Petit Julien welcomes you back to the Populist Pub.  

As a nation, we are groping for some sense of hope that we are emerging from the economic morass. The ranks of the unemployed continue to swell and millions of working Americans and retirees worry that the economic tsunami may engulf them next. The government has enacted a dizzying array of bailouts and assistance plans aimed at stabilizing the banking industry, thereby clearing a path to recovery in the real economy.

There is plenty of criticism for the government's actions to date, much of which is centered on understanding what brought on the crisis in the first place. Many critics attribute the 1999 repeal of the Glass-Steagall Act of 1933 and the 2000 enactment of the Commodities Futures Modernization Act as the impetus for the wreckless financial gambling of the last 8 years. For sure, this is not wrong and various measures of reform are now working their way through the Congressional process.

However, in an excellent article published in the April edition of Harper's Magazine, Thomas Geoghegan argues that we have not focused enough on the big deregulation that precedes all other deregulation. For him it was the day that America changed. His essay is titled: Infinite Debt; How Unlimited Interest Rates Destroyed The Economy.

. . . no amount of New Deal regulation or SEC-watching could have stopped what happened…The problem was not that we ‘deregulated the New Deal’ but that we deregulated a much older, even ancient, set of laws. We dismantled the most ancient of human laws, the law against usury, which had existed in some form in every civilization from the time of the Babylonian Empire to the end of Jimmy Carter’s term.

As Geoghegan explains it, the big deregulation is contained in the Supreme Court decision of December 18, 1978 in the case of Marquette National Bank v. First of Omaha Service Corp.

Minnesota was trying to impose its law against usury on an out-of-state bank. The Court held that Minnesota could not cap the credit card of a Nebraska bank, because both banks were subject to the National Banking Act of 1864, which allows national banks to charge interest at the rate set by the state "where the bank is located", regardless of the laws in the state where the bank is actually lending money. So it became the law of the land: the old, state-mandated top rates of nine percent or so were gone; now, thanks to the Supreme Court and the National Banking Act of 1864, there were no effective caps on what the big national banks could charge credit-card holders.

Yep, who could have foreseen credit cards in 1864? The removal of interest rate caps were obviously harmful to the average person. But Geoghehan goes on to show the far reaching impact the ruling had on American manufacturing and the demise of the middle class.

It may be hard to grasp how the dismantling of usury laws might lead to the loss of our industrial base. But it's true: it led to the loss of our best middle-class jobs. Here's a little primer on how it happened.

First, thanks to the uncapping of interest rates, we shifted capital into the financial sector, with its relatively high returns. Second, as we shifted capital out of globally competitive manufacturing, we ran bigger trade deficits. Third, as we ran bigger trade deficits, we required bigger inflows of foreign capital. We had "cheap money" flooding in from China, Saudi Arabia, and even the Fourth World. May God forgive us - we even had capital coming in from Honduras. Fourth, the banks got even more money, and they didn't even consider putting it back into manufacturing. They stuffed it into derivatives and other forms of gambling, because that's the kind of thing that got the "normal" big return; that is, not five percent but 35 percent or even more.

Go back to the top and repeat the sequence. It was what scientists call an autocatalytic reaction. It just kept going. All of that cheap money would have been a good thing if it had gone into manufacturing. But it didn't. The capital inflows from the big trade deficits couldn't go into manufacturing because the returns in banking were just too high. And because this autocatalytic reaction kept going - as long as there was the imbalance between finance and industry - the system could not readjust or stabilize. The bigger the deficit, the bigger the capital inflow; and the bigger the capital inflow, the bigger the financial sector became; and the bigger the financial sector became (relative to manufacturing), the bigger the trade deficit became.

Geoghegan acknowledges there were other key ingredients involved in helping the financial sector become so dominant. Employers found out they could ignore the Wagner Act, which led to a decline in organized labor's influence. Moreover, employers began using Chapter 11 bankruptcy provisions to cancel the earned rights of their employees and dump their obligations not only to workers but retirees as well. He is particularly critical of the labor movement for not being a better guardian of the manufacturing sector.

After the dot-com bust, we lost even our taste for investing in high tech. But we missed those dot-com profits, and so we turned our powers of invention to the bubbles themselves. We invented bigger and better pumps, in the form of new financial products. The good news was that these new financial products would continue to give the kinds of returns that the financial sector had, in a post-usury-law world, come to expect.

But there are at least two paradoxes here.

Paradox one: "You say interest rates were too high, but in fact, the Fed rate, which sets most other interest rates, has rarely been lower than it was over the course of the past decade". I admit it's paradoxical. But as we now know, with low-interest mortgages - even the subprimes - the interest rates really were high, because they were variable. People took these loans in the same way they got credit cards, and paid no interest for the first three months. They were teasers or loss leaders. And even if those rates did not rise "variably", a mortgage with very little down is a guarantee that the new "owner" is so house poor that he or she will need other kinds of debt to get by - credit-card debt at 35 percent.

Paradox two: "You say the banks were awash with money, but in fact it now seems the banks were all broke". After all, the Treasury is now trying to bail out the banks themselves by injecting them with hundreds of billions of taxpayer dollars. It's trying to fix the books. But if the banks had such high returns - if they were making such a killing on interest - how is it that now they have no assets?

It's easy for the banks to go broke, fast, or to let their assets run down, if they can lend at rates of twenty percent to 35 percent. Why keep anything in reserve? That's what bankers did when there were caps on the returns! But not now: remember CitiBank's famous ad, "Put Your Money to Work".

Well, it's so cynical for a bank to say that, I thought. It's a euphemism for saying: "Hey, you're not in enough debt - you need to be in more debt".

But it seems CitiBank believed its own ads. That's why it collapsed. "Put your money to work". Now Robert Rubin's bank has gone belly-up. Like a homeowner with a second mortgage, it was "putting its money to work". Of course, equity left in the bank would have been "working" or making some return, but the people who ran our banking system believed they could make even more in a banking culture in which all the caps on interest rates were off.

The insidious effect of infinite debt is the resulting disinvestment of manufacturing in favor of finance. Instead of seeing real wages increase with productivity gains over the past 35 years, the working class settled for easy credit. This only served to accelerate the flow of capital from manufacturing to the financial institutions. The results today are a very bloated financial sector with little manufacturing base on which to stage a recovery. Even so, Geoghegan has some ideas on what we need to do.

• Pass new laws against usury. Cap interest rates. Establish a federal agency to conduct annual reviews of banks for honesty and fairness.
• Create a system of state-owned banks, similar to the German banks known as the Sparkasse. Eliminate all bank fees, discourage oppressive collection cases and stop gratuitous destruction of people's credit ratings. These banks would lend only to the most credit worthy and set benchmarks for not only how private banks should behave, but also how people should behave.
• Restructure the board of directors at banks and financial institutions that have taken public money. New boards should be constituted which include at least one or two "public guardians" as directors.
• The banks we have bailed out should follow the Golden Rule. (i.e. They would be required to cancel an appropriate amount of consumer debt, especially in instances where people would have paid back the principle, had the interest rates been more reasonable.)
• Explore ways to inject equity directly into the accounts of working people rather than banks.

This is merely a brief overview of a very entertaining and enlightening essay. You can read the entire article in the attached pdf file. Also, in case you have been wondering, yes, this is THE Thomas Geoghegan who ran in the IL-05 special election to fill Rahm Emanuel's open seat. Unfortunately, he wasn't able to really explain some of the very progressive ideas he has in the short time frame that election allowed. Hopefully, he will try again in the future.