The Great Deformation (108 page)

At the end of the day, a random subset amounting to 15–20 percent of US households has made a killing in the mortgage refinancing game since
the financial crisis, and has done so in a manner that embodies the worst features of crony capitalism. Their good fortune came at the expense of society's savers, who had no say whatsoever in this giant wealth transfer; it was effectuated by what amounts to fiscal policy implemented by an un-elected central bank in response to overwhelming pressure from Wall Street speculators.

To be sure, Bernanke and his fellow monetary central planners rationalize their capitulation to Wall Street demands through a lame version of Keynesian stimulus. Households will purportedly have more discretionary income after refinancing their mortgages and so will increase their consumption spending, thereby triggering a round of multiplier effects on sales, production, jobs, and income. This might be labeled the MEW-II doctrine. In this version, however, the equity withdrawal occurs on the monthly installment plan (e.g., lower mortgage payments) rather than in a lump sum cash-out.

That the MEW-II doctrine is actually a pitiful fig leaf is evidenced by the stunning $435 billion decline in personal interest income since August 2008. On the eve of the crisis, the GDP accounts clocked interest income at an annual rate of $1,420 billion, but after four years of aggressive financial repression by the Fed the run rate had shrunk to only $985 billion by August 2012. And those figures are in nominal dollars; in real terms, interest income was down by 40 percent. Needless to say, the negative spending multiplier from this draconian reduction in household interest income easily outweighs any gains from lower mortgage payments.

The facts, then, are quite startling. The Fed has now driven mortgage rates lower than they were even during the 1930s. So doing, it has neither levitated housing prices nor triggered Keynesian spending multipliers, even as it has generated massive, random wealth transfers among American households. There is only one possible explanation, therefore, for the Fed's dogged adherence to this mindless policy; namely, that Bernanke made a totally erroneous depression call and then went all-in on money printing. Now the Fed is stuck, hostage to insuperable Wall Street pressures to continue juicing its bloated machinery of speculation.

THE FALSE DEPRESSION CALL

THAT PETRIFIED WASHINGTON

Wall Street's occupation of the third floor of the Treasury Building could not have been more timely or strategic. Decisively empowered by Bernanke's professorial-sounding depression call, the Goldmanite wheeler-dealers and their bully-boy leader essentially declared economic martial law. For the remaining few months of the Bush administration this
cabal of error, arrogance, and greed kept the fear of depression palpable in Washington—a mood that the spenders and Keynesians of the in-coming Obama White House were quick to exploit.

Yet, even as their massive $800 billion “stimulus” boondoggle was being enacted in February 2009, the severe but swift inventory correction that incepted the previous fall was flattening out. The US economy actually hit bottom and began a natural cyclical rebound by June 2009. By that point in time, not even the first $75 billion of the stimulus bill—that is, one-half of 1 percent of GDP—had hit the spending stream. As documented below, there had been no economic Armageddon looming at all. The politicians had been turned loose for an orgy of spending and tax cutting that had no justification.

That truth is evident in a vast range of data that make a mockery of Bernanke's depression call. For instance, liquidation of manufacturing inventories is always an early catalyst of business downturn, so it is remarkable that the data for 1981–1982 and 2008–2009 are virtually identical. In constant dollars (2000$), the decline in factory inventories was $60 billion, or 14 percent, in the earlier period and $70 billion, or 15 percent, in the recent downturn.

Needless to say, Paul Volcker did not scare the wits out of Washington with a depression call in 1981–1982. He knew full well that an inventory liquidation of this magnitude had occurred in 1974–1975 without triggering anything remotely resembling a depression; and in any event, the inventory collapse during the Great Depression had been four times greater. Likewise, the decline in actual industrial production had been 17 percent during the current cycle, not even remotely in the same ballpark as the 50 percent decline between the 1929 crash and the July 1932 bottom.

In fact, during the nine months after Lehman's failure there is no trace of depression-scale shocks in any of the economic data. And this interval is a fair test of the underlying, or “pre-policy,” path of the US economy because none of the spasm of extraordinary fiscal or monetary stimulus touched off by the Bernanke depression call had yet impacted the data.

Whatever the intent of the monetary politburo in the Eccles Building, for example, its actions had plainly not affected activity rates in the American economy by the end of the June 2009 quarter, the National Bureau of Economic Research's official date for the recession's end. That's because there was no transmission of monetary policy through the credit process, the only real route to the Main Street aggregates of spending and income. In fact, the natural forces of debt liquidation totally overwhelmed the Fed's desperate money printing during this period, explaining why nearly all of
the freshly minted deposits it pumped into the dealer markets and banking system flowed right back as excess reserves on deposit at the Fed.

During the nine months after the Wall Street meltdown, therefore, the Main Street economy was on its own. To be sure, zero interest rates and the Fed's alphabet soup of liquidity programs did serve to bail out insolvent banks and speculators and to restart the Wall Street carry trades after the March bottom. But none of the Fed's monetary juice showed up as added spending power in the real economy, as evidenced by the fact that bank business loans declined by 18 percent, consumer credit shrank by about 5 percent, and home mortgages by 2 percent during this period.

Similarly, as indicated above, the Obama stimulus bill had pumped only modest amounts of incremental dollars into the economy by the time the recession was over. The $800 per family tax relief component, for example, amounted to just $15 per week in reduced withholding, and even that did not become operational until well into the second quarter of 2009.

So what happened during this nine-month interval is pretty clearly an indication of the natural business cycle then under way. Yet, even as the economy rolled over, there were several factors breaking its fall that should have been apparent to any reasonably attentive analyst on September 15, 2008. One of the most important was the automatic fiscal stabilizers—unemployment insurance, food stamps, disability benefits, early Social Security retirement, and reduced tax collections—which had been built into the system for decades.

Another was the fact that the United States had become a service economy and therefore was far less inventory intensive. Total business inventories amounted to about 10 percent of GDP in September 2008, a figure dramatically lower than upward of 35 percent in 1929. This meant that the multiplier effect from inventory liquidation would be far less severe and self-fueling.

The reason for this more benign balance sheet condition was straightforward. On the eve of the Great Depression the primary production industries—agriculture, mining, and manufacturing—accounted for more than 70 percent of GDP. These sectors have a long pipeline of crude, intermediate, and finished inventory and therefore exhibit high inventory-to-sales ratios.

By the time of the 2008 financial crisis, however, the primary production sector had become a mere shadow of its former self, amounting to only 17 percent of GDP. When recession hit the American economy, therefore, the downward spiral of inventory liquidation was muted. Aerobics class instructors, for example, experienced modestly reduced paid hours, but
unlike factories and mines, fitness centers didn't go dark in order to burn off excessive inventories; they stuck to burning off calories.

In fact, by 2008 China, Australia, and Brazil had become the world's new mining and manufacturing economy; that is, the United States of 1930. When upward of 50 million Chinese migrant workers were sent home from idle factories in late 2008, the villages of China's vast interior became the “Hoovervilles” of the present era. So owing to the fact that inventory and production adjustment took place mainly in the outsourced economies abroad and that the automatic stabilizers were already in place at home, there was no downward lurch in US incomes and spending.

The vast difference between 1930 and 2008 is crystallized in the data on personal consumption expenditure and personal income. When the bottom dropped out of the primary production sector during the Great Depression and took employment and incomes down hard, real PCE subsequently plunged by nearly 20 percent. By contrast, even without any significant Keynesian stimulus during the initial nine months after the September 2008 financial crisis, real PCE declined by only 2 percent.

This order of magnitude difference—that is, only one-tenth the Great Depression era impact—is dispositive. Furthermore, the relative resilience of PCE, which accounts for 70 percent of GDP, should have been easily predicted in September 2008, even under the assumption of no extraordinary policy stimulus. Bernanke's depression call, in fact, was reckless and uninformed.

The reason that PCE remained resilient is that in present times roughly 90 percent of personal income comes from private service industries, government jobs, and transfer payments. As Professor Bernanke made his rounds warning about the Great Depression 2.0, there was absolutely no reason to believe income from these sources would plunge.

In fact, during the next nine months government transfer payments rose by 16 percent, or at an annualized rate of $300 billion, and thereby offset the $275 billion drop in total wage and salary income. Moreover, even this 4.1 percent drop in wage and salary income, the raw material for consumption spending, was highly skewed. On the eve of the crisis, government employee compensation was $1.15 trillion, and not surprisingly it increased at a 2 percent rate during the nine months after the Lehman events; likewise, compensation in the private service sector was $4.2 trillion, and it declined only modestly, at a 3.8 percent annualized rate.

On the other hand, the goods-producing industries—manufacturing, construction, and mining—had been shrinking for decades and therefore posted a total payroll of only $1.2 trillion by the time of the financial crisis. So even though wage income in this sector fell at a steep 12 percent rate
during the nine-month period, this drop was a rounding error in the larger scheme of things, amounting to just 1.1 percent of overall personal income.

Ironically, therefore, the long-term structural challenges facing the American economy—the offshoring of goods production and the massive growth of transfer payments and government payrolls not financed by current taxes—functioned as ballast to the Main Street economy in the immediate aftermath of the Wall Street meltdown. Yet none of these structural dynamics were a mystery.

As a plain matter of professional competence, the chairman of the Fed should have known that the vast bulk of wage and salary income no longer came from the inventory-intensive sectors and that consumption spending would be powerfully boosted by automatic transfer payments. There was simply no structural basis for the kind of self-feeding economic free-fall implied in the Great Depression 2.0 horror show that Bernanke pedaled to petrified congressmen.

As it happened, the initial wave of inventory liquidation and labor-shedding triggered by the Wall Street meltdown burned itself out quickly during the first nine months after the Lehman crisis. Thus, business inventories totaled $1.540 trillion in August 2008. While that figure dropped by about $215 billion during the course of the recession, fully $185 billion of the liquidation had occurred by June 2009. Thereafter, business inventories bounced along a bottom of $1.325 trillion from August through December, indicating that the downward momentum of the economy had already dissipated.

The story was similar with nonfarm payrolls. While the recession had technically started months earlier, the jobs count was still 136.8 million as of August 2008. During the subsequent course of the recession, 7.5 million of these jobs were eventually eliminated before the bottom was reached in February 2010. Once again, however, about 6.6 million of this payroll reduction, nearly 90 percent, was completed by June 2009.

During the six months from November through April, job losses averaged 750,000 per month. This heavy labor-shedding cycle occurred because the Wall Street meltdown was the equivalent of an economic punctuation mark; it demarcated that the credit-fueled housing and consumption binge was over. Accordingly, American businesses downsized their payrolls on a onetime basis by about 5 percent, in accordance with the now far less sanguine prospects for the economy—but this did not mark some irrational binge of job destruction that could spiral into depression.

In fact, the labor force adjustment subsided quickly and convincingly. During the May-June period the rate of job loss slowed to 400,000 per month, followed by 250,000 per month in the July-September quarter, and about 135,000 per month in the final quarter of 2009—before the job market
stabilized and then began to rebound in early 2010. The adjustment in business spending on equipment and software was even more short-lived: it dropped by 16 percent between the third quarter of 2008 and the first quarter of 2009, and then stabilized during the June quarter before beginning to recover thereafter.