Bank Bailouts

Let’s start with foreign policy. Within the framework of U.S. geopolitical primacy shared by both parties, Barack Obama has departed significantly from the foreign policy of George W. Bush in both substance and style. With respect to substance, he is fulfilling his campaign promise to draw down U.S. involvement in Iraq cautiously while increasing resources for the fight against bin Laden’s jihadists and their Taliban supporters, who, unlike Saddam Hussein, planned or suborned the 9/11 attacks.

McCain, by contrast, not only supported Bush’s unnecessary and unjustified Iraq war, but has consistently been more hawkish than Bush, as difficult as that may be to imagine. Remember, during the 2000 Republican presidential primary McCain, not Bush, was the initial favorite of the neoconservatives, who proudly called themselves “McCainiacs.” During the second Bush term of 2005-09, Republican realists like Defense Secretary Robert Gates (whom Obama wisely has retained) replaced neocons and neocon-friendly hawks allied with Dick Cheney such as Donald Rumsfeld, Paul Wolfowitz and Douglas Feith. If McCain had been elected, it seems likely that this would have been reversed. Neocons like Elliott Abrams, instead of dwelling in exile at the Council on Foreign Relations, might well be back making foreign policy in the executive branch.

The difference in foreign policy style would have been even more striking. America produces two kinds of soldiers — flamboyant, aggressive warriors like MacArthur and Patton, and quiet, prudent military statesmen like Washington, Marshall and Eisenhower. McCain, the former Navy pilot and son and grandson of U.S. Navy admirals, belongs to the former mold. His patriotic and pro-military oratory is both sincere and moving to Americans — it has often moved me — but proclamations about the virtue of America’s cause and America’s invincible might that go over well in pancake dinners on the campaign trail tend to alarm people in other countries. Whatever his other lasting achievements may be, Barack Obama in only a few months has already proven to the world that all Americans are not vainglorious, swaggering, self-righteous provincials who prefer to lead by intimidation rather than by inspiration and negotiation.

Nowhere is the difference between the Obama administration and a counterfactual McCain administration greater than in Middle Eastern policy. Despite domestic political limitations, President Obama, by taking a hard line on the expansion of illegal Israeli colonies (“settlements”) in Palestine, has stood up to the Israeli right and its American allies more than any president since George Herbert Walker Bush in the aftermath of the Gulf War. If McCain were president, Israel’s far-right Prime Minister Netanyahu would have a close friend in the White House and the executive branch almost certainly would be staffed in part with officials with longtime ties to the Israeli right wing, as it was under George W. Bush.

In foreign policy a McCain administration would have been a third Bush term — or even worse than Bush III, if McCain had brought neocons back to replace the realists of Bush’s second term. In domestic policy, a McCain administration probably would also have been a third Bush term.

McCain opposed Bush’s tax cuts at the time of their passage. However, by the time he won the Republican presidential nomination in 2008, he had not only drunk the Bush Kool-Aid but mixed some more. During the campaign he proposed making Bush’s tax cuts permanent and slashing an additional $300 billion.

To be sure, presidents do not always govern on the basis of their campaign promises (contrast Obama’s campaign rhetoric with his present waffling on military tribunals and Chinese currency manipulation). McCain’s evident lack of interest in economics, compared to military and foreign issues, helped to sink his campaign after the world economy crashed in 2008. It is impossible to be sure how he would have responded to the crisis, had he been elected. But we can make educated guesses about the possibilities.

For one thing, a division certainly would have emerged between Republicans with ties to Wall Street and populist conservatives, particularly if McCain had retained Hank Paulson as secretary of the Treasury. Just as under Obama, under McCain congressional Republicans probably would have opposed bailouts for zombie banks and other too-big-to-fail institutions. The Wall Street wing of each party tends to defeat the populist wing, except during presidential primaries every four years — and then only in rhetoric. So it seems likely that President McCain, perhaps reluctantly, would have consented to a continuation of the Paulson policy of bailing out the financial sector to avoid nationalization. In other words, the McCain-Paulson bailout policy would probably have been very similar to the Obama-Summers-Geithner bailout policy. 

When it came to the question of stimulus spending, in a world where McCain won the White House there also would have been a divide between establishment Republicans like Martin Feldstein, who support a Keynesian stimulus, and die-hard conservatives who are opposed to any government spending, except on war. One of President McCain’s top economic policymakers probably would have been Douglas Holtz-Eakin, his chief economic advisor during the campaign. In January, when the Democratic stimulus bill was being criticized, Holtz-Eakin, who has long claimed that the merits of infrastructure are oversold, argued that there was too much infrastructure spending in the stimulus.

Around the same time, Republican alternatives to the Democratic stimulus were based on tax cuts rather than public spending. In today’s circumstances, as intelligent Republican economists acknowledge, this would be folly. Following years in which Americans borrowed too much, it is necessary to compensate for the collapse in aggregate demand for goods and services with more public spending on infrastructure, public services and social insurance, while Americans gradually return to a pattern of saving more. It would be insanity to cut taxes, allowing recession-crippled public services like fire departments and social insurance like unemployment benefits to collapse, in order to encourage Americans to go deeper into debt by binging at the shopping mall. (Note: Such a consumption-based stimulus makes sense in countries with manufacturing trade surpluses like China and Japan, where there needs to be a shift from overproduction for export to more domestic consumption.)

But the issue is not logic but a McCain presidency. My guess is that in Counterfactual America, the Wall Street and populist wings of the Republican Party would have agreed on a compromise: a stimulus, but a small stimulus made up mostly of tax cuts for individuals and corporations. If President McCain faced a Democratic Congress, as he probably would have, he could have used the threat of a veto to whittle down a Democratic stimulus bill, putting in more tax cuts and cutting out more infrastructure spending and aid to states and cities. That’s my guess, anyway.

If I’m right, then in the summer of 2009 we might have ended up with the worst possible economic policy under President McCain: a zombie bank bailout as costly and misguided as Obama’s, combined with a too-small stimulus made up mostly of tax cuts. Add premature efforts at deficit reduction likely to kill off a feeble economic recovery, and the disaster would be perfect. Given that the zombie bailouts started under Bush and that tax cuts were Bush’s preferred stimulus policy, in economic policy as well as foreign policy a McCain presidency might well have resembled a third term for George W. Bush.

Obama and the Democrats are not perfect and all-wise, nor are McCain and the Republicans always wrong on all issues (that statement should be good for some hate mail!). McCain in earlier years was often praised by liberals for his support of cap-and-trade legislation like the Markey-Waxman bill, which the Obama administration has embraced. But the cap-and-trade approach, as thoughtful environmentalists like Michael Shellenberger and Ted Nordhaus have argued, and the idea of punitive carbon taxes (as opposed to a modest carbon tax, which makes sense) represent a misguided approach to energy reform based on making dirty energy more expensive, rather than seeking to make clean energy cheaper by means of largely public investments in new technologies. Today’s Republican Party — not unreasonably, in my view — favors massive long-term investment in nuclear energy, which would slash greenhouse emissions without raising electricity prices for working Americans or driving even more American manufacturing abroad. The GOP also supports increased drilling on U.S. territory for oil and natural gas, which by lowering the price of both could weaken autocratic and hostile petro-states. I disagree with the Republican Party about most things, but as the saying goes, even a blind hog finds an acorn now and then.

Healthcare is another area where McCain deserves some credit. During the campaign McCain, like Obama, favored subsidizing the purchase of private health insurance by uninsured Americans without eliminating employer health insurance plans. During the campaign Obama criticized McCain for suggesting that this could be paid for by taxing at least some employer-provided health insurance benefits. But now that Democrats want to formulate a real healthcare plan over the summer, there is a growing consensus that the costs of expanded coverage should be paid for in part by taxes on some if not all employer benefits. On that particular issue, and a few others like a greatly expanded child tax credit, candidate McCain was right.

On balance, however, I think it is hard to argue that the country would not be in worse shape today under President McCain than it is in under President Obama. In foreign policy we would probably have a revival of neoconservatism, with incalculable damage to America’s reputation in the world. In domestic policy, President McCain might have used his veto power and an alliance with conservative Blue Dog Democrats in a Democratic majority Congress to salvage the Bush tax cuts and thwart an adequate stimulus. Then there’s regulatory reform of the financial sector, which has yet to occur. As deferent as the Obama administration is to Wall Street, can anyone doubt that a McCain administration would have been even more deferent?

The Obama administration deserves, and can benefit from, thoughtful criticism. But before giving up on Obama after only a few months, critics of this president should ask: WWMD? (What Would McCain Do?) 

Here’s their business model: “We place highly leveraged bets, sometimes as much as 35 or 40 to 1. In return, the government implicitly agrees to bail out our banks, and if we’re fired, we’ve negotiated sweetheart deals with golden parachutes. If we bet right, then our banks keep the windfall profits and we get big bonuses. If we bet wrong, not to worry — the taxpayers will bail out our banks and the government will pay for the cost of the bailouts by cutting Social Security and Medicare. Suckers!”

While TBTF rigs pre-tax income for financial elites, American tax law rigs their after-tax income to their benefit. In the 1980s, capital gains tax rates were equal to income tax rates. But then in the 1990s Clinton and the Republican Congress lowered the capital gains rates. So billionaires who derive most of their money from their investments and savings pay taxes at a lower rate than the majority of Americans, who, like Warren Buffett’s proverbial secretary, rely on their labor income.

Andrew Mellon, who dominated American economic policymaking as treasury secretary in the 1920s during the administrations of Harding, Coolidge and Hoover, was denounced by the liberal reformers of his day as the embodiment of plutocracy. But here is what he had to say about taxing capital versus wages in his 1924 book, “Taxation: The People’s Business”:

The fairness of taxing more lightly income from wages, salaries or from investments is beyond question. In the first case, the income is uncertain and limited in duration; sickness or death destroys it and old age diminishes it; in the other, the source of income continues; the income may be disposed of during a man’s life and it descends to his heirs.

Surely we can afford to make a distinction between the people whose only capital is their mental and physical energy and the people whose income is derived from investments. Such a distinction would mean much to millions of American workers and would be an added inspiration to the man who must provide a competence during his few productive years to care for himself and his family when his earnings capacity is at an end.

To which today’s conservatives, no doubt, would reply: “Andrew Mellon was a liberal!”

CEO compensation. In the last generation, American CEOs have been much better paid than their European and Asian counterparts, without having done remarkably better jobs.

American CEO compensation is rigged with perfect legality by two practices. The first is allowing the compensation of CEOs to be determined by boards of directors, whose members are frequently cronies of the CEO. Well-paid cronies, in many cases. You can be paid hundreds of thousands of dollars a year for attending a few board meetings and rubber-stamping whatever your friend the CEO wants. When the Sarbanes-Oxley Act sought to impose more responsibility on board members, this was denounced as an assault on the foundations of free enterprise. Freebie enterprise, is more like it.

CEO compensation is also inflated by the practice of stock buy-backs. Several decades ago, the practice of rewarding CEOs with company stock options was supposed to improve the performance of their companies and of the American economy as a whole. That worked out well, didn’t it?

American companies routinely and legally drive up the prices of their stock by buying back shares in the stock market. This is the equivalent of a celebrity author buying mass quantities of his or her own book, in the hope of driving it up best-seller lists. Stock buy-backs do not strengthen the company or lead to innovation. They merely inflate the wealth of the CEO and other company employees who are paid with stock options.

Long-term shareholders might object, but they are a dying breed. Most shareholders want to maximize the price of stocks before they cash out by selling them to the proverbial “greater fool.” Thanks to buy-backs, stock options have aligned the interests of CEOs and shareholders — but at the expense of prudent, long-term investment in American companies and American industries.

Professional compensation. Bailed-out bankers and crony capitalist CEOs are not the only Americans who benefit from rigged markets for compensation. Let’s not forget the professional class, which makes up roughly 10 percent of the population (the approximate number of Americans with graduate or professional degrees).

The professions are guilds. To put it another way, they are the most powerful unions in America. They are unions for the affluent. They rig labor markets the way that guilds have always done — by preventing anybody who doesn’t belong to the guild from practicing the trade.

In most states of the Union, you can’t practice law or medicine without both passing exams and possessing a medical degree or a law degree. In the early 20th century, law was an undergraduate degree. Then law schools began requiring four-year college education as a prerequisite, in order to keep the lawyer labor market tight by weeding out Americans who can’t afford at least seven years of higher education.

While raking in rents from their credentials, America’s affluent professionals are delegating more and more of their work to poorly paid subordinates — nurses and health aides, paralegals, adjuncts. While gouging students and parents with high tuitions, today’s universities and colleges assign more and more teaching to “freeway fliers” — often graduate students paid near-poverty wages or affluent professionals who teach as a hobby. God forbid that a well-paid, tenured professor should have to teach undergraduates, instead of jetting to conferences in luxury hotels.

Note that none of these methods of rigging the market to artificially inflate incomes — TBTF, stock buy-backs that drive up stock options, the professional credentials cartel — can be blamed on capitalism or markets. There are still genuine entrepreneurs who get rich by founding companies that provide new and useful goods and services, and there are still genuine capitalists who get rich by investing in them. But getting rich the old-fashioned way by getting customers to buy what you sell is hard, compared to paying politicians to rig markets and tax policies in your favor.

Once upon a time, rigged market capitalism in America benefited the many, and not just the few. Between the 1930s, the New Deal raised the wages of working-class Americans by rigging labor markets in their favor. From the 1920s the New Dealers inherited a system of low immigration, which lasted until the 1970s and helped to create tighter labor markets at the bottom. The black Southern poor who moved North in the Great Migration benefited disproportionately when jobs were opened up for them by the cutoff of mass European immigration.

The New Deal’s minimum wage and maximum hours legislation helped millions of the working poor to join the working class or middle class. And liberal New Deal Democrats promoted unions in peace and war, with the result that by the 1950s about a third of the private sector workforce was unionized (today it is less than 7 percent).

Beginning with Ronald Reagan, the U.S. government has systematically derigged labor markets for the many while rigging compensation markets even more for the elite few. Mass immigration, including mass illegal immigration, resumed after the 1960s, lowering wages for the poorest workers and weakening the ability of unions to organize. In the late 20th century, Congress allowed inflation to erode the real value of the minimum wage. Even after several increases, it is still lower, in real terms, than it was in the 1960s. And having effectively destroyed private-sector unions, the right is now trying to eliminate public sector unions, on the theory that schoolteachers and emergency responders are a much greater threat to the American economy than the reckless bankers who created a near-Depression and the CEOs who are rewarded for offshoring one industry after another.

What is rigged can be derigged; that is the lesson of the derigging of the institutions that raised the incomes of the American middle and working classes, between the Great Depression and the 1980s. TBTF can be eliminated, either by allowing giant, interconnected financial institutions to fail, or, more realistically, by turning them into tightly regulated public utilities that don’t make risky bets. CEO compensation practices can be reformed by law. Corporations are creations of the governments that charter them, and charters can contain any rules that lawmakers choose to put into them. And the rents extracted by the academic-professional complex can be reduced, by lowering the barriers to entry to the professions or, more radically, by reorganizing medicine, law and university teaching so that they are no longer structured as trades run by medieval guilds.

Of course, to succeed, this agenda has to be promoted by politicians, many of whom are members of the credentialed professional guilds, dependent on campaign donations from financial and corporate elites whose compensation depends to a large degree on markets that are legally rigged.