The big Hank Paulson-lead bailout has failed by all objective measures. It’s a complete, trillion dollar, failure.

(For those of you needing a refresher, here’s the present crisis in a nutshell. The banks, filled with lazy and overpaid assholes, fucked up. Trillions of dollars in money that could not be lost, were shoveled into pyramid schemes that, inevitably, collapsed. Burnt, and well aware of their total incompetence at what should be the easiest task imaginable (lending at 6%, paying out depositors at 3%, pocketing the difference), the banks stopped lending to just about everyone. Businesses suddenly had their lines of credit evaporate. Lines of credit are critical for almost all companies to function on a daily basis.

In order to restart this sort of critical lending, Paulson shoveled money into the hands of the banker fuckups—paying taxpayer dollars for the detritus from the failed pyramid schemes, buying chunks of their failed banks with the same pool of cash and so on. The banks still didn’t lend, and continued to freeze lines of credit. Without credit, businesses were forced to rapidly shrink and scale back, leading to the largest monthly job losses in decades.)

In other words, the economic team of these waning days of the Bush administration are like Slim Pickins in Dr. Strangelove:

Obama’s crisis management plan—laid out this weekend-is better, but still does little to solve the underlying dynamic that lead to this disaster. In other words, Slim Pickins again:

Americans have been living beyond their means, right? That’s the line we’ve been fed. We’re just adjusting, being forced down to earth after decades of flying higher than our wings could support. It’s an odd explanation, a bit like telling someone dying of cancer that their problem was letting the cancer go metastatic. “Why’d you allow those cancer cells spread all over? That’s your problem right there!”

For most of the Americans drowning in debt, it wasn’t extravagance that lead to their downfall. It was the mundane—trying to keep themselves living indoors, to return themselves to health, to educate themselves—that precipitated collapse. In real dollar terms, Americans have been paid steadily less for decades. As wages for work decreased, costs of living increased. The typical worker in the United States has no more control of this dynamic than the weather.

It’s not like the productivity—how much a worker can get done for a given amount of money—of American workers has declined. In fact, this period of stagnated and declining wages corresponds to a time of fantastic increase in American worker productivity. Americans, going over the lip of this collapse, are among the world’s most productive people—second only to the Norwegians.

Yes, American workers tend to be expensive in absolute terms. It doesn’t matter. This productivity, by definition, means American workers should be some of the most competitive in the world—capable of producing more for less than just about any other person. American workers—factory lineworkers, service industry workers, agricultural workers earn their high wages by being better at their jobs than just about anyone else on the planet. Those are the numbers.

If “free-trade” worked, Americans should be among the winners. And yet, the United States accrues a massive, growing and ongoing trade deficit year after year.

It’s this imbalance, more dollars leaving the United States in trade for goods and services than return, that is at the rotting core of the present fiasco. As a consequence, our trade partners built up massive piles of dollars—dollars that had to be invested by government bureaucrats, who gave the money to self-aggrandizing idiots on Wall Street, who promptly shoveled the dollars into get-rich-quick schemes.

Why can’t Americans sell goods abroad? How does China, whose workers don’t even make it into the top fifty of productivity, maintain a massive trade deficit? Manipulation.

Nearly a year ago, I wrote on this very question after reading an exemplary Atlantic Monthly article lucidly describing the mechanism and effect of these manipulations by James Fallows.

Here’s James’ description:

Let’s say you buy an Oral-B electric toothbrush for $30 at a CVS in the United States. I choose this example because I’ve seen a factory in China that probably made the toothbrush. Most of that $30 stays in America, with CVS, the distributors, and Oral-B itself. Eventually $3 or so—an average percentage for small consumer goods—makes its way back to southern China.

When the factory originally placed its bid for Oral-B’s business, it stated the price in dollars: X million toothbrushes for Y dollars each. But the Chinese manufacturer can’t use the dollars directly. It needs RMB—to pay the workers their 1,200-RMB ($160) monthly salary, to buy supplies from other factories in China, to pay its taxes. So it takes the dollars to the local commercial bank—let’s say the Shenzhen Development Bank. After showing receipts or waybills to prove that it earned the dollars in genuine trade, not as speculative inflow, the factory trades them for RMB.

This is where the first controls kick in. In other major countries, the counterparts to the Shenzhen Development Bank can decide for themselves what to do with the dollars they take in. Trade them for euros or yen on the foreign-exchange market? Invest them directly in America? Issue dollar loans? Whatever they think will bring the highest return. But under China’s “surrender requirements,” Chinese banks can’t do those things. They must treat the dollars, in effect, as contraband, and turn most or all of them (instructions vary from time to time) over to China’s equivalent of the Federal Reserve Bank, the People’s Bank of China, for RMB at whatever is the official rate of exchange.

With thousands of transactions per day, the dollars pile up like crazy at the PBOC. More precisely, by more than a billion dollars per day. They pile up even faster than the trade surplus with America would indicate, because customers in many other countries settle their accounts in dollars, too.

The PBOC must do something with that money, and current Chinese doctrine allows it only one option: to give the dollars to another arm of the central government, the State Administration for Foreign Exchange. It is then SAFE’s job to figure out where to park the dollars for the best return: so much in U.S. stocks, so much shifted to euros, and the great majority left in the boring safety of U.S. Treasury notes.

And thus our dollar comes back home. Spent at CVS, passed to Oral-B, paid to the factory in southern China, traded for RMB at the Shenzhen bank, “surrendered” to the PBOC, passed to SAFE for investment, and then bid at auction for Treasury notes, it is ready to be reinjected into the U.S. money supply and spent again—ideally on Chinese-made goods.

At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all. These are in effect enforced savings…

Both James and I publicly wondered how this imbalance would unravel—gracefully or in a sudden and sharp panic. For the former to happen, the Chinese government would have to recognize that such schemes are unsustainable. They didn’t. It’s ending now in the panic.

To this very moment, a scant 35% of China’s gross domestic product is consumed by Chinese people—down from about 50% in the 1980’s. That’s astonishingly low.

If Chinese workers and factory owners were allowed to keep more of what they earn, everyone would benefit. The Chinese would be able to enjoy a plusher life, as well as the trappings of a modern industrial society (such as, ahem, pollution controls and nonpoisonous infant formula.) Some of these goods would be made by Americans—such as smokestack pollutant scrubbers—starting a proper flow of goods back and forth between the countries—rather than just a huge pile of dollars growing on one side. China, as a trading partner, must become more like Canada.

The US government printing dollars, to maintain the illusion for a short bit longer that ongoing trade deficits don’t matter, won’t fix the global economy. Nor will throwing more Americans into poverty. Instead, ending this crisis will require the Chinese to become wealthier. That’s the policy we should focus on, rewriting trade deals and industrial policy to make it so, if we are to ever recover.

Jonathan Golob is an actual doctor.

24 replies on “The Big Picture of the Big Bailout Failure”

  3. For most of the Americans drowning in debt, it wasn’t extravagance that lead to their downfall. It was the mundane—trying to keep themselves living indoors, to return themselves to health, to educate themselves—that precipitated collapse.

    I think we all know plenty of examples where that simply isn’t true. The percentage of those below the poverty line hasn’t changed in 40 years.

  4. you forget that the vast majority of consumer debt is and was in mortgages. buying a 500k house or condo is not the mundane and most of those people were as greedy and foolish as the bankers were.

  5. Cute summary… though completely misses the cause of our situation…

    That being that Fannie Mae was under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people so in 1999 it eased the credit requirements on the loans that it would purchase from banks and other lenders in order to encourage banks to extend home mortgages to individuals whose credit was generally not good enough to qualify for conventional loans.

    Even the New York Times could see the writing on the wall way back in 1999:

    http://query.nytimes.com/gst/fullpage.ht…

    ”this is another thrift industry growing up around us. If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.” – Peter Wallison a resident fellow at the American Enterprise Institute September 1999

    Yeah… no one saw this coming… And yeah… it’s all the fault of evil bankers. – Not!

    Thanks Bubba!

  7. F @3: While you are correct–the official statistics say that the percentage of Americans living below the poverty line has only modestly increased–the measure used there is flawed.

    The standard roughly boils down to “do you spend more than 1/3 of your income on food.” This standard made sense in the 1960’s, when it was established. For the subsequent decades, inflation in other necessities–particularly housing, healthcare and education (to remain economically viable)–has been higher than that for food.

    If you consider these individual needs, there has been roughly a doubling of the percentage of families legitimately struggling to make ends meet.

    Andrew@4: This also becomes complex. It’s a rational choice to bid up some sorts of desirable housing–that along key mass transit corridors, for example. I’m not saying people who invested in the South Beach condo market are blameless. I’m more considering people just trying to afford rent or a mortgage payment on a primary house.

    Also, we must consider the looming threat of all the consumer debt (credit cards and the such) that seems likely to default as the economy worsens. That might end up matching or dwarfing what was lost on housing.

    @5: I’ve heard this line on conservative blogs. It’s been roundly refuted, by people smarted than me on economic matters.

    But, let me ask you a question: Do you really think the ongoing trade deficit is just fine? A product of a well functioning free market?

  9. Oh… and Fannie Mae did all this under the direction of Franklin D. Raines, Fannie Mae’s then chairman and chief executive officer who at the time said:

    ”Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements, yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

    So he (under pressure from his boss Bill Clinton) decided to give them loans they couldn’t qualify for! What could possibly go wrong with that?!?!?!

    And buy the way, this genius is the same guy who advised Obama on mortgage and housing policy matters during the campaign.

    Change in deed…

  10. @7

    Since when is the New York Times a conservative blog?

    And no. The ongoing trade deficit is not “just fine”. Nor is it a product of a “well functioning free market”.

  11. Few things rational come out of big-picture economics. Witness the comments to this post…

    @2: Paulson is going to step down. Obama has already named his replacement. (The Fed Chairman of NY)

    @3: The Federal Poverty line is a joke to anyone that studies poverty. Not to mention that it’s definition has been changed at times to make the numbers look better. Anyway, see New York’s efforts to create a better measure of poverty.

    @4: The amount of simple mortgage debt isn’t that great. It’s the leveraging of the debt, through credit-default-swaps, CDOs, etc derivatives etc that’s leading to major bank losses.

    @5 (and 4): That’s Fox News’ crowd’s talking point #1. (Don’t loan to subprime!) Again, the losses on subprime mortgages aren’t all that great. It’s just that they’ve been leveraged to the hilt and no reserves were in place. Imagine you have $100, but the bank lets you invest as if you had $10,000 in the market. Say the market drops just 2%. You lose $200, but now everyone is scared and the bank wants its $10,000 back. Well, you only had $100 to begin with, and you lost $200 of the bank’s money, so now you’re $100 in debt.

    That’s the real problem as far as total losses go: insane leverage. Banks took their safest thing, their bread and butter (loans & home loans), and leveraged them a gazillion times so that they could make more money. There’s lots of factors (rating agencies, dumb loosening of lending standards, etc), but leveraging is #1.

  13. For most of the Americans drowning in debt, it wasn’t extravagance that lead to their downfall. It was the mundane—trying to keep themselves living indoors, to return themselves to health, to educate themselves—that precipitated collapse.

    Three words: Drive through Bellevue.

    Seriously, you’re living in a cave if you don’t see elective spending all around you.

  14. @ 11,

    But that kind of logic makes our heads hurt.

    Better to just blame the victims like You_Gotta_Be_Kidding_Me and move on while giving trillions of our tax dollars to the bankrupt billionaires club.

    And by the way @ You_Gotta_Be_Kidding_Me,

    Banks and investment houses have this thingy called risk management, the basics of which states they have evaluate borrowers on the three Cs: capacity, collateral and credit.

    No company was required to lend money to borrowers who couldn’t repay it.

    This was a systemic failure based on some fairly preposterous ideas about housing values always going up in spite of fewer and fewer people being able to afford the new, higher prices. Throw in some time-bomb products like Interest Only and payment Option ARMs and the results were obvious and predictable.

    But you can go ahead and blame poor people if you want to, since that’s what this is really about and those Wall Street Welfare Queens are incapable of taking any responsibility for their actions.

  16. @ 14,

    Where did I blame “the victims”? I thought I was pretty clear in placing blame with Fannie Mae and the Clinton administration.

    And as to risk management, the banks employed it. They used the minimum capacity, collateral and credit guidelines required to qualify their loans for re-sale to Fannie Mae.

    Where did I imply that any company was required to lend money to borrowers who couldn’t repay it? The banks simply sold loans they knew they could re-sell. They did not, and would not have, made these loans if Fannie hadn’t made it clear that it would buy them (and assume all risk associated with them.)

    I agree that this was a systemic failure based in part on some fairly preposterous ideas about housing values always going up (ideas bought into by the Clinton administration and being perpetuated by the “foreclosures are bad” mentality of the current policy makers).

    And yes, the results were obvious and predictable. (See the New York Times article I linked to originally.)

  17. You_Gotta_Be_Kidding_Me

    Ah, the old CRA chestnut. That one’s been debunked so many times, I’m not sure which debunking to link to. How about this announcement from the FDIC? Or how about this one , which includes this quote:

    “It’s telling that, amid all the recent recriminations, even lenders have not fingered CRA. That’s because CRA didn’t bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA — or any federal regulator. Law didn’t make them lend. The profit motive did.”

  19. How else did Clinton magically make FNMA give people loans they didn’t qualify for?

    So he (under pressure from his boss Bill Clinton) decided to give them loans they couldn’t qualify for! What could possibly go wrong with that?!?!?!

    How about reading the rest of my second link?

  20. @7 But even taking your “doubling” as fact, this only explains what’s happening to 20% of Americans. If the overall savings rate is 0%, the other 80% are living beyond their means too, and this can’t be blamed on the “necessities”.

  21. I gotta come out against You_Gotta_Be_Kidding_Me. Fannie and Freddie had their problems, sure, but it was the commercial and investment banks’ insatiable appetite for subprime that drove the housing bubble. Remember, Fannie and Freddie are only authorized to take conforming loans, that is loans with a certain amount of money down, a certain credit rating, and a certain size limit (no “jumbo” loans). While these requirements were relaxed during the ’90s and ’00s, allowing Alt-A’s for instance, Fannie and Freddie never had subprime mortgages on their books.

    Furthermore, this is a banking crisis. You think all these banks are insolvent because they have Fannie and Freddie securities on their books? Those are backed by the government. The banks are insolvent because they took a bunch of crappy mortgages and securitized them. Then they securitized those securities into CDO’s, tranches of which received AAA ratings, even though it really represented a portfolio of BB mortgages. I think Jonathan nails it when he calls it a Ponzi scheme.

    Where I have to differ with Golob is on the “Blame China” issue. No one’s going to defend the Chinese regime, but the fact is that China is not just sitting on a bunch of dollars. They are using them to finance our deficits, in the form of Treasury Bills (they were also highly invested in Fannie and Freddie securities). We enjoy this credit in the form of everything from low taxes to low mortgage rates. If the Chinese were to stop doing this (and they may–how do you think they’re going to pay for their bailout?), we would have serious problems here. The dollar would plummet, our deficits would soar, the economy would stumble. Not to say that the situation is sustainable, but we should hardly be discouraging Chinese investment in the US. I suggest you read this article, also by Fallows, if you want to know more (and read David Ricardo if you want to know why free trade is a good thing): http://www.theatlantic.com/doc/200812/fa…

  22. @20,

    It’s not just a matter of necessities. Americans have seen stagnating wages over the past few decades and decreasing wages over the past several years. In order to maintain their standard of living, they had to decrease their savings and increase their debt. Everyone would have been better off if Americans had been willing to see reality: that our country is less wealthy than it was three decades ago and that supply-side economics is fucking us. Unfortunately, they chose to ignore reality in their own finances and in our country’s governance.

    Golob is still correct. Decreasing wages = increasing debt for most people, since most people refuse to live worse than the generation before them.

  23. You hinted at it earlier, but missed half the story in your policy prescription.

    China must begin consuming at home, yes. Let’s keep blame where it belongs: China’s governmental policy for development did involve starving its people out of the countryside to force them into cities where competition for jobs is so fierce that sweatshop conditions are dominant. They have to adopt higher labor standards in order to improve wages and build a wider consumer class. The US doesn’t have policy control there.

    But regarding the consumer base in the US, we do have greater control. The scale of this crisis of capitalism is directly related to the scale of income inequality in the US and other countries. Reduce income inequality and you step towards stability.

    What are some of the policy choices facing us right now? One of the biggest choices we can make is to reverse the decline of unions in the US. This has the added benefit that the money labor puts into good, progressive political causes can balance out the lobbying efforts of big business. Indeed, @5, bankers are at fault in this crisis because we did know it was coming long before it hit, but decisionmakers were constantly hounded by well paid, well connected corporate lobbyists.

    Lobbying reform will help, but the simple fact is that USian democracy has always been about the power of money to buy votes. Bankers weren’t reigned in because they had too much power in their checkbooks.

    We have a very tangible opportunity to pass legislation in the US that will fundamentally alter the income distribution of the US. The Employee Free Choice Act will change the rules about how unions are organized.

    I worked for SEIU and watched our members’ dues go to long and costly campaigns for recognition from the employers. Why? Because in a “fair election” for union recognition, anyone who organizes against the employer gets fired. Let’s not mince words about what that could mean–they collect unemployment, fall behind on their bills, have trouble feeding their family. and could lose their homes. That’s not a fair election. That’s Option A) agree with your boss or Option B) starve.

    Card check is as fundamentally democratic as an election. Elections are a familiar form of democratic choice, but signing a petition, or a card, is a democratic choice, as well. While the signed cards are collected at various venues and over a longer period of time, union organizers can’t fire anyone, can’t deprive them of sustenance, take away their home. Walmart will tell horror stories about aggressive labor organizers terrorizing workers until they sign the card to make the organizer go away, but let’s keep perspective. If an unwanted organizer shows up at your door, close the fucking door and nothing happens. Try locking your employer out of the building and… well, I guess we’ll have to keep our eyes on Chicago. (http://www.youtube.com/watch?v=3REvNNzDU…)

    The Employee Free Choice Act is a good, structural step towards a solution to the economic crisis. If organizing drives didn’t include card check battles, that would probably save unions 30-50% of their new worker organizing costs. That’s money to bring more workers back into organized labor and to strengthen the worker organization that already exists.

    Obama supports EFCA and Democrats seem poised to pass it. Good. I won’t hold my breath, though. I’ve been disappointed by Democrats too many times and I’m worried about a Republican filibuster in the Senate. If you want some scary shit to research, see the Chamber of Commerce’s efforts to block EFCA. They will stop at nothing. It confirms for me that I’m on the right side.

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