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The Fix We're In

With the stock market nosediving, credit lines freezing, retirement savings disappearing overnight, and the state budget on the chopping block, we are facing an economic peril as great as any since the Great Depression.  What are we to make of these frightening times?  What does it say about the way we have structured financial institutions and about decision-making at every level from the household to corporate boardrooms and the regulatory arms of government?  We asked some leading voices in the world of economics, political science, and public policy to help make sense of the tumult we find ourselves in.  See all of the responses below.

Alan Wolfe on "the utter failure of conservatism"

For reasons known only to superior minds than my own, and perhaps not even to them, the stock markets are rebounding as I write, just after their worst week in modern history. Still, no one doubts that we are in something of an economic crisis and that much in this country will change.

I spoke yesterday at the John F. Kennedy Library at a forum in honor of the lives and work of Arthur Schlesinger Jr. and John Kenneth Galbraith. We were first treated to a video that Schlesinger made shortly before his death in which he asked how America, having made such a horrendous mistake in Vietnam, could repeat the same thing in Iraq. Much the same could be said about the economy: How, after finally learning in the 1930s the dangers of unregulated capitalism, could be have deregulated capitalism again?

If Iraq destroyed the credibility of one half of conservative ideology -- this is the half that says we can run the world anyway we choose -- the drying up of liquidity drains all appeal from the remaining 50 percent, which is that the best economic system is one that rewards the fewest with the most. I have not been witnessing much liberalism in American politics the past few decades. The utter, if predictable, failure of conservatism means I will seeing a lot more in the next couple of them.

The question is what kind of liberalism it will be.

In my forthcoming book The Future of Liberalism, due out in February, I argue that the crucial ingredient in liberalism is its sense of purpose. Liberals do not believe that the world is structured in such random ways that no one can apply their social intelligence to direct society in directions chosen by people themselves. On the contrary, the modern era is one in which people slowly learned that their fates lay neither in the whims of a capricious God nor in the dictates of an arbitrary nature. Adam Smith and John Maynard Keynes may have disagreed about the scope of government intervention into the economy. But they agreed that people should take into their own hands the directions of their own lives.

The particular economic turmoil we are experiencing is not like a tsunami and it is not divine retribution from God for our sins. It was caused by human beings who designed a system that made it impossible for other human beings to be held responsible for their acts. If we are capable of designing something that bad, we can create something that much better.

Let us hope, then, that economic troubles can produce political benefits. We need that rarest of political creatures, people who actually believe that there is a common good and are willing to serve it. Self-interest got us to where we are. But there are, we have been forced once again to learn, more incentives in the world than greedy ones. There is an opportunity to turn the page on this crisis. To do it we will have to trust ourselves.

Alan Wolfe is professor of political science and director of the Boisi Center for Religion and American Public Life at Boston College. He is the author or editor of more than a dozen books, including, most recently, Does American Democracy Still Work? (Yale University Press, 2006) and Return to Greatness: How America Lost Its Sense of Purpose and What it Needs to Do to Recover It (Princeton University Press, 2005).

Jacob Hacker on the "Great Risk Shift" hitting home

What is going on with our economy?

The stories in the headlines are about the financial crisis at the top. But the story that explains our deeper economic anxieties is the slow-moving financial crisis facing the rest of us. Over the last generation, as I wrote in my recent book, The Great Risk Shift, economic risk has shifted from the broad shoulders of government and corporations onto the fragile backs of American families.

The shift has occurred in nearly every area of our economic lives — our jobs, our health care, our retirement savings, our family finances. It is at the heart of Americans’ economic worries today. And addressing it is our nation’s biggest long-term economic challenge. More and more Americans are feeling insecure — and they’re right to. Job-based benefits like health insurance and retirement pensions are either disappearing or shifting more costs and risks onto workers, as in the shift from guaranteed pensions to 401(k) accounts. Bankruptcies and foreclosures are stunningly more common today than a generation ago, and most who experience these dislocations are in the middle class before they do.

No less telling, research I have done using the Panel Study of Income Dynamics, shows that the instability of family incomes has risen substantially since the early 1970s. The gaps between the rungs on our economic ladder have increased, but what has also increased is how far people slip down the ladder when they lose their financial footing.

These are not simply problems confronted by workers with limited education. More than one in three recent college graduates start their first job without health insurance. In recent years, people who have gone to college have experienced more family income instability than high-school dropouts did in the 1970s.

You might hear that people can still spend even when their incomes drop. That may have once been true, when growing home values provided a last-resort ATM for struggling middle-class families. But now that ATM is broken. Outside of their home, middle-class families have strikingly little in the way of liquid wealth with which to deal with short-term income fluctuations. Indeed, according to a recent analysis of working families with incomes between two and six times the poverty level, more than half of middle-class families have no net financial assets besides their home.

The late Herbert Stein, chairman of Nixon’s Council of Economic Advisers, reportedly once pronounced that “Things that can’t go on forever, won’t.” Families cannot maintain consumption through borrowing forever, and the bill that eventually comes due can devastate family finances.

It is common to say that providing Americans with a basic foundation of security will drag our economy down. But it is a grave mistake to see security as opposed to opportunity. We give corporations limited liability, after all, precisely to encourage entrepreneurs to take risks. If middle-class Americans are to make the risky investments necessary to thrive in our new economy, they need an improved safety net, not an ever more tattered one. We cannot bailout Wall Street and say “toughen up” to Main Street.

First and foremost that means affordable health coverage that moves with workers from job to job. In a policy brief released last year, I outlined a proposal called “Health Care for America” that would extend good insurance to all non-elderly Americans through a new Medicare-like program and guaranteed workplace health insurance. Happily, the Lewin Group, an independent health care consulting organization, estimates that Health Care for America would cover everyone younger than 65 without any additional national spending on health care — and for the relatively modest federal costs of around $50 billion — while saving $1 trillion in national health spending over the next ten years.

Some worry that we cannot afford to provide health and economic security to all. What recent events suggest is that we cannot afford not to.

Jacob S. Hacker is professor of political science and co-director of the Center for Health, Economic, and Family Security at the University of California-Berkeley. He is also a fellow at the New America Foundation in Washington D.C.  His most recent books are Health At Risk: America’s Ailing Health System  — And How to Heal It, and The Great Risk Shift: The New Economic Insecurity and the Decline of the American Dream.

Stephen Crosby on budgeting in an economic crisis

So here we go again. 

Billion dollar deficits; tax revenues falling short of projection; “9C cuts” emanating from the governor’s office.  A national recession (never mind an international liquidity crisis) begets a local budget crunch, forcing state policymakers — whose constitution forbids deficit spending — to scramble to make ends meet.  We’ve gotten better at dealing with these slowdowns: At the end of the Massachusetts Miracle, the Dukakis administration had to raise the income tax, float bonds to pay operating expenses, borrow from the federal government to pay unemployment compensation, almost totally forgo paying for pension liability, and cut state spending dramatically.  After recovering from the high tech collapse in the late ‘80s, the dot-com bust in the late ‘90s, and years of fluctuating economy in the George W. Bush years, Massachusetts is in much better shape.  We have $2 billion in various rainy day accounts; our pension funding schedule is steadily approaching current; we’ve relegated “Taxachusetts” to the dust bin with cumulative tax cuts that have saved taxpayers something like $4 billion annually.  Yet with all that, the Massachusetts budget is once again in crisis.

The challenge for policy makers — and having been a policy maker, I know just what a challenge this is — is to react strategically, rather than tactically.  Mid-year budget cuts in state agencies — the dreaded so called 9C cuts — is no way to run a railroad. 

Policymakers and administrators alike get consumed with scouring their budgets, wrestling with unhappy trade-offs, and debating with advocacy groups, rather than running their agencies and planning for the future.  Virtually all state employees are distracted from doing their jobs, worrying whether they will lose their jobs or their budgets will be cut. The governor has used 9C cuts boldly, and he gets credit for decisiveness and political courage.  But if things get worse, utilizing one time fixes (property sales, debt refinancing, delayed pension fund payments, and rainy day funds) for mid-year course corrections like we face today is not a bad idea, if it is coupled with a long-term, in-depth strategy for the next year’s budget.  Budget cuts for FY2010 can be planned for.  Strategies for making big changes can be developed and implemented.  Time can be taken to really consider the costs and benefits of programmatic changes.

So what are the big strategies that we could be considering for FY2010? State employee pension and health benefits are unsustainable, both economically and politically.  Now is the time to bring employee contributions to health benefits and defined benefit pension plans more in line with private sector norms.  In exchange for holding local aid harmless — which the governor is heroically trying to do — the state should empower a host of reforms for municipal governments which can bring their fiscal and operational status into at least the 20th century: participation in the state’s health and pension plan should be mandatory for municipalities that underperform them; municipal health and pension benefits (such as the option of retiring at age of 55 with as much as a 75 percent pension) must be revised; regional procurement and service delivery, perhaps organized by the regional planning agencies, must be made mandatory. 

With the time to do it properly, we should re-think our draconian “three strikes” policy and imprisonment for minor drug offenses — since they fill our prisons with minor offenders, at great public cost. Similarly, we should scrub our standards for the use of nursing homes, so we can encourage vastly cheaper community-based and assisted-care treatment, for seniors with the capacity to cope with less assistance. And we need to rethink new revenue streams, like casinos, local option meals and hotel taxes, and the gas tax.

All of these, and there are others, are big, politically-charged changes.  They can only be made in crisis, and they can only be made in a coordinated effort by the governor and the Legislature. And they can be made with extensive citizen participation. The combination of today’s interactive technologies with the governor’s considerable communication skills presents the opportunity for him and the legislative leadership to help citizens understand these issues and contribute to their resolution, in a methodical process to develop the “2010 Massachusetts Recovery Plan.”

Stephen P. Crosby is the dean of the McCormack Graduate School of Policy Studies at the University of Massachusetts at Boston.  From 2000 to 2002, Crosby served as Secretary of Administration and Finance to Governors Paul Cellucci and Jane M. Swift.

David Weil on transparency and the economic crisis

A recurring refrain of those discussing the way forward from the current economic crisis is the call for more transparency.  After Congressional passage of the Emergency Economic Stabilization Act on October 2, for example, Treasury Secretary Henry Paulson stated, “Transparency throughout this process will be important, and I look forward to providing regular updates as we move ahead to implement this strategy.” 

The value of transparency, like motherhood and apple pie, is easy to invoke. Yet the meaning of transparency can be elusive, particularly when applied to a crisis of the complexity and scale of the current one. I offer a few comments on where and how transparency may be useful in the short, medium, and long term.

The turbulence of the stock market in the days since passage of the “Bailout Bill” by Congress derives in part from the hour-by-hour (or minute-by-minute) effort by investors to read the tea leaves on whether or not markets have hit the bottom.  Emotions are driving behavior because we are in such uncharted waters.  Explanatory transparency can play an important role in the short term in moderating emotions.  In particular, we need greater transparency by Secretary Paulson, Federal Research Chairman Bernanke and other key public leaders in explaining to investors and the wider public how the various means that have been created to deal with the capital crisis actually work, thereby setting clearer expectations about how long they will take to implement and have their intended effects.

The unrealistic notion among many that passage of the initial legislation or the agreement between the Treasury, Federal Reserve, FDIC, and banks on injecting capital would instantaneously lead to a “solution” to the crisis added fuel to recent turbulence.  It is essential that Paulson and others provide a clearer roadmap by laying out what is to be done and how it will likely play out in the capital markets and ultimately the real economy.

Second, in the medium term, we need to rebuild trust in public and private institutions by expanding procedural transparency. Deep recessions arise in part from collapsing expectations about the economy and the future. Rebuilding faith in our future requires addressing the deep distrust that has grown during the Bush administration about the way that decisions are made in both public and private spheres. Coming out of this crisis requires restoring confidence that leaders of major institutions will make defensible decisions guided by the larger public good. The secretive nature of decision-making in the Bush administration and its record of distorting information in foreign and domestic policymaking to serve its narrow interests have been corrosive.  Providing the public with greater insight into how and why decisions are being made to deal with the economic crisis will be crucial to repairing frayed public confidence. 

Finally, in the long term, we need to rebuild the regulatory transparency systems that provide information in key parts of the financial sector. This must begin with revising both who provides information to potential mortgagees and the type of disclosure documents they receive. No system of transparency can work if the purveyors of information have incentives to obfuscate. It should not be a surprise that mortgage brokers and other lenders who bore little if any of the risk of loan defaults assured potential borrowers that disclosure documents regarding the costs and risks of their mortgages were irrelevant, complex, and legalistic paper exercises. Making sure that part of the mortgage risk is borne by lenders will better align the incentives for truthful disclosure. But that alone is not sufficient: we must also change the way that information is conveyed to the millions of people who will once again seek to borrow when the crisis begins to subside, and ensure that it is conveyed in formats and language that people can truly understand and weigh.

We also will need to rebuild transparency in the wider investment markets. Once again, this requires changing basic incentive relationships between those who convey information, those who rate securities, and those who use that information so that the parties who appraise investments receive no direct financial benefit from the ratings they assign to them. And we need to rethink how we convey that information to conform to the principle often ascribed to Warren Buffett: Never invest in something that you don’t understand. It seems clear now that very few of the people who bought and sold sophisticated derivatives actually understood how they worked, much less the risk associated with them. Future capital markets will continue to employ complicated financial instruments to allocate risk. Those capital markets will need new mechanisms to translate those risks into comprehensible formats.

The road back to a healthy economy will be a long and difficult one. Rebuilding trust through explanatory, procedural, and regulatory transparency policies will be an important element in finding our way forward.

David Weil is professor of economics and Everett W. Lord Distinguished Faculty Scholar at Boston University School of Management and co-director, with Archon Fung and Mary Graham, of the Transparency Policy Project at Harvard’s Kennedy School of Government.

Edward Glaeser on "the silver lining of bleak fiscal times"

As Gov. Patrick tried this week to balance the state budget, he was also balancing his desire to provide social services with the need to respond to a $1.1 billion tax revenue shortfall. A nation can react to a financial crisis by borrowing billions, raising taxes or just printing more money. States have fewer options.  Raising taxes on business and the rich will prod them to locate elsewhere. The Commonwealth hasn’t printed its own currency for quite some time.   

The most natural way for state budgets to address the business cycle would be to borrow during lean years and save during fat ones. After all, it isn’t particularly sensible to cut social services when economic times get tough. The governor’s new budget proposals does a little bit of this kind of “income smoothing,” by drawing down $200 million out of the rainy day fund and by further delaying the date at which our pensions system will be fully funded. However, Article LXII of the state Constitution requires any large scale borrowing to get a two thirds super-majority of the Legislature, which pushes the state government to live, more or less, within its means. 

The silver lining of bleak fiscal times is that they push state leaders to try to trim fat from the state budget.  One of Gov. Patrick’s proposed cuts is a $20 million in “earmark spending” in the Massachusetts Office of Travel and Tourism. And the $22 million cut in Judiciary spending might actually pave the way towards much-needed, and long-discussed, improvements in the administration of our vital court system.

I wish that our leaders worried as much about saving money during booms as they do during busts, but fiscal downturns do make it politically easier to challenge wasteful spending. Even when the money involved is small, eliminating obvious forms of pork helps convince the public that the Commonwealth is being well run.   

However, the governor can’t close a $1 billion-plus shortfall with the rainy day fund and voluntary reductions. More than 70 percent of the state’s spending goes on education and health. Major cuts were always going to have to come from one or both of those two areas. 

In richer times, state politicians divided into spenders (often liberal Democrats) or savers (often more conservative Democrats and Republicans). Spenders usually wanted to strengthen both public education and public healthcare. In this fearful new age of fiscal limitations, the Commonwealth doesn’t have the cash to spend more on everything. Political leaders and eventually voters must make a painful choice: are we going to focus more resources caring for our sick or training our children?   

Gov. Patrick seems to have decided to put schools first. He cut higher education spending substantially, but left state aid to primary and secondary schools largely untouched, except for a $14 million cut in for special education reimbursement. The really big cuts came in healthcare, especially a $200 million reduction in MassHealth spending.

Why did the governor cut medical spending rather than school support? Perhaps he thinks that educating our children is a more important investment for the state’s future than spending on the sick. Perhaps, the governor just accepted that the Legislature was never going to let him cut local aid, and he didn’t want another fight with Speaker DiMasi. My guess is that the real explanation is that governor thought that $200 million could be cut from healthcare reimbursements without any significant reduction in service levels, at least in the short run.   

It may well be right that if these cuts in health care payments paid to providers are relatively short-lived, then hospitals will just soak them up  In the longer run, these cuts will surely create a meaningful reduction in service levels, but I suspect that the state will make up for today’s cuts by boosting healthcare payments in the future. If that is the case, then Massachusetts is actually addressing the fiscal downturn by borrowing after all. We’re just not borrowing from investors; we’re borrowing from hospitals. If the plan is to cut hospital spending today and boost it in a few years, then the state is implicitly using health care providers as its lenders of last resort. It would have been better if the state had saved more during the boom, but since we didn’t, we shouldn’t be surprised that our leaders are trying creative ways to make up for our revenue shortfall.

Edward L. Glaeser is a professor of economics at Harvard University.

Tamara Draut on "the deregulatory impulse"

If I had to choose one word to describe the financial situation confronting the United States, it’d likely be “outrageous.” It’s outrageous that we find ourselves forced to spend billions of dollars to clean up another speculative bubble created by Wall Street. It’s outrageous that our economy is close to a collapse that was entirely preventable if certain key regulators (Alan Greenspan chief among them) had heeded numerous calls for more oversight of the sub-prime mortgage lending and financial derivatives markets. And it’s outrageous that millions of families will lose their homes as a result of toxic products pushed by unregulated mortgage lenders and brokers, who had the full backing of capital from august financial institutions.

As our nation’s economic morass spreads throughout the globe, high-level multi-national summits are planned, and American banks are nationalized, it’s easy to forget that the crisis began with the pedaling of sub-prime mortgages. Fueled more by demand from Wall Street than by demand from homebuyers or homeowners, a vast army of unregulated mortgage brokers barreled through down-on-their-luck neighborhoods offering salvation via cash-out refinancing in the form of exploding adjustable rate mortgages.

Contrary to popular perception, the majority of these mortgages weren’t taken out by speculative investors, nor by middle-class families fulfilling their aspirations for ever-more home on an ever-shrinking income. In fact, in many cases, the mortgages were sold to existing homeowners, who were duped into trading their affordable fixed-rate mortgage for an ultimately unaffordable one. According to the Wall Street Journal, by the end of the refinancing boom, more than half of all sub-prime loans were going to people with credit scores that could have qualified them for traditional mortgages. 

These sub-prime mortgages were typically second mortgages -- cash-out refis by strapped homeowners dealing with job loss, medical expenses, or the simple reality that their basic costs were rising faster than their earnings. Unlike the market for prime mortgages, where buyers search out a lender or broker when they’re purchasing a home, sub-prime mortgages were aggressively marketed to current homeowners, particularly in predominantly African American and Latino neighborhoods. Many sub-prime borrowers were elderly homeowners, who hadn’t ever thought about refinancing, but were convinced of the idea when a broker knocked on their door. According to a report by the AARP, more than 60 percent of a sample of older borrowers reported that a broker or lend had initiated the contact, leading the AARP to conclude that these loans were “sold, not sought.”

The sub-prime mortgage frenzy that begat a financial meltdown of catastrophic proportions is yet again a terrible lesson of what happens when the deregulatory impulse goes too far (remember the S&L collapse and ENRON/WorldCom, etc). Wall Street devised arcane instruments that were supposed to ensure against risk in the form of mortgage-backed securities, credit default sweeps, and so on — but instead infected the entire financial bloodstream. Meanwhile, Congress and regulatory agencies loosened laws designed to protect consumers from shady lending practices and toxic financial products — making cash-strapped homeowners a convenient host.

The current meltdown is the logical conclusion of a radical conservative philosophy that captured mainstream institutions and the regulatory mechanisms supposedly charged with protecting the public interest. The dictum quite simply demanded that government get out of the way of financial innovation.

Over the last two decades, average Americans have lost ground as earnings have stagnated or declined, while the cost of everything from health care to college to food have risen faster than inflation. And government has stayed out of the way, disinvesting in our nation’s infrastructure and overall neglecting the public purpose. While re-regulation of the financial sector must be a first-order task, it is the long-term planning of our economy that has been sacrificed in the name of market fundamentalism and small government. Redirecting our nation’s energies and brightest minds — in both the private sector and the public sector — to creating a future characterized by innovation and broadly shared prosperity must be the larger, and more fundamental challenge. If there is any silver lining to this crisis, it may be that it has expanded the boundaries of what’s possible.

Tamara Draut is vice president of policy and programs at Demos, and the author of Strapped: Why America’s 20- and 30-Somethings Can’t Get Ahead.

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