A Short Guide to How the Bush Administration Reacts to Crisis

The New York Times (via Naked Capitalism ) comments on Paulson's financial industry "regulation" proposal:

While the plan could expose Wall Street investment banks and hedge funds to greater scrutiny, it carefully avoids a call for tighter regulation.

The plan would not rein in practices that have been linked to the housing and mortgage crisis, like packaging risky subprime mortgages into securities carrying the highest ratings.

......The bulk of the proposal, however, was developed before soaring mortgage defaults set off a much broader credit crisis, and most of the proposals are geared to streamlining regulation.

Basically they are continuing the pattern of proposing something they wanted to do anyway as the answer to the crisis of the day (see "Bush Tax Cuts", "Bush Tax Cuts II: Grandchild's Woe", and "Rambo IV: Operation Iraqi Freedom"). Style points as well for spinning "non-regulation" as "regulation" and for scrupulous avoidance of effectiveness.

The Coming Big Story

Paul Krugman:Taming the Beast

America came out of the Great Depression with a pretty effective financial safety net, based on a fundamental quid pro quo: the government stood ready to rescue banks if they got in trouble, but only on the condition that those banks accept regulation of the risks they were allowed to take.

Over time, however, many of the roles traditionally filled by regulated banks were taken over by unregulated institutions — the “shadow banking system,” which relied on complex financial arrangements to bypass those safety regulations.

Now, the shadow banking system is facing the 21st-century equivalent of the wave of bank runs that swept America in the early 1930s. And the government is rushing in to help, with hundreds of billions from the Federal Reserve, and hundreds of billions more from government-sponsored institutions like Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

Given the risks to the economy if the financial system melts down, this rescue mission is justified. But you don’t have to be an economic radical, or even a vocal reformer like Representative Barney Frank, the chairman of the House Financial Services Committee, to see that what’s happening now is the quid without the quo.

Last week Robert Rubin, the former Treasury secretary, declared that Mr. Frank is right about the need for expanded regulation. Mr. Rubin put it clearly: If Wall Street companies can count on being rescued like banks, then they need to be regulated like banks.

Mark Thoma lays out a pretty decent summary of the change in tax laws and financial regulations that brought us to where we are today (though I noticed Bill Clinton's role in repealing Glass-Steagal was not mentioned). Basically massive tax cuts for the wealthy created a wave of new money, which financial deregulation allowed to flow into new ungoverned instruments.

Pretty soon the new money was finding its way into all sorts of formerly sleepy sectors of markets chasing the next hot thing and pretty reliably creating progressively larger catastrophes. The current catastrophe in the credit markets is large enough to really hurt. Assuming we manage to deal with the crisis successfully, the prudent thing would be to establish rules and regulations to make sure such things don't happen again. Unfortunately, Wall Street has thrown plenty of payola Washington's way which has so far stifled reform. Paradoxically, a larger crisis may be in the national interest because it would change the M.O. for political survival from fund raising and not rocking the boat to making changes before the voters throw the bums out.

Deja Vu All Over Again

VIa Naked Capitalism I found an interesting post on Robert Reich's blog. He quotes Marriner Eccles, a depression era Federal Reserve governor, on the cause of the great depression:

As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.

That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.

The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.

Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.

This then, was my reading of what brought on the depression.

"...an exceptional expansion of debt outside of the banking system" See Paul McCulley's "Shadow Banking System"

Consumption financed by debt, well with negative savings rates I'd say we're there.

Roaring 20s inequality, we've got it .

Strapped Consumers who can't go anymore, check