The Deficit Commission Proposals to cut social security

Washington, D.C.- Dean Baker, Co-Director of the Center for Economic and Policy Research (CEPR) released the following statement on the proposals offered by Erskine Bowles and Alan Simpson, co-chairs of the President's deficit commission: "Senator Alan Simpson and Erskine Bowles appeared to have largely ignored economic reality in developing the proposals they presented to the public today. "The country is suffering from 9.6 percent unemployment with more than 25 million people unemployed, underemployed or who have given up looking for work altogether. Tens of millions of people are underwater in their mortgage and millions face the prospect of losing their home to foreclosure. "This situation is not the result of government deficits, contrary to what Mr. Bowles seemed to suggest at the co-chairs' press conference today. The downturn was caused by the bursting of an $8 trillion housing bubble. This bubble was the basis of the construction and consumption demand that drove the economic expansion through 2007.  "The large government deficits are the only factor sustaining demand following the loss of this bubble wealth. If today's deficit were smaller, we would not be helping our children; we would just be putting their parents out of work. Simpson and Bowles somehow think they have covered this concern by delaying their cuts until fiscal year 2012, 11 months from now. Virtually all projections show the unemployment rate will still be over 9.0 percent at the point when the Simpson-Bowles cuts begin to slow the economy further. This leaves the economy like a plane with one engine already out and Simpson Bowles prepared to knock out the other engine as well. "The failure to understand current deficits contributes to a misunderstanding of the debt burden. For example, Simpson and Bowles raised fears of an exploding debt reaching 90 percent of GDP by the end of the decade. There is no reason that the Fed can't just buy this debt (as it is largely doing) and hold it indefinitely If need be, the Fed can use other tools at its disposal to ensure that this expansion of the monetary base does not lead to inflation. "This creates no interest burden for the country, since the Fed refunds its interest earnings to the Treasury every year. Last year the Fed refunded almost $80 billion in interest to the Treasury, nearly 40 percent of the country's net interest burden. "This means that the country really has no near-term or even mid-term deficit problem, just paranoia being spread by many of the same people who led the economy into its current disastrous situation. "Over the longer term, the country is projected to face a deficit problem but this is almost entirely attributable to the projection that private sector health care costs grow at an explosive rate. This projected growth rate of health care costs would eventually lead to serious budget problems in addition to leading to enormous problems for the private sector. However, the underlying problem is the broken health care system, not public sector health care programs. For some reason, though, Simpson-Bowles never directly addresses these of the health care system. "Simpson and Bowles apparently never considered a Wall Street financial speculation tax (FST) as a tool for generating revenue. This is an obvious policy-tool that even the IMF is now advocating, in recognition of the enormous amount of waste and rents in the financial sector. Through an FST, it is possible to raise large amounts of revenue, easily more than $100 billion a year, with very little impact to real economic activity. The refusal to consider this source of revenue is striking since at least one member of the commission has been a vocal advocate of financial speculation taxes. It is also worth noting that Mr. Bowles is a director of Morgan Stanley, one of the Wall Street banks that would be seriously impacted by such a tax. "Finally, it is striking that the Co-Chairs felt the need to address Social Security, even though it was not part of their mandate. The commission's mandate was to deal with the country's fiscal problems. Since Social Security is legally prohibited from ever spending more than it has collected in taxes, it cannot under the law contribute to the deficit. Their proposal would cut benefits for tens of millions of middle class workers who are overwhelmingly dependent on Social Security for their retirement income. It would also raise the retirement age for lower income workers who have seen little increase in life expectancy. "While there are some positive items in the report (it would limit the mortgage interest rate deduction get rid of the deduction for cafeteria benefit plans), it suffers from the fact that the co-directors never reflected on their basic economic assumptions. It is hard to avoid the conclusion that this exercise was a waste of time and that we should go back to having Congress determine our budgets through the normal process rather than secret commissions." ###

The Deficit and our children: Some facts please

The Deficit and Our Children: Just the Facts

Share  Dean Baker Truthout, April 26, 2010 This is deficit-fest week with President Obama’s deficit commission scheduled to have their big public kickoff on Tuesday, followed by an all-day affair sponsored by the Peter G. Peterson Institute the next day. If the deficit hawks succeed, everyone should be really really scared about the deficit by the end of the week and just dying to cut Social Security and Medicare for the sake of our grandchildren. While there will be many facts about the debt and deficit tossed out at these gala events, there are some important tidbits of information that are likely to go unmentioned. So, courtesy of billionaire investment banker Peter G. Peterson (not) we bring these facts to you here. Under any plausible set of projections, our children and grandchildren will enjoy far higher standards of living than we do today. On average, real hourly compensation is projected to rise by at least 1.2 percent a year. This means that workers in the year 2040 will enjoy compensation levels that on average are more than 40 percent higher than what workers receive today. This means that even if they paid hugely higher taxes, our children and grandchildren will have far more after-tax income than we do today. There is a problem of inequality so that most workers may not share in this income growth. Due to the growth of inequality, most workers have seen little improvement in living standards over the last three decades. If the trend towards growing inequality continues, then workers in 2040 may not be much better off than workers today, but that is an issue of intra-generational inequality, not inter-generational inequality. Fixing inequality would cause us to focus on issues like trade policy, the ability of workers to join unions and taxpayer subsidies to the financial sector, not budget deficit. The reason that the country is projected to face enormous deficits in the future is our broken health care system. We pay more than twice as much per person for our health care as people in Canada, Germany and other wealthy countries. This gap is projected to grow even larger in future decades. We have little obvious benefit from this additional spending, since people in all these countries have longer life expectancies than we do. If our per person health care costs were comparable to those in other countries then our budget projections would show huge surpluses, not deficits. The debt to China has nothing to do with the budget deficit and does not present the disastrous risks claimed by the deficit hawks. The United States borrows money from China because of the trade deficit. The budget deficit is beside the point. If we had the same level of GDP and the same value of the dollar against the Chinese yuan, we would have just as large a trade deficit with China today even if the budget were balanced. If we are concerned about borrowings from China, then we should focus on reducing the value of the dollar, not the budget deficit. If we didn’t have a budget deficit, China could be offsetting its trade surplus by buying private assets like shares of General Electric stock or bonds issued by private corporations. Of course, if China wanted to acquire government bonds it could sell these other assets and buy government bonds any day of the week. So, there is no special reason for anyone to be concerned about China owning U.S. government bonds as opposed to any other U.S. financial asset. Finally, the scare story, that China might one day dump its bonds and send the dollar tumbling, is absurd on its face. Both the Bush and Obama administrations were pressuring the Chinese to raise the value of its currency. Are we worried that one day they will dump their huge holdings of dollars and send the yuan soaring against the dollar? In other words, the deficit hawks want us to be worried that the Chinese government will one day do exactly what we have been asking them to do for years: stop buying up dollars to depress the value of the yuan against the dollar. The country faces real problems. In the short-term we face the problem of re-employing people in an economy with near double-digit unemployment. In the longer term we need to rebuild the economy on a cleaner more energy efficient path. And, we desperately need to fix our health care system. How we deal with these problems will determine the well being of our children and grandchildren. Unfortunately, the deficit hawks diverted discussion from the housing bubble when it was growing to ever more dangerous levels. It is unfortunate that even now they can still use their money and power to prevent the country from focusing on the real dangers to the country’s future.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of False Profits: Recovering from the Bubble Economy. He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues.

 

Banking crisis: Baker

A Talk With Dean Baker: "We Really Need Much More
Stimulus"

By Leo Gerard Campaign for America's Future March 4,
2009

http://www.ourfuture.org/blog-entry/2009031004/talk-dean-baker-we-really-need-much-more-stimulus

Leo W. Gerard: Economist James K. Galbraith, the Lloyd
M. Bentsen Jr. Chair in Government/Business Relations
at the University of Texas, recently told Deborah
Solomon of the New York Times that you are 'the person
with the most serious claim' for predicting the
onslaught of the current credit disaster.

The promo for your most recent book, "Plunder and
Blunder: The Rise and Fall of the Bubble Economy"
(PoliPoint Press, 2009), says the fall of the bubble
economy was 'completely predictable.' But you were
standing nearly alone out there for some time yelling,
'The collapse is coming, the collapse is coming.'

When did you get the first inkling that the collapse
was impending and what did that feel like?

Dean Baker: I learned from the stock bubble in the
1990s that the timing was hard to predict but I first
became convinced that it was starting to burst in the
fall of 2006, (house prices had begun to fall) and I
wrote a forecast projecting a recession for 2007. It
turned out that I was still somewhat premature. I was
expecting the price decline to gain speed more quickly
and to have a more immediate impact on the economy.
However, according to the National Bureau of Economic
Research, the official arbiter of recessions, the
current recession did begin in 2007, so I was not too
far off.

As a more general matter, I did feel somewhat
vindicated, although it was striking to me, that even
as the bubble was very much in the process of deflating
in late 2007 or even early 2008, most economists were
still convinced that it would have little consequence
for the economy. I recall repeated pronouncements from
former Treasury Secretary Henry Paulson and Federal
Reserve Board Chairman Ben Bernanke that the problems
were contained in the subprime market.

Gerard: What were the clues you saw that others ignored
or missed?

Baker: For most economists, the idea that a market
would take leave from its senses - that it would be
driven by speculation - is almost inconceivable. Given
that we had just seen a massive bubble in the stock
market, it really should not have surprised people to
see one also develop in the housing market.

The main factor that attracted my attention was the
sudden spurt in house prices beginning in the mid-90s.
For the hundred years from the 1890s to the 1990s,
house prices nationwide had just tracked the overall
rate of inflation. Yet, from 1995 to 2002 (when I first
noticed the bubble), house prices rose by 30 percent in
excess of the rate of inflation.

There was no explanation for this sudden jump in prices
based on the fundamentals of supply and demand. Income
growth had been healthy in the late 90s, but not
extraordinary by the standard of the early post-war
years. Furthermore, income growth had largely stopped
during the 2001 recession.

Population growth was slowing, which should have slowed
housing demand. On the supply side, we were building
houses at near record rates, so clearly there was no
serious supply constraint.

If there is a big run-up in house prices and no obvious
force driving it on either the demand or the supply
side, then it sure looks like a bubble. Just as
additional confirmation, I checked rents, which tend to
more or less follow sale prices. Rents had increased
only slightly more than the rate of inflation in the
late 90s, and by this decade, they were falling behind
inflation. There certainly was no evidence of growing
demand pressure on the housing market there.

Finally, I noticed the rise in vacancy rates. This is
consistent with people buying homes for speculative
purposes. Many investors were willing to gamble on a
high price for a new home or condo, betting that it
would go up even more in the future. Of course, this is
not sustainable. Not many people can afford to keep a
unit vacant for a long time, since it means that they
are paying the mortgage and getting little or nothing
back. The high vacancy rates of this era virtually
guaranteed that the bubble would burst.

Gerard: Did you also see problems with subprime
mortgages contributing to the bubble?

Baker: The problems in the mortgage market were hardly
a secret. The subprime share of the market nearly
tripled from 2002 to 2006. The Alt-A share, which are
typically mortgages taken out by small business owners
with variable income (and often in accurate tax
returns), exploded from around 1 percent to 15 percent.
This should have set off flashing red lights to any
serious economist.

And, the stories about liar loans and phony documents
were everywhere. I was getting e-mail from people
around the country telling me about friends and
relatives employed by mortgage banks who were told to
put in fake numbers so that the banks could issue
loans. Certainly the regulatory agencies must have
known this was going on.

Gerard: But if you noticed those clues, and looking
back on it, those clues are actually quite obvious, why
did the vast majority of financial analysts and
economists and managers for large investment funds
including pensions and endowments, fail to see the
bubble and its implications?

Baker: The bulk of financial analysts and economists
largely repeat the conventional wisdom without ever
seriously trying to assess whether it makes sense. They
unthinkingly follow the conventional wisdom because of
the structure of incentives in their profession. No one
is going to get fired because they didn't see the
housing bubble. In fact, few people are likely to even
miss a promotion because they didn't see the bubble.

Economists and financial analysts are not like
steelworkers or people in other occupations. They don't
get evaluated based on their performance. They can mess
up every day of the week through their whole careers,
and this would be just fine, as long as they messed up
in the same way as their peers.

On the other hand, the few economists/analysts who
spoke up to warn about the bubble were taking huge
risks. Of course, we were all ridiculed at the time. If
you were an economist working at a major investment
bank and tried to tell them that all their big money-
making deals were going to get them in trouble, they
would probably tell you to shut up and fire you if you
didn't.

If the housing market stayed strong and house prices
kept rising or just remained stable, then any economist
who had warned of the bubble would be laughed off as a
chicken little.

In short, the incentives are such that the overwhelming
majority of economists will never challenge
conventional wisdom even if they think it is wrong.
They are there to hold on to their jobs, not to inform
the public about the economy.

Gerard: Did you know the collapse would be this bad?
How bad will it get?

Baker: I knew that it could be very bad. I was trying
to be contained in my pessimism (I couldn't completely
ignore the conventional wisdom either), but I did warn
that the downturn could develop into a Japan-style
financial crisis. This obviously is the case that we
are looking at. Of course, if the Fed and Treasury had
moved more quickly, they could have prevented some of
the damage that the financial system is now seeing.

The same applies to fiscal stimulus. It was painful
sitting through the months of the election campaign and
then the transition when the government was completely
paralyzed. At that point, economists from across the
political spectrum all recognized that the economy
needed further stimulus, but the politics were such
that nothing could move.

As it is, the stimulus package passed by Congress is a
good start, but it is nowhere near big enough to turn
the economy around. The unemployment rate is virtually
certain to shoot past 8.0 percent in the February jobs
report and is likely to hit 9.0 percent by summer. If
we are lucky, the stimulus will provide enough of a
boost to keep the unemployment rate from reaching 10
percent, although I would not take this for granted at
this point.

In addition to higher unemployment, house prices will
continue to fall at least until summer. The big
question in my mind is whether house prices return to
their pre-bubble level or they overshoot on the way
down. At this point, I would bet on overshooting. This
implies an even larger loss of wealth for homeowners,
more foreclosures and more big losses for banks.

Gerard: Will the stimulus stop the free fall?

Baker: If we are to turn things around, we really need
much more stimulus and we need it quickly. My favorite
idea at this point is a tax credit to employers for
giving workers paid time off. For example, if employers
offer paid parental leave or sick leave, or paid
vacation, or increase the days they already offer, then
the tax credit would cover the lost work. This can be a
quick way to get millions of people back to work.

The arithmetic on this is straightforward. Suppose that
employers of 100 million people give their workers an
amount of additional paid time off that is equal to 5
percent of their work time. These employers would
suddenly have demand for 5 percent more workers, or 5
million workers. I can't think of a quicker, less
bureaucratic way to create jobs at this point,
especially now that we have already funded most of the
shovel-ready infrastructure projects.

Gerard: What must be done to prevent this from
recurring?

Baker: There are two key points. First we must rein in
the political and economic power of the financial
sector. The financial sector must serve the real
economy, not the other way around. There is a long list
of reforms that are needed to ensure this outcome, but
the main point is that an efficient financial sector is
a small financial sector.

One way to keep it small is to tax it. If we had a very
modest financial transactions tax, for example 0.25
percent on the purchase or sale of a share of stock, it
would have very little impact on people who invest for
the long-term. However, it would have a huge impact on
people who are buying at 2:00 and selling at 3:00. This
sort of tax would discourage such speculation, making
the markets friendlier to long-term investors.

It would also reduce the size of the financial sector,
since the industry makes much of its profit off this
sort of speculation. In addition, such a tax could
raise more than $100 billion a year. That's real money
even in Washington.

The other point is that a balanced economy, in which
workers share in the gains of growth, is not conducive
to financial bubbles. We didn't have any major bubbles
in the three decades following World War II. During
this period, productivity gains were passed on in wage
gains, which in turn fed consumption, which led firms
to invest in expanded capacity. The basis for the
bubble economy was created in the 80s when this
virtuous circle broke down and workers could no longer
count on seeing their wages rise in step with
productivity.

In short, if we want to prevent another financial
bubble and the sort of economic collapse caused by its
bursting, we should support policies that allow workers
to share in the gains of growth. That sort of world
favors investment in the productive economy rather than
financial speculation.

=====

[Leo Gerard is president of the United Steelworkers of
America (USWA)

[Dean Baker, co-director of the Center for Economic and
Policy Research in Washington, D.C., has written
several books. His most recent, "Plunder and Blunder:
The Rise and Fall of the Bubble Economy" (PoliPoint
Press, 2009), chronicles the growth and collapse of the
stock and housing bubbles and explains how policy
blunders and greed led to the catastrophic market
meltdowns.]

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