea that we may need to abandon conventional notions of fiscal and monetary virtue has few takers.

This, in turn, brings me to the further concern I have with the Minskyite interpretation of the post-2008 depression. Even if you believe that financial excess set the stage for the slump that followed—and despite my sympathy for the secular stagnation view, I guess I mostly do—there was still no good reason why the slump had to be as terrible as it was. Containing the fallout from a financial crisis isn’t nearly as easy as Milton Friedman misled economists into believing, but it’s not impossible. In particular, although you’d never know it from the news media, which play down any success of Obama’s, there’s an overwhelming consensus among economists that the 2009 Obama stimulus substantially reduced unemployment relative to what would have happened otherwise. Given the extremely low interest rates that have prevailed all along, that stimulus could easily have been bigger and gone on longer. What we got instead, however, was a wrongheaded obsession with deficits and unprecedented fiscal austerity, which greatly deepened and extended the slump. European nations had fewer options, because they were and are trapped in a dysfunctional monetary system, but there too the slump was made much worse by wrongheaded policies.

The point is that focusing, as Martin Wolf does, on the measurable factors—the “shifts”—that increased our vulnerability to crisis is incomplete. Yes, rising levels of private debt, increased reliance on shadow banking, growing international imbalances, and so on helped set the stage for disaster. But intellectual shifts—the way economists and policymakers unlearned the hard-won lessons of the Great Depression, the return to pre-Keynesian fallacies and prejudices—arguably played an equally large part in the tragedy of the past six years. Say’s Law—the false claim that income is automatically spent—made a comeback. So, incredibly, did liquidationism, the view that any effort to ameliorate the pain of depression would postpone needed adjustment. It’s true that conventional economic analysis fell short in the face of crisis. But when policymakers rejected orthodox economics, what they did by and large was to reject it in favor of doctrines like “expansionary austerity”—the unsupported claim that slashing government spending actually creates jobs—that made the situation worse rather than better.

And this makes me a bit skeptical about Wolf’s proposals to avert “the fire next time.” The Shifts and the Shocks is an excellent survey of how we arrived at the mess we’re in, and Wolf’s substantive proposals at the end, especially for reform of the euro system—system-wide deposit insurance, higher inflation so that the burden of adjustment is better shared, among other reforms—are all worthy and laudable. But the gods themselves contend in vain against stupidity. What are the odds that financial reformers can do better?

1486. Global Industrial Production Shakes Off 2007 Doldrums

By Floyd Norris, The New York Times, July 18, 2014

INDUSTRIAL production around the world plunged after the Great Recession began, and in most advanced economies has yet to fully recover. But that is not the case in many emerging economies, with production hitting new highs.

The United States this week reported that industrial production, excluding construction, rose 0.2 percent in June and was up 4.3 percent from a year earlier. That is a faster rate than any other major advanced economy has shown recently, but it pales next to the rates of growth in such countries as China and India.

The accompanying charts show the change in levels of industrial production since the end of 2007, as the recession was beginning in the United States. The latest report indicates that production in the United States was 3 percent higher in June than it was in December 2007. That is, however, largely because of increased oil and gas production. Overall manufacturing output is still a bit below the pre-recession levels, although production in the motor vehicle industry has been strong.

Asia Leads the Way in Industrial Production

Industrial production in the United States has recovered from the Great Recession, but most other advanced countries continue to struggle. Emerging economies, led by those in Asia, have raised production much more rapidly. The charts show changes from production in December 2007, the month the recession began in the United States, with the world average shown for comparison.

The Netherlands government compiles industrial production reports from 27 advanced economies and 54 developing economies around the world, and computes international averages. Its latest report shows that world production in April was almost 12 percent higher than it had been at the end of 2007, but that production in the advanced economies was nearly 5 percent lower than it had been.

In the emerging economies, production was up by more than a third from the 2007 level, primarily because of the performance of Asian countries, where production is up by more than 60 percent.

China releases data only on annual changes, making any calculation of month-to-month changes hard to estimate, but it appears that its production has approximately doubled from the 2007 level. In India, production is up nearly a quarter since the recession began.

The Asian boom has not helped Japan, the largest advanced economy in the region. The latest production figure is nearly 14 percent lower than the 2007 number.

Until 2011, industrial production in Germany — the third largest exporter in the world, behind China and the United States — recovered more rapidly than did production in the United States. But since then, it has stabilized. In May, production remained nearly 3 percent below the 2007 level.

That is, however, much better than in any of the other major eurozone countries. Over all, production in the eurozone is 11 percent lower than in 2007. Among the three largest countries in the zone other than Germany, France has done the best, with production still down 15 percent. In Italy, production is off 22 percent and in Spain it is down 28 percent.

An exception to the eurozone doldrums seems to be Ireland, where production is now a little higher than it was in 2007. In May, the production figure was up more than 20 percent from the year before, a far better performance than in any of the major euro economies.

In Britain, which is outside the eurozone, production also seems to have stagnated. In May, the level was 12 percent below the 2007 figure.