Rebound: Why America Will Emerge Stronger from the Financial Crisis By Stephen J. Rose • St. Martin’s Press • 2010 • 277 pages • $24.99
The buzz you hear is not from mid-summer cicadas. It’s the chorus of Wall Streeters betting that recovery will soon blossom like the flower-drooping dogwoods in Central Park. On little cat’s feet, the price of a two-bedroom condo in Manhattan has stolen past $2 million, and glossy apartment brochures once again weigh down The New York Times. Plutocrats of finance lean back contentedly in their hand-tooled leather chairs: “Whew! Dodged a bullet. Blew up the world and still notched a near-record bonus pool. Must have done something right.”
There is broad consensus on the causes of the financial collapse. Beguiled by academic theories of “rational markets,” policy-makers over some 30 years gradually withdrew nearly all regulatory oversight from big financial institutions. The peak of permissiveness came in 2005-2006, as Federal Reserve chairman Alan Greenspan was pumping out rivers of new money to squelch an American recession.
Interest rates fell to record lows, and cash-stuffed investors clamored for yield. By 2005 or so, even the whitest of white-shoe firms were vacuuming up toxic sub-prime mortgages, credit card receivables, auto loans, and the junkiest paper from absurdly leveraged corporate buyouts. The illusionist alchemy of structured finance, abetted by venal rating agencies, shape-shifted the dross into investment-grade gold that the banks spread throughout the globe. When reality finally bit down hard, there was no place to hide.
Few experts, aside from Greenspan and Ben Bernanke, his successor at the Fed, any longer insist that the crisis was an utterly unpredictable “hundred-year” random event. Quite a few people, in fact, actually foresaw it. In 2005, just when the asset bubble was sliding toward hyperinflation, Raghuram G. Rajan, then chief economist of the International Monetary Fund, laid out the risks in painfully precise terms, at a Kansas Federal Reserve conference, of all places, convened to honor Greenspan. It was a brave speech. The elite of the economics and finance professions was in attendance, so Rajan must have expected to be booed off the platform, as he nearly was. Prominent among the rock-throwers were Bob Rubin and Larry Summers, successive Treasury secretaries in Bill Clinton’s last term, and field generals in the deregulatory blitzkrieg.
The mega-jackpot question now is whether the crisis is over, or at least in the first stages of winding up. The big banks have been rescued, one way or another, and the freefall in output and employment has been arrested. But while bond traders and foreclosure specialists are enjoying chubby good health, the rest of the economy still feels mangy and sulky-mean.
Two books, from quite different perspectives, shed contesting search beams on the topic. The subtitle of Stephen J. Rose’s Rebound: Why America Will Emerge Stronger From the Financial Crisis–says it all. Rose is an expert on demographics and social strata, a former community organizer, and a Democrat, but with a blue-dog streak. He was an adviser to Robert Reich when Reich served as Labor secretary in the Clinton Administration, but his data series are much like those long promulgated by the Cato Institute and Alan Reynolds, among others, to refute the notion that inequality increased over the last quarter century.
Rose is much more careful than Reynolds, and his data are mostly solid. His central point is that official counting conventions tend to exaggerate long-term trends like the growth in inequality, the stagnation in middle-class incomes, the shortfalls in personal savings, and other symptoms of economic distress. He doesn’t deny such trends, but he argues that they are not nearly as extreme as often portrayed. He sees the glass as “three-quarters full rather than three-quarters empty”–which leaves a much stronger base for a recovery than most pundits imagine. Liberal polemicists would do well to take better account of his data–although I think he is missing some worrisome trends that could derail his forecast.
There are few statistics, and nary a graph, in Barry Lynn’s Cornered, which is more an impassioned howl of anger than a careful analysis. Lynn’s target is what he calls the steady “financialization” of industry, the tendency for business strategies to be twisted to serve the short-term interests of a “neofeudalist elite” of financiers. Lynn’s book is far from flawless, and especially in the early chapters, some of its arguments and examples are either wrong or inconsistent. But it gains focus and power as it proceeds, building to a stem-winder of a conclusion that I found quite convincing–that corporate power, which during much of the postwar era was uneasily distributed among employees, CEOs, investors, communities, and customers has “become concentrated once more in the capitalist alone.” So we have “control without ownership; power without responsibility; appetite without mind.”
Rose pays special attention to income trends. The standard Census Bureau data are reported by “household,” the bureau’s basic statistical unit. Since 1979 or so, the Census data show that inflation-adjusted growth for the bottom half of the population is not much above zero–running at a third to a half percent a year. Rose starts by adjusting the data for trends in household formation. Up through the 1970s, nuclear families stayed together longer–granny helped take care of the kids, and junior and sis frequently lived at home until marriage. With rising affluence, and large benefit increases for the elderly, granny kept her own digs, and kids got their own places sooner. One consequence was that household formation grew much faster than population, automatically dampening reported growth in household incomes.
And since the new householders were disproportionately single, and elderly or young, they were precisely the cohorts with the lowest average incomes–which would look even lower since the Census excludes non-monetary transfers like food stamps. Medicare and Medicaid, and housing subsidies, which go primarily to the poor and aged. So in 2007, the bottom two “quintiles,” or 40 percent, of households contained only 32 percent of the population, tilted toward people in their lowest earning years. The census data, in short, cannot be taken as a fair description of inequality, although they have been red meat to liberals.
Rose prefers the Panel Studies of Income Dynamics, created by the National Science Foundation with ongoing funding from a consortium of federal agencies. It is a longitudinal study that documents the financial ups and downs of 9,000 families, at a very detailed level, since 1968. Rose extracts four comparable cadres, one for each decade since the study’s inception, and compares their decadal performance. All cadre members are aged 26-59 because those are the years of most intense engagement in the work force.
The results? Most of these Americans, in all socioeconomic brackets, saw substantial real income growth in every decade. Individual incomes are surprisingly volatile year-to-year, although much less so over five-year periods, but the volatility is strongly tilted to the upside. And, finally, the last 30 years have seen an unmistakable trend toward greater income inequality. There was also a discontinuity in the inequality trend in the pre-crash 2000s, when it flipped to a near-vertical rise, as the very rich gorged on the Wall Street bubble. But Rose argues that the bubble years are an outlier, not a permanent feature of the economy. The key finding from his analysis is “the huge growth in people in the share of households with incomes over $100,000. These are the people…who are going to power our recovery.”
Rose presents similar analyses for health insurance coverage, debt, retirement issues, and others, often with surprising results. I would not have guessed that median cardholder credit card debt is zero. But since the majority of card -holders pay their full card balances every month, the median card-holder indeed carries no interest-bearing credit card debt. For the people who do carry debt, Federal Reserve surveys show low median balances, in the $3,000 range. (Bank reports look much higher because they are daily slices of bank credit advances, without regard to payment-due status.)
Rose’s style is to attack anyone who disagrees with him, promising to “rigorously” expose their “flawed methodologies.” In the case of one data series I am familiar with, however, Rose’s analysis is incorrect.
The economists Thomas Piketty and Emanuel Saez (P-S) regularly publish an analysis of the tax returns of the top 10 percent of taxpayers. According to Rose, two other economists, Frank Levy and Peter Temin, “showed that the Piketty and Saez data implied that 82 percent” of a quarter-century’s income gains went to the richest 1 percent–to Rose, a show piece for liberal “inequality” exaggerations. Rose applies a newer inflation measure and additional adjustments to drop the 82 percent number all the way down to 39 percent. The P-S data, obviously, are wildly off.
This is craftily written. The 82 percent figure came from a careless Levy-Temin math mistake, which was subsequently corrected, in a note that Rose cites elsewhere. The original P-S data actually implied that 62 percent of income growth went to the top 1 percent; the new inflation adjustment dropped that to 52 percent, which Rose adjusts further to 39 percent. But Rose only adjusts downward. He doesn’t include capital gains, for instance, which are heavily skewed to top earners, and ignores the credible evidence of large-scale tax evasion. A fair conclusion is that somewhere between 40 and 50 percent of a quarter-century’s income growth went to the top 1 percent. That is shocking by any measure and doesn’t become more palatable by comparing it to a spurious “82 percent” figure.
Barry Lynn’s Cornered, in contrast with Rose, is an argument by anecdote. His central insight is that the same market-worshiping brand of economics that brought us the financial crisis has also reshaped the structure and ethos of the rest of American business–ultra-relaxed antitrust enforcement, and for CEOs, a single-minded focus on share price performance, to the exclusion of all other values. In theory, the idealized investor would act like Warren Buffett–think long-term, invest steadily, and build a highly skilled work force. In the real world, however, corporate CEOs have piled on debt to buy back stock, cut back on investment, driven down costs, and tossed away employees like disposable paper towels, justifying it all by falling consumer prices.
The monopolies in Lynn’s subtitle aren’t old-time giants like Standard Oil; indeed, some of them you’ve never heard of. The fierce cost-cutting that started with the 1980s buy-out boom led to large-scale outsourcing of traditional company functions, from component manufacturing to personnel processes and data management. While there are a half dozen or so major car companies, for instance, there are typically only a couple of makers of critical components, like antilock brakes, ignition systems, or doors and seats, whom everyone sources from. The new monopolies, that is, exist two or three layers down the value chain–not at the Ford or GM level, but at the much more concentrated firms that supply both of them. The German company, Robert Bosch, for instance, has long been the dominant world player in anti-lock brake and fuel injection ignition systems, for example.
Consider a 2007 pet food scandal, involving a wave of pet deaths traced to chemically adulterated wheat gluten made in China. It turned out that a middle-sized, financially shaky Canadian company called Menu Foods manufactured the pet food containing the adulterated gluten. Radical outsourcing in pet food manufacture, however, meant that perhaps a quarter of all canned or pouched pet food, involving some 150 brands, actually came from Menu Foods. So much for consumer choice.
But the real villain, in Lynn’s view, is not Menu Foods, but Wal-Mart, which stocks half of all pet food sold in the United States. Wal-Mart, Lynn writes, despite its boosters’ claims, “is not a consumer-friendly agent sitting between the consumer and Menu Foods…[I]t sits atop the entire system,” and imposes the rigid price disciplines that force all brands toward the cheapest, and often, riskiest, suppliers. That extreme, below-the-brand concentration is evident across American industry–from beer to soft drinks, from farm seeds to plants and meat, from medical supplies to glass frames, from vaccines to airplane engines.
Lynn is clearly onto something and is a gifted writer, but he piles up so many anecdotes and historical excursions, some of questionable relevance, that one can readily skim the early chapters. And he often overstates his case. Automobile outsourcing, for example, was probably driven more by technology than financiers. The sophistication of modern cars has grown to the point where it would nearly impossible for a company to “insource” all of its components. Boeing is another of his examples of extreme outsourcing. But that’s always been Boeing’s business strategy. While it usually makes its own wings and tails, it is primarily an airplane designer, systems integrator, and assembler. No single company could make all the components of a modern jet airliner.
While Lynn details the cash-stripping behavior of the investor-activist Carl Icahn, he leaves out the much bigger scandal of the institutionalized private-equity industry. During the bubble years, by my rough calculation, private-equity takeovers may have generated as much shaky debt as subprime mortgages, even as the partners plundered companies’ cash through devices like “special dividends.” Forty percent of all private equity debt is reportedly either distressed or already in default. For all that good work, general partner tycoons like Steve Schwarzman and Henry Kravis get special tax breaks.
Lynn’s focus on the financialization of industry is a most useful vantage point. Why was there a housing and consumer-spending boom in the 2000s? Because consumer goods and housing were sectors that Wall Street was particularly good at financing. As the housing runup was peaking in late 2005, Merrill Lynch reported that half of all GDP growth in the first half of the year was housing-related, as was half of all private sector job creation since 2001.
From 2000 through 2007, Americans taken together–consumers, businesses, governments–spent $4.5 trillion more than Americans produced. Where did that money come from? From foreigners–mostly private investors in the early days, but as time went on, mostly from central banks especially in China. Where did the money go? Mostly right back where it came from, which is why they lent it in the first place. Personal consumption jumped from about two-thirds of U.S. GDP in the mid-1990s to an unheard of 72 percent of GDP by 2007, with the lion’s share of the new consumption sourced abroad. The financial engineers, in short, were guilty of much more than merely flogging toxic securities. They actually engineered a radical, and potentially catastrophic restructuring of the American economy in the process of feeding their securities machinery.
The same “rational markets” economists who’d emceed the financial crash were delighted with Wall Street’s vast new monetary water-wheel. Bernanke waxed Panglossian on the topic–it was not only sustainable, but likely the best of all possible worlds. Most of the key economists in the Obama Administration would have agreed with him.
The analyses in the Lynn and Rose books point up the difference between structuralist arguments like Lynn’s and those of traditional economists like Rose. Rose lays out his case for a robust, early recovery competently, clearly, and, exceptions noted, generally fairly. It is a strong case. But its central premise is that markets and individuals adjust for the most part pretty automatically. The ranks of mega-store retail clerks shrink as those of manufacturing export workers expand. Perhaps.
While Lynn offers little in the way of prognostication, his focus on the extreme economic distortions created by the financial sector over the past couple of decades suggests the possibility of severe conversion issues. For many years, economic growth in America has come from brilliantly efficient distribution of foreign-made consumer goods, low-tech residential housing construction, and no-questions-asked provision of consumer credit.
In principle, we all know that’s over. We can’t go back to the credit-driven, throw-your-hat-away binge economics of the 2000s. In practice, the entire burden of the recovery program from Bush through Obama has been to get housing and consumer spending goosed up again. Since Bernanke’s Fed has created some $2 trillion of new credit since the crash, there is no doubt that we can do that to some extent, as the newest GDP data seem to confirm.
The best case for current policies is that a modest recovery in housing and consumer spending might create breathing space for somehow engineering a conversion to a less consumer-driven, more savings and investment-oriented growth path, one that is also less import-dependent and more sustainable–or that the “laws” of economics somehow ensures that the conversion will happen all by itself.
Rose believes this best case to be true. If he’s wrong, however, and we’re just administering feel-good palliatives, that may even reinforce the old destructive addictions, then we could be facing a wrenching Japanese-style non-recovery, slogging along with little or no growth for a decade or more.