Dollarzone and Eurozone failures – “Socialism for the rich” central-banking 2008-2016
Photo by Ibrahim Boran via Unsplash
”The Federal Reserve isn't just inflating markets. It's also shifting a massive amount of wealth from the middle-class and poor to the rich, according to billionaire hedge fund manager Stanley Druckenmiller…
"This is fantastic for every rich person," he said Thursday, a day after the Fed's stunning decision to delay tightening its monetary policy. "This is the biggest redistribution of wealth from the middle class and the poor to the rich ever."
"Who owns assets—the rich, the billionaires. You think Warren Buffett hates this stuff? You think I hate this stuff? I had a very good day yesterday.”
September 2008 and Lehman Brothers collapse became a milestone in global history because of its symbolism that people worldwide could recognize and feel about. A bank became a symbol of a global financial system being in crisis, at least regarding the “Western part” of the world as the USA and EU. And it was all connected to the US housing market and policies created during the presidency of George Bush Jr. As the Obama administration took over during the same year.
The US government intervention came among other things based on using public money worth 50 billion dollars officially to prevent house owners from being evicted. The idea was that mortgage loan companies would use public money in order to reduce and remove the debts of house owners who were fulfilling certain criteria. According to President Obama, this program would help between 3-4 million house owners.
However, the opposite took place which came to be exemplified in Jeremy Fletcher’s personal history. Instead of receiving help, Jeremy Fletcher ended up in a financial nightmare being exposed to stress, threats for eviction, lower financial credit and family problems. US federal government program as Home Affordable Modification Program or HAMP came to be administrated by the mortgage companies meaning that the US government came to subsidize mortgage companies’ pending times and administrative costs.
The unofficial intentions of the government were not to help house owners directly but to “secure soft landings” for the banks. This was done by delaying house owners´ bankruptcy were individuals as Jeremy had to send 5-6 loan applications that were “lost” by the companies as City Mortgage. The results of the HAMP program were less than one million house-owners with receiving real help while around six million owners were evicted. The winners were the banks and mortgage companies, thanks to the government, while the losers were low and middle-income individuals.
In the USA, the economic recovery from 2008 to 2016 was lower compared to similar levels after World War II. Except for using public money for dealing with certain sectors as the housing and mortgage market, one of the official ideas of quantitative easing policies is to stimulate the real economy. However, as the cases of the USA and EU are showing this cannot be seen as a good cause. Another case is that QE policies in one country, especially larger economies, lead to similar behaviours in other ones. The Republican party initially drove such policies during the Bush era.
Interesting how a party often proposing free markets and limited government could do centrist politicians continued such policies and QE as by Obama. Both liberals and socialists can agree that socialism for the rich is a bad idea and those trickle-down economics do not work, or at least do not work on the free/ less regulated markets.
As liberal opinion-maker, Mattias Svensson writes in his book about “The return of the big state” (Det stora statens återkomst in Sweedish), criticism of free-market politics among left-wing actors have often been based on the perception that free markets are “trickle-down” economics where there are few rich and some of their money eventually ends up among the poor. Because in free, open or less regulated markets one becomes rich mostly thanks to selling stuff that people, in general, want to buy like clothes, food and toys. In more regulated and state-driven markets, it is often easier to become rich thanks to usage, or better said, misuse or criminal use of government and public institutions.
Basically, QE policies have a very limited and bad impact on the real economy. And what happened in 2008-2106 was mostly a failure of the state, public institutions and politics than comparing to the market and private sector. The period of can be described as 2008-2016 was a period of wealth distribution from poor and middle-income earners to high-income earners and rich.
Regarding the USA, the problem was not about the deregulation of the US financial sector. The problem was in regulations and their content. This also occurred due to the implementation of Basel rules, which allowed large banks to purchase more risky financial instruments due to lower demands for capital cover rate. Another case was the spirit of the time of 2001 and 9/11. During the 1980s and 1990s American economic policy was mainly based on deregulation, liberalizations and what can be called neoliberal capitalism.
After the terror attacks and in combination with the later financial crisis, Keynesian economic ideas of spending public and taxpayer’s money became more popular even among the Republican party. Patriotism became used in economic references. One case was the General Motors communication about “Keep America rolling” with references to the importance of nation and cohesion. In basics, it was about buying cars with credit and interest rate free loans.
Part of the pre-crisis development was George Bush Jr reform ideas about making it easier for ethnic minority groups as African and Latin Americans to own their homes. The idea was that government intervention in the banking market would lead to more people in the USA owning their homes and thereby standing for values as individuality and success. This reform was part of his electoral campaign in 2004. But such willingness and interests to govern, enjoy the power and conduct politics led to wrong results. In 2004, a libertarian journalist James Bovard warned that easy government-sponsored credits to individuals who had high credit risks and were not in a good position to pay back the money in the long term could lead to catastrophic results for American taxpayers.
Basically, if Bush did not change the rules that were in place before 2004, the economic and financial crisis probably would have been much less serious and devastating. When Bush left power in 2008, there were around 28 million high-risk loans with low-possibility payback. And the main actors in that financial theatre were half-public companies Fannie Mae and Freddie Mac.
According to IMF-economist Simon Johnson, during the crisis, it was possible to see how the interest of the financial companies was going hand in hand with government decision-making regardless of parties. This explains how Wall Street companies are interlinked with government institutions since it was common that individuals working in finance sectors would change jobs between private and public.
Freddie and Fannie were spending money on the lobby, even up to 200 million dollars. Such money would go to politicians as democrats Barney Frank and Christopher Dodd. In the case of Dodd, who prevented government supervision of Freddie and Fannie, the governing Democratic party was chosen to make new regulations for the financial sector after the Lehman’s crash. To balance this history, it should be mentioned that the republican politician Newt Gingrich came to earn around 1,6 million dollars in payments by being the voice of Freddie and Fannie. To makes things worse, Fannie and Freddie also sponsored academic research to confirm their agenda where even Joseph Stiglitz was involved.
Today, more than 10 years after the crisis started taking place, there are still ongoing discussions in US politics if Fannie and Freddie, which were established during the 1930s and the era of government interventionism, should be preserved, abolished or limited. The whole process in which Fannie and Freddie were involved was based on giving loans to high-risk consumers, turning loans into obligations and securities, selling them to other private or public institutions and then making new loans. But the problem was not the market – it was government regulations. In combination with Basel rules that made insecure securities and assets look secure thereby leading to moral hazard behaviour among banks as Citibank, Bank of America, Lehman Brothers, Goldman Sachs. As Svensson writes, the most connected banks to government programs and politics were those who were the worst ones and made politics worse.
A similar situation came to take place in Europe, regarding the Eurozone and its governance. One important thing with Euro as a currency is that historically it was more of a political idea and project than of an economic one. According to the EU treaties, when being a member state of the Eurozone governments must keep the state deficit under 60% of the total GDP and budget deficit to be highly 3%. And in 1997, only two years of euros official introduction, only three states – Luxembourg, France and Finland-were fulfilling these requirements.
Before Greece could enter the Eurozone it was known among the leading EU political circles as among the European Council (heads of states, prime ministers) that the Greek government at that time was not honest with their financial statistics. Here the following political manifestations can be seen. German chancellor Helmut Kohl stated that the majority of the population was not in favour of abolishing the Deutschmark and ignoring warnings from economists to promote the European project. Romano Prodi, who except being prime minister of Italy, was the president of the European Commission and made statements in an interview for Financial Times that the euro would lead to challenge, which would lead to new policy instruments being created.
Also, for the EU there was another case when comparing to the USA. In the beginning, there was a feeling of the EU dealing with the crisis very fast. Even a more critical economist Hans-Werner Sinn wrote that the European Central Bank made a good decision to provide Eurozone banks with more financial liquidity by lowering security demands for loans. Sinn argues that already in 2009, the crisis was over but instead of going back to normal the ECB: s temporary policy became the new normal.
This made it possible for Eurozone states to create new credits via national central banks as in the case of Greece. Being members of the Eurozone meant that states had better credit ratings and could create credits to “fill the budget holes” but this was all depending on ECB: s guarantees plus cover from European taxpayers money. The Euro-crisis paradox came to manifest as Svensson writes “the world’s most imbalanced system”. Not even federations as the USA or Switzerland accept such imbalances between different states or cantons. Euro-crisis became a period of breaking and ignoring European constitutionalism such as bailouts between governments.
The Irish state has until 2041-42 to pay back its debts from the Euro-crisis. This is only one example of how serious and deteriorating the situation was during that period. ECB became an owner of state obligations with low security in billions of euros. This took place due to ECB: s decision to do whatever it takes to save the Euro, as its president Mario Draghi stated once. Securities for loans are made of public obligations in heavily indebted states like Greece and Italy.
However, due to the new banking regulations and mechanism, such loans became “solid assets” regardless of the market’s judgments. Svensson presents such behaviour as similar to “financial instrument equivalent to East German government made car Trabant ”. Therefore, one problem with the proposal for creating an EU-banking union is that it would mean higher risks for European taxpayers since a more institutionalized and integrated Eurozone would also mean the EU-level being more responsible for buying obligations and QE behaviour in order for governments to make new credits.
The whole process can be described as a mixture of bad competitiveness, higher prices and unemployment, lower wages and trust in EU institutions. It also leads to banks and hedge-funds as those based in France and Germany to take even higher risks and moral hazard behaviour since ECB and European taxpayers’ money is seen as a guarantee. Basically, the ECB applied similar policies that failed in the USA. And in similar ways to the USA, the case of the Euro-crisis shows that it was not a failure of the market in the first place but a failure of governance. It was also manifested in “Too big to fail” behaviour where states and public institutions are protecting banks.
Within academic research, there are some general agreements on how a financial system should work:
1. Banks need higher own capital for security and to earlier admit looses
2. Public regulations on the mortgage/housing market need to be reformed in order to prevent risky and destabilizing subventions (as with Freddie and Fannie)
3. Large private financial institutions need to understand that they are not to big to fail and can end up in bankruptcy.
This is also shown in empirical evidence that cases of austerity, reducing debt and accepting lower wages sooner or later lead to new economic growth and dynamic development. Comparing to the case of Japan, which is among the most prominent examples of long-term stagnation based on low-interest rates and long-term debt.
In the EU, this can be seen where Estonia, Latvia, and Lithuania were better at dealing with the crisis than Greece and Italy. And having over-indebted states in the Euro-zone was shown to positively impact richer individuals in the Euro-zone by having access to valuable assets with taxpayers’ money and public institutions as a guarantee. Therefore, as in the case of the USA, one can speak about transformation from a market-driven economy to central planning, but which ends in the socialization of the credit market that benefits the rich but has a negative impact on poorer and youthful segments of society – socialism for the rich.
It can be said that QE policies do not lift and stimulate the whole economy, especially the “real economy” as wages and assets among a majority of individuals. Even if such policies can stimulate the financial sector, they also end up the misuse of taxpayers money and benefit a smaller number of individuals that already are wealthy. It ends up with taxpayers, young and retired people being exposed to negative economic impact and debts while politicians and bureaucrats protect private financial institutions.
Regarding Sweden’s development things came to look better. Not being a member of the Eurozone contributed but at the same time, Swedish banks as SEB and Swedbank were exposed to the financial situation in the Baltics. The absence of currency devaluation in Baltic states (before introducing the Euro) and imposition of austerity measures affected the Swedish state finances, and private banks were not negatively affected. Also, the Swedish government mobilized around 1500 billion SEK (which was around two budgets) at the beginning of the crisis for dealing with eventual shocks.
The Swedish system was that banks abstained from using much money because the regulations were perceived as strict. As a result, when looking at statistics from 2001-2015, government debt, tax pressure, and public spending all went down in different numbers.
Swedish state was not in the same position as the USA one as a “TBTF guarantor” and neither in the same position as the Finnish one who had to bail out indebted Eurozone states. However, not everything was good in Sweden at that point. The Swedish central bank (Riksbanken) tends like the Norwegian one to follow the footsteps of the ECB. And from a global perspective, if there are several and more influential central banks as Fed or ECB conducting QE, such a process would lead to similar behaviours among other central banks. Riksbanken did not buy state obligation papers as ECB but has via its negative interest rate policy impacted a more unstable housing market with increasing house prices and debts among the owners.
As in other parts of Europe, the financial crisis led to an increased government role. Also, globally, there have been similar trends with increasing public expenditure and increasing loans equal from 5%-10% of GDP as in BRICS states. Moreover, as a result of government intervention, capital flows from the USA and EU to at that time “emerging markets” also led to higher prices for accommodation, food and energy. A similar case is in Sweden, where prices on stocks and housing increase while they are not included in older models for calculating inflation.
Today, deflation is more known as reducing consumer prices, not a “bad thing”. For ECB: s function it is vital to understand that modern studies show that inflation and price stability around 2% are unnecessary. The QE inflation policies have not led to wished results while deflation has not been shown as bad for economic growth. And not only that but QE has also influenced more global instability in the sense of governments, as between the USA and China, being more intolerant and sceptical to each other. QE is equal to stagnation, poverty and debts, global instability, conflicts, and nationalist behaviours.
As Svensson puts it, the word extreme is used often in bad ways to discredit political opponents but not often when it comes to QE policies. What is known now is that QE leads to financial imbalances, reducing future pensions and redistribution to the richest. QE has not prevented Japan to improve its economy since 1998. Since the beginning of the 2000’s states and supranational institutions as in the EU have become the main consumer and controller of banks and central banks. Zero rates and state-driven credits became the new normal. In 2016 IMF reported that the world is most indebted than ever, meaning that repayments are among us, our children and grandchildren. As Svensson puts it, yesterday’s unthinkable policies will become new the normal tomorrow.