We blame our financial crisis on the non-regulation of large banks with reason but our joblessness is not just the result of the financial crisis. It is also the result of the changing technologies.  And this has gone on for quite awhile.

First it was the technology advances in agricultural that threw thousands off the farms. So millions migrated to manufacturing jobs in the cities.  Before robots, automobile plants gave a large proportion of the working class a middle class income. Then manufacturing jobs disappeared in large numbers, partly due to international corporations taking jobs abroad and partly due to technology.

Service jobs don’t pay as well as manufacturing jobs. But even in serven jobs, automation has come. Years ago a good living could be made as a secretary, the vast majority of those jobs are gone. We are our own secretaries. Today a parking lot has no attendants, just a machine to print your ticket and take your money. Now it is the service jobs being auomated.  These kinds of manufacturing and service jobs which used to give the working class a wage are leaving us.

Of course, we still have an important manufacturing sector. High tech was the largest overseas industry export, with U.S. high-tech manufactured goods comprising 17.8 percent of total U.S. exports in 2009.  The Tech America Foundation reports that the U.S. high-tech industry lost 115,800 net jobs in 2010, for a total of 5.75 million workers. Of course, we don’t know how many of these jobs were shipped overseas and how many were losses to the recession or to automation. We do know that we are still importing more high-tech merchandise than we export.

• U.S. high-tech imports reached $299 billion in 2009, down 11 percent from $336 billion in 2008.
• U.S. high-tech merchandise exports totaled $188 billion in 2009, down 16 percent from $223 billion in 2008.

The Economic Policy Institute, a Washington think tank, says American companies have created 1.4 million jobs overseas this year, compared with less than 1 million in the U.S in 2010. Even the manufacturing jobs remaining are under threat by the use of visas bringing in high tech professionals instead of hiring Americans. Why would this happen? Because hiring foreigners for domestic jobs is cheaper.

What strategies can we adopt? Some countries protect their workers. Brazil is booming and it has a government that seeks to protect jobs through tariffs. But American policymakers, regardless of party, believe that tariffs backfire. Unfortunately, it is more complicated than that. And our public policymakers don’t do well with complicated. Take the controversey over the Obama administration’s attempt to suppor the solar panel industry. We used to be the largest producer of solar panels in the world. China has become the number one producer of solar panels in the world but if we supported the solar panel industry the way China supports its solar panel industry, we would have remained number one. Whent the Obama adminstration sought to financially support the solar panel industry, the administration came under attack when one loan failed.

How can we possibly change the path we have taken? Not easily. The first step is to recognize that we have a problem. And public policymakers are not willing. Our Congress is tied into campaign donations from multi-national corporations that wish to continue sending jobs overseas. So the very leaders who should be focusing on the quality and quantity of jobs are compromised. 

Josh Lerner. professor at Harvard Business School, cited that there are government strategies which are useful. The Bayh-Dole Act of 1980, encouraged innovation because universities got automatic title to research paid by the federal government. And this encourages universities to engage in research. President Obama has encouraged the growth of green jobs without much success to date. But at least it was a recognition that the problem is there.

The Kaufman Foundation found that from 1980-2005, nearly all net job creation in the United States occurred in firms less than
five years old. This data set also shows that without startups, net job creation for the American economy would be negative in all but a handful of years. So clearly at least one possible strategy would be for our policymakers to support startups. But there are few strategies out there. We need to focus on how to create good paying jobs.

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When Standard & Poor’s warned it would lower the U.S. government’s AAA credit rating by one or more levels even if Congress raised the debt limit in time to avert a default, all sorts of dire predictions were made about the monetary system.

One predictions was that if Standard & Poor’s lowered their rating to AA+ that such an action would “modestly raise” the federal government’s borrowing costs. That did not happen.

Another prediction by Fitch Ratings was that “As money market funds hold approximately $1.3 trillion in U.S. Treasuries, nearly half of their total $2.7 trillion in assets, investors would probably be spooked in the event of a default by the U.S. government and rush to the exits to redeem their shares.” That did not happen.

Remember the opposite happened when Standard & Poor’s lowered their rating. There was a rush to buy U.S. Treasuries and borrowing costs were lowered. U. S. Treasuries are still seen as one of the safest investments in the world.  So much for predictions.

But it is interesting that people were worried about it. And it led me to wonder about the market’s fears. I have questions about all the borrowing that goes on withU.S. Treasuries and their relationship to “repos.” Before this discussion, let me say this -

I would submit that the financial crisis was not caused by homeowners borrowing too much money. It was caused by giant financial institutions borrowing too much money, mainly on the “repo” (repurchase) market. Have you ever heard of the “repo” market which is one of the largest markets in the world?

First, let’s talk about U.S. Treasuries. The United States government borrows money through issuing Treasury securities which come ion four types, short-term treasury bills (T-bills), Treasury Notes (one to ten years), Treasury Bonds, (20 to 30 years) and TIPS (Treasury Inflation Protected Securities for 5, 10, and 30 year maturities.

The Repo Market uses U.S. Treasuries. Repos is short for repurchase agreements between large institutions which loan money to dealers usually overnight. Let’s say that you are a large company and you have $20 million that you don’t need until tomorrow.  You make a deal with a dealer that has borrowed money in the form of U.S. Treasuries from a cleaning bank. The deal might be 5% for the use of your $20 million overnight which amounts to $2777.78 for the company. The dealer uses the company’s money overnight and repays the company in the morning with interest. The dealer is an intermediary between a clearing bank and a large institution which has big bucks for a few hours – corporations, banks, state and local governments. All sort of institutions use the repo marker, usually overnight.

What happened in September 2008?

“What happened in September 2008 was a kind of bank run. Creditors lost confidence in the ability of investment banks to redeem short-term loans, leading to a precipitous decline in lending in the repurchase agreements (repo) market.” –Robert E. Lucas, Jr., Nancy L. Stokey, visiting scholars, Federal Reserve Bank of Minneapolis, May 2011.

That is why a possible default of the U. S. Government is such a big deal. It is the fear factor. Any decline in the value or the liquidity of U.S. Treasuries would result in increased margin calls which pressures the overall availability of funds in the repo market. What if the dealer could not repay the company in the morning? What if that happened all over the country? That was September 2008.

Repurchase agreements (repo) are the largest part of the ’shadow’ banking system: a network of demand deposits that, despite its size, maturity, and general stability, remains vulnerable to investor panic.” –Jeff Penney, senior advisor, McKinsey & Company, June 2011.

Professor Gorton talked about Repos’ flaws: “Repo has a flaw: It is vulnerable to panic, that is, ‘depositors’ may ‘withdraw’ their money at any time, forcing the system into massive deleveraging. We saw this over and over again with demand deposits in all of U.S. history prior to deposit insurance. This problem has not been addressed by the Dodd-Frank legislation. So, it could happen again. The next shock could be a sovereign default, a crash of some important market — who knows what it might be?” –Gary B. Gorton, Professor of Management and Finance, Yale School of Management, August 14, 2010.

Look at http://repowatch.org/

Unfortunately, there has been little attention paid to the Repo market; it is too big to be unregulated without controls. Could it happen again? Yes, it could happen again. Large institutions could get scared and want their money back and dealers may not have the funds at that moment.

What is free trade? Free trade means that nations agree to trade goods and services without government interference – no tariffs, no underlying government regulation. The concept of free trade is supported by mainstream economics (neoclassical) which assumes that there is a level playing field worldwide; that free trade means governments do not help the private sector.

However, we know that is not the case. China’s government has put enormous investment in certain of its industries. One example is solar energy. China’s government has invested in this industry with the result that China now leads the world in the production of solar panels. There are dozens of examples of governments investing in private companies to help them in the tough worldwide competition that has developed.

America companies who put their manufacturing plants in China benefit enormous. It is called the “free rider.”  American companies with manufacturing plants keep reaping all the rewards of selling to an enormous, high-price market like America’s. But their China supply bases enable them to avoid many of the costs of this market’s upkeep. Principally, they don’t need to bear the financial burdens of employing relatively expensive American workers. And they can dodge the taxes that pay for the regulatory apparatus, schools, and other public services essential for maintaining the nation’s prosperity and quality of life.

Free trade advocates ignore these issues.  Prof. Peter Soderbaumof Malardalen University, Sweden, “This neoclassical trade theory focuses on one dimension, i.e., the price at which a commodity can be delivered and is extremely narrow in cutting off a large number of other considerations about impacts on employment in different parts of the world, about environmental impacts and on culture.”

Of course Soderbaum is right. Free trade has had an enormous impact on employment in this country.

What are multinational corporations? Since 1977, the Bureau of Economic Analysis has tracked U.S.-headquartered multinationals through legally mandated surveys that collect and publicly disseminate operational and financial data. It tracks all multinational companies headquartered in the United States. The BEA defines a U.S. multinational company as any U.S. enterprise that holds at least a 10% direct ownership stake in at least one foreign business enterprise.

There was a wonderful blog called the fourteenth banker, an anonymous writer, and he or she wrote about the financial services industry from the inside.  At one point he/she quoted Harold Meyerson of the Washington Post who pointed out that “the share of the profits of U.S.-based multinationals that came from their foreign affiliates had increased from 17 percent in 1977 and 27 percent in 1994 to 48.6 percent in 2006. As the companies’ revenue from abroad has increased, their dependence on American consumers has diminished. The equilibrium among production, wages and purchasing power – the equilibrium that Henry Ford famously recognized when he upped his workers’ pay to an unheard-of $5 a day in 1913 so they could afford to buy the cars they made, the equilibrium that became the model for 20th-century American capitalism – has been shattered. Making and selling their goods abroad, U.S. multinationals can slash their workforces and reduce their wages at home while retaining their revenue and increasing their profits.”

Congress and the President have not addressed the impact that multinational corporations have had on our economy, and especially on our workforce. Unfortunately, as long this country’s policymakers continue to focus on piecemeal solutions to our broken economy, we will continue to bleed jobs.

The federal government taxes corporations from 15 to 35 percent of their profits. Corporations, those organized under the C category in the IRS code, argue that the corporate taxes in the United States are much too high as compared to other countries. It is actually more complicated than that. (Remember we are not talking about S corporations, such as lawyers, doctors, etc., which are not incorporated and are a limited liability corporation. Taxes on S corporations are taxes on the individual, not a corporation, and thus are governed by the IRS’ individual income tax rates.)

First, what are coroporate tax rates in this country? The federal corporate tax rates in 2010 as defined by the Legal Information Institute of the Cornell Law School are:

(A) 15 percent of so much of the taxable income as does not exceed $50,000,

(B) 25 percent of so much of the taxable income as exceeds $50,000 but does not exceed $75,000,

(C) 34 percent of so much of the taxable income as exceeds $75,000 but does not exceed $10,000,000, and

(D) 35 percent of so much of the taxable income as exceeds $10,000,000.

The United States has one of the highest corporate income tax rates on paper at least – 35 percent. Next comes Australia and New Zealand at 30 percent. On the low end is Ireland with 12.5 percent.

 Now we come to the important question. Do corporations actually pay those rates? Of course not.

The IRS tax code taxes a corporation’s taxable income. This means the gross income (sales minus the cost of goods sold and any tax exempt income); then the corporation can subtract allowable tax deductions including depreciation expense.

The first fact about this corporate tax rate is that American corporations do not pay taxes on overseas profits unless they bring those profits back to the United States. This is a clear incentive to keep monies abroad.

The second fact about this corporate tax rate is that American corporations can become a foreign corporation by stating that its headquarters are in another country and still operate in the United States. They then pay the corporate income tax of that foreign country. Currently, Switzerland is a favorite having a corporate tax rate of 12 to 15 percent depending upon what town the corporation resides. Sixty Minutes did a show on corporate taxes, or the lack of them, and it is clear that whatever tax law is passed, the corporations have teams of lawyers to figure what how to get around the taxes.

My favorite story from the Sixty Minutes piece is when U.S. Representative Doggett proposed legislation that a corporation should be taxed on where their top management actually resides, not on a piece of paper. Based upon this proposed legislation, two multinational corporations that had headquarters in the United States shipped their top management to Geneva.

It is true that in 2004 Congress passed a law that said any corporation that moves overseas must continue to pay U.S. tax rates. But there are so many loopholes, the legislation is not effective.  Many of the loopholes come in the form of tax credits as well as generous rules allowing corporate losses to be carried forward for twenty years.

The New York Times recently had an article talking about how corporations used the loopholes: “Of the 500 big companies in the well-known Standard & Poor’s stock index, 115 paid a total corporate tax rate — both federal and otherwise — of less than 20 percent over the last five years, according to an analysis of company reports done for The New York Times by Capital IQ, a research firm. Thirty-nine of those companies paid a rate less than 10 percent.”

The Urban Center and Brookings Institution report that – “Revenue from the corporate income tax fell from between 5 and 6 percent of GDP in the early 1950s to 2.1 percent of GDP in 2008.”

If Congress were working properly, we could very well lower the corporate tax rate and gain more tax revenue by simply closing all the loopholes. But the current Congress is more likely to lower the corporate tax rate and not close the loopholes.

Yuliya Demyanyk as a senior research analyst works for the Federal Reserve in Cleveland. She has documented the rise and fall of the subprime mortgage industry. A subprime mortgage is a mortgage given to a individual whose credit rating is dubious. Often suprime mortgages were adjustable-rate mortgages; that is, the interest rates were not fixed but could increase given the terms of the loans. This definition of a subprime mortgage is simplistic. Demyanyk pointed out that lenders sometimes labeled a mortgage subprime, even if the borrower had a good credit rating if the loan was unusual such as a fixed rate mortgage changing into an adjustable rate mortgage after a certain number of years. Demyanyk considers this one of many myths about the subprime mortgage industry during the collapse.

The subprime mortgage industry was only 16 percent of all U.S. mortgage debt in 2008. Why then did the suprime mortgage collapse play such a major role in an international financial crisis? Demyanyk states that the complexity of the subprime mortgage industry lent itself to creating leverage problems in the financial institutions. Subprime mortgages were packaged into securities that were repackaged into complex financial instruments called derivatives. The financial institutions split these derivatives into tranches and sold them to customers such as pension systems. Thje financial institutions became highly leveraged as they bought more and more of these securities to sell them. The credit rating agencies which received fees from the financial institutions helped the boom by rating 80% of these securities as triple AAA. When enough of these mortgages starting defaulting, the securities lost their value and the financial institutions were threatened. They were threatened not only because they had gone into so much debt buying these securities but because of the complexity, no one could figure out what any of the tranches were worth. Hence, the government bailout commenced.

Greed makes individuals stupid.

PS. If you would like to read more about Demyanyk’s research, click on the link.

 Levitin and Wachter wrote a terrific paper on the role of investment banks in the housing collapse and the shift from regulated to unregulated securitization:

 “…it was the result a fundamental shift in the structure of the mortgage finance market from regulated to unregulated securitization…..  Prior to 2003-2004, most mortgage-backed securities (MBS) were issued by regulated government-sponsored entities (GSEs), Fannie Mae and Freddie Mac and the federal agency Ginnie Mae (collectively with the GSEs, the “Agencies”). In 2003-2004, the market shifted radically toward MBS issued by unregulated private-label securitization conduits, typically operated by investment banks. The shift occurred as financial institutions sought to maintain earnings levels that had been elevated during 2001-2003 by an unprecedented refinancing boom due to historically low interest rates…..Thus, the shift from Agency securitization to private-label securitization also corresponded with a shift in mortgage product type, from traditional, amortizing, fixed-rate mortgages (FRMs) to nontraditional, structurally riskier, non-amortizing, adjustable-rate mortgages (ARMs), and in the start of a sharp  deterioration in mortgage underwriting standards.”

According to Mortgage Finance’s Statistical Annual Report, fixed-rate mortgages made up over 75% of conventional loans in 2002-2003. In 2004, fixed-rate mortgages dropped to a 66% market share.

Levitin & Wachter point out that the growth of privately labeled mortgage-backed securities (PLS), forced the GSEs to lower their underwriting standards in an attempt to reclaim lost market share. The GSEs private shareholders insisted that the GSEs reclaim market share. Shareholder pressure pushed the GSEs into competition with PLS for market share, and the GSEs loosened their guarantee business underwriting standards in order to compete. In contrast, the wholly public FHA/Ginnie Mae maintained their underwriting standards and ceded market share.

Federal Reserve Board data show that:

• More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.
• Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.

What I like about Levitin & Wachter is the focus on investment banks in the housing prices collapse rather than the Morgenson’s trashing of Fannie Mae and Freddie Mac that was only part of the problem.

The current rage in analyzing the current housing crisis is the book by Gretchen Morgenson, Reckless Endangerment. A financial editor and columnist for the New York Times, Morgenson blames the housing prices collapse on government affordable housing policy in league with Wall Street. I have two problems with her book.

First, Morgenson is right on target talking about the lack of regulatory effort, but her history starts with the Clinton adminstration that sought and succeeded in broadening home-ownership. She documents the role President Clinton played in reducing regulations over the banking industry which helped to bring about the housing prices collapse. Morgenson focuses on the mismanagement of Fannie Mae and Freddie Mac and the close relationship between the investment banks and themselves, but what she failed to do was to return to the beginning of deregulation.

Deregulation did not begin with President Clinton’s administration. It began with the Depositary Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) which set a relatively high variable-rate ceiling for all banks and preempted state usury laws with respect to first mortgages. What a disaster that was! Morgenson doesn’t mention it. Then the 1982 Germain Depository Institutions Act freed up the savings and loan banks with disastrous results. Remember those – the S&Ls. The Alternative Mortgage Transaction Parity Act (AMTPA) as part of the DIDMCA prohibited any state law from restricting alternative mortgage financing such as balloon payments and adjustable rate mortgages. The conservatives had taken over the Presidency and their first actions were to prevent states from protecting its citizens against banking greed. So much for states’ rights.

To top it off, Congress passed the 1984 Secondary Mortgage Market Enhancement Act (SMMEA). This allowed the banks to compete with Frannie Mae and Freddie Mac. It opened the door to private mortgage backed securities (MBS). What is that? It is the process of buying mortgage loans from banks, pooling the mortgages, and selling them.

The second issue is Morgenson’s statements that the “Wall Street” learned so much from Johnson at Fannie Mae. The idea that the financial elites learned from the public sector betrays an ignorance about the role financial elites have played in American history.

Read it but remember the forest, not just a few trees.

In 1997, Brooksley Born, now retired, directed a small federal office, the Commodity Futures Trading Commission, the federal agency which oversees the futures and commodity options markets. However, she was blocked from overseeing off-exchange markets for derivatives.(Derivatives are so-named because they derive their value from something else, such as currency or bond rates.)

She wanted to release a “concept paper” — essentially a set of questions — that explored whether there should be regulation of over-the-counter derivatives. President Clinton’s economic advisors were furious with her.

CFTC regulation was strenuously opposed by Federal Reserve chairman Alan Greenspan, Treasury Secretaries Robert Rubin and Lawrence Summers.

Simon Johnson and James Kwak in their new book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, stated: ” Larry Summers, Deputy Treasury Secretary for President Clinton called her and said: ‘I have thirteen bankers in my office, and they say if you go forward with this you will cause the worst financial crisis since World War II.’” Unintimated, Born released a concept paper the following year much to the chargin of Clinton’s economic team.

A year later,following the suggestion of Clinton’s economic team, Congress enacted the Commodity Futures Modernization Act, which effectively gutted the ability of the CFTC to regulate OTC derivatives. With no other agency picking up the slack, the market grew, unchecked.

Years later she was proven right. The failure to regulate derivatives helped bring on the greatest recession since the Great Depression. In 2009, she was awarded the John F. Kennedy Profiles in Courage Award in recognition of the “political courage she demonstrated in sounding early warnings about conditions that contributed to the current global financial crisis”.

Although Democrats try to trace the causes of the financial crisis back to the Bush administration, clearly, President Bush and Clinton both contributed to the current financial crisis as did Congress. The next time you see a Congressional hearing and the Congressmen and women are chastising the bankers, remember the legislation that Congress passed.

“Oh, yes, we have class warfare in America. My class is winning.”

                                                                              Warren Buffet

In our current financial crisis, the activity of significant lending by banks to those who wanted to own a home was followed by those banks selling off the mortgage loans to investors. This had two consequences: the banks no longer were responsible for their loans (the loans were not on their balance sheets); thus, the banks became incredibly irresponsible about whom they would loan money; and two, once the mortgages were sold, the investors bundled those loans, and, thus, no one was able to keep track of who’s got what and to whom. This bundling is called securitization.

Of course we can change this. We can regulate the banks. We used to do that . It was called the the 1933 Glass-Steagall Act and it prevented banks from being so irresponsible that they could sell mortgages. Over time the Glass-Steagall Act’s powers were eroded by both Republicans and Democrats. (Yes, the Democrats were also responsible, not everything can be blamed on Ronald Reagan.)

Not only did Congress eroded the Act so did the Federal Reserve Board which has regulatory jurisdiction over banking, but not the stock market. Therein lies the rub. The banks were increasingly losing profits to nonbanking institutions who were intruding on banking territory. Congress got so nervous that in 1994, when Congress was still under Democratic rule, Congress passed the Home Owners Equity Protection Act. It empowered the Federal Reserve board to make rules for mortgages even for institutions that were not banks.  (I say this in case you think it doesn’t matter which party wins – it does matter).

Wonderful! Except Mr. Greenspan, head of the Federal Reserve, did not enforce the regulation. Remember Mr. Greenspan, he believed in the power of the market to self-regulate. We didn’t need regulation.

Now we are at the point where most sensible people say – we need regulation, let’s figure out what that will be.  However, we have the Republicans saying we have too much regulation and since the minority is running the Senate, we could end up with no new regulation to address this financial crisis.  What a country!