The Young Are on the Streets Because They Have the Most to Lose

Oct 3, 2011Mike Konczal

mike-konczal-newWhy are so many of the protesters on Wall Street college-age kids? Because their futures are at stake.

This Occupy Wall Street sign is my favorite:

The sign has a clever double meaning. The young have the most to lose by standing idle and not having their voices heard in the political process, and they have the most to lose by actually being idle -- or unemployed.

Why are so many of the protesters on Wall Street college-age kids? Because their futures are at stake.

This Occupy Wall Street sign is my favorite:

The sign has a clever double meaning. The young have the most to lose by standing idle and not having their voices heard in the political process, and they have the most to lose by actually being idle -- or unemployed.

The media hasn't learned the lessons from the 1960s, as there is still a tendency to dismiss young people protesting because they are young. You can see this phenomenon in the original New York Times coverage, and it appears in much of the rest. But at the heart of dismissals of young college kids in the 1960s was the idea that they had a very bright future ahead of them that they were taking for granted. For instance, here's President Nixon in the New York Times, May 1970:

You know, you see these bums, you know, blowin' up the campuses. Listen, the boys that are on the college campuses today are the luckiest people in the world, going to the greatest universities, and here they are, burnin' up the books, I mean, stormin' around about this issue, I mean you name it -- get rid of the war, there'll be another one.

Can it be argued that young people, college educated or not, are particularly lucky in this recession? Every category of worker is doing terribly in the Lesser Depression. My former editor Derek Thompson has a must-read article, "Who's Had the Worst Recession: Boomers, Millennials, or Gen-Xers?," which compares the three age categories across employment, income and wealth, and finds that everyone is suffering across the board.

But let's focus on the young. The issue of debt, especially student debt, hovers over the protests. How is the employment ratio looking for young people with a college degree? Here's data from last year:

And that doesn't factor in the fact that many college educated workers are working jobs that don't require college degrees. They are essentially using their degrees to crowd out those with a high school diploma or some college education from the jobs they would normally take. And no matter what jobs they are able to get, student debt hangs around their necks like an albatross.

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This impacts everyone who is young. Here's a summary of the recent 2010 Census' American Community Survey by PBS:

  • Employment among young adults between the ages of 16 to 29 was at its lowest level since the end of World War II. Just 55 percent were employed, compared with 67 percent in 2000.
  • Nearly 6 million Americans between the ages of 25 to 34 lived in their parents' homes last year.
  • Young men are nearly twice as likely as women to live with their parents.
  • Marriages among young adults hit a new low. Just 44 percent of Americans in that age group were married last year.
  • Other trends were also headed in the wrong direction. In 43 of the 50 largest metro areas -- often a magnet for 20-and-30-somethings -- employment declined.

In our desperate bid to replicate Japan, we are also replicating the poverty and joblessness among Japanese youths. This 2010 AOL article, "Japan's Economic Stagnation Is Creating a Nation of Lost Youths," can give you a sense of our trajectory.

Will we get our own version of the hikikomori? Young people are doubling up and not moving out of their parents' houses in this recession. If we looked at solely their own income, their poverty rates would be astounding. From the Census Bureau:

These “doubled-up” households are defined as those that include at least one “additional” adult -- in other words, a person 18 or older who is not enrolled in school and is not the householder, spouse or cohabiting partner of the householder...

In spring 2007, there were 19.7 million doubled-up households, amounting to 17.0 percent of all households. Four years later, in spring 2011, the number of such households had climbed to 21.8 million, or 18.3 percent...

Young adults were especially hard-hit, with 5.9 million people ages 25 to 34 living in their parents’ household in 2011, up from 4.7 million before the recession. That left 14.2 percent of young adults living in their parents’ households in March 2011, up more than two percentage points over the period.

These young adults who lived with their parents had an official poverty rate of only 8.4 percent, since the income of their entire family is compared with the poverty threshold. If their poverty status were determined by their own income, 45.3 percent would have had income falling below the poverty threshold for a single person under age 65.

Even if we can ever move out of the short-term recession, it will impact young people for years to come. Looking at a research summary compiled previously by Roosevelt Institute super-intern Charlie Eisenhood, Beaudry and DiNardo (1991) found “that every percentage increase in the [national] unemployment rate is associated with a 3-7 percent drop in entry-level contract wages.” Kahn (2009) found an estimate on the high end of that spectrum, discovering an “initial wage loss of 6 to 7% for a 1 percentage point increase in the unemployment rate measure.”

Unfortunately, the recession’s effect is not limited just to the initial job search and wages. The negative impact persists far beyond that. Kahn found that the effect “falls in magnitude by approximately a quarter of a percentage point each year after college graduation. However, even 15 years after college graduation, the wage loss is 2.5% and is still statistically significant.”

Job mobility is also affected. Kahn found a “negative correlation between the national unemployment rate and occupational attainment (measured by a prestige score) and a slight positive correlation between the national rate and tenure.” She concludes that “workers who graduate in bad economies are unable to fully shift into better jobs after the economy picks up.” Worse, Oreopoulos found permanent wage effects on workers with low expected earnings (based on occupational prestige).

So yes, young people have an important stake in what happens going forward. Do we continue policies that benefit Wall Street and the top 1 percent? Do we tax the rich to rebuild America? Do we reform a financial sector that dominates the economy? The list of choices in front of us goes on and on. Their whole future, indeed all of ours, depends on it. It's no wonder that they've taken to the streets.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Joseph Stiglitz: Government Must Play a Role in the Housing Market

Sep 19, 2011

Housing policy is central to our economy and the Great Recession, and Roosevelt Institute Senior Fellow Joseph Stiglitz made that abundantly clear in his remarks at a recent event, "The Government's Role in Housing." Americans spend so much of their income on housing that "when we're talking about housing, we're talking about standards of living," he said. Meanwhile, "How we solve our housing market problems will have a lot to do with the recovery." But while hardline Republicans think there is no role for government in practically anything, Stiglitz contended, "If the government now just walked out of [housing], the market would collapse and our economic downturn would be worse."

Housing policy is central to our economy and the Great Recession, and Roosevelt Institute Senior Fellow Joseph Stiglitz made that abundantly clear in his remarks at a recent event, "The Government's Role in Housing." Americans spend so much of their income on housing that "when we're talking about housing, we're talking about standards of living," he said. Meanwhile, "How we solve our housing market problems will have a lot to do with the recovery." But while hardline Republicans think there is no role for government in practically anything, Stiglitz contended, "If the government now just walked out of [housing], the market would collapse and our economic downturn would be worse."

The government got involved in the mortgage market in the first place because it wasn't working. "We didn't have a good mortgage market... we had discrimination," Stiglitz pointed out. Plus it had to address "continuing market failures." As a country, we used to understand that markets aren't perfect and that there is a role for government. "There was in the past a view that yes, we understand that markets sometime behave badly, they make shoddy products, they don't live up to what they're supposed to do," he said. "That's why we have regulation."

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No time like the present, and no place like the housing market. "The market failures in this market are pervasive," Stiglitz said. "There will need to be government intervention in one form or another." So what should it look like? He outlined seven key areas that need to be addressed:

1. Reform the bankruptcy code: We've made it more difficult for borrowers to discharge debts, but "we have to solve the problems of the past," he said, including the heaping pile of underwater mortgages.

2. Make financial markets more competitive, including the payments mechanism.

3. Deal with TBTF institutions: It's not just banks that are too large, but even without government involved, Fannie Mae as an institution "was too big to fail," he said.

4. Re-focus the banking system: Get it "back to doing what it should be doing, and that is lending," not speculating or pushing paper around to make a profit.

5. "We need strong consumer protection." End of story.

6. Deal with the structure of the mortgage market: "We have a whole system of conflicts of interest and an intstiontal structure of the market is one that makes it not work in the way that it should," he said.

7. Understand the fundamental flaws of securitization: "The benefits have been overestimated and the cost underestimated."

Just a few small suggestions, right? But without addressing these issues, we'll continue to have a housing market that fails the American people and creates a huge drag on our stagnant recovery.

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Happy Lehman Brothers Bankruptcy Day

Sep 15, 2011Matt Stoller

Three years later we still haven't dealt with the problems in the financial crisis. (Follow Matt Stoller on Twitter at @matthewstoller)

Lehman's bankruptcy happened three years ago today. It should be quite clear at this point that another Lehman is going to happen again. Policymakers didn't deal with the crisis of 2008-2009; they turned it into a much longer crisis with far greater lasting damage.

Three years later we still haven't dealt with the problems in the financial crisis. (Follow Matt Stoller on Twitter at @matthewstoller)

Lehman's bankruptcy happened three years ago today. It should be quite clear at this point that another Lehman is going to happen again. Policymakers didn't deal with the crisis of 2008-2009; they turned it into a much longer crisis with far greater lasting damage.

There are two intertwined issues with any major financial panic. One issue is liquidity -- can an asset be sold or traded without significant movement in the price? Can an institution exchange its assets for assets of similar value? In a bank run, the answer is no. People are too afraid to accept that their bank deposit is worth what is in the account because they don't trust the bank that tells them what they have in the account. The second issue is solvency -- is there enough value to pay off all creditor claims? Are assets greater than liabilities, even in a liquid market?

The basic point to understand about the financial crisis is that it isn't in fact over. The liquidity crisis of 2008-2009 was temporarily abated, but the solvency problem hasn't been dealt with. The global financial architecture is essentially dominated by too many obligations, a.k.a. debt, that cannot be paid. This can only be addressed by a mass writedown of debts. Usually creditors don't like being told they can't have the money they think they have and force is required. Debtor deals are often preceded by civil wars, world wars, or depressions. But not always -- sometimes a debtor cartel can force writedowns. So that's the solvency issue.

What does this have to do with Lehman Brothers? Well, Lehman's bankruptcy was the moment when the financial system looked feeble and insolvent. If you did not have an FDIC insured account, you could not be sure that money would be there the next day. Essentially, Lehman's bankruptcy was the moment that the global bank run for businesses and billionaires became real. Companies that needed to make payroll, insurance companies that needed to pay out claims, corporations that funded themselves in the commercial paper markets, nonprofits and cities using auction rate securities -- basically anyone with any need for liquidity -- could no longer do business. Investors piled into "safe assets," a.k.a. Treasury bills, sending the yield "down to a few hundreds of a percent."

In the repo market, which is where the shadow banking system got much of its funding, there were margin calls because previously somewhat safe assets like corporate bonds required larger haircuts. It was, again, a giant bank run. The Fed and Treasury eventually stopped the bank run, providing enough liquidity and fiscal help to restore temporary confidence to the banking system. But the solvency crisis wasn't solved. It has been papered over, and remains with us today, ready to rear its ugly head at any moment (see the Eurozone).

A solvency crisis is often accompanied by a liquidity crisis, which is why the FDIC tries to shut down a bankrupt bank on a Friday and reopen it on Monday under new management. You don't want a bank run when a bank goes under. You want depositors to be made whole and, ideally, to have so much confidence the system works that the real economy is entirely insulated from financial shocks. Unfortunately, the failure to address the solvency problem or put forward a framework that insures the banking system (using a scheme sketched out by Jane D'Arista in this prescient 1991 paper titled "No More Bank Bailouts") means that users of the financial system are nervous.

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Lehman Brothers itself was insolvent, but its problems were probably common among investment banks at the time. I don't have anything to add on why that institution went under. For that, the Valukas report on the firm's bankruptcy provides an excellent explanation. Basically, everyone in a position of power in and around the investment bank was corrupt. Lehman had fairly reasonable risk controls; management just ignored them. Senior Lehman officer Ian Lowitt noted this in the summer of 2007, after a decision to ignore risk limits. “In case we ever forget; this is why one has concentration limits and overall portfolio limits. Markets do seize up.”

Yes, they do.

The regulators knew. As Anton Valukas, the bankruptcy trustee said, "So the agencies were concerned. They gathered information. They monitored. But no agency regulated."

There was the failure of information sharing among regulatory agencies, about which Valukas said:

Like most Americans, I was disturbed to learn after 9/11 that various intelligence agencies did not always share information with one another. I thought we learned something from that, but apparently not.

And then there was the whole misleading investors problem, with Repo 105. But all of this was framed by a basic solvency crisis, which Tim Geithner memorialized with his comment about "air in the marks" in the bad assets on Lehman's books. The investment bank owed more than it owned, and everyone knew it. It was a solvency crisis, that then became a liquidity crisis.

This could have been fixed. But it hasn't been, because of an overall failure of financial-friendly economists. I'll quote Alice Rivlin, in a "let them eat cake" moment in 2008 on the foreclosure wave that triggered the crisis.

We should not forget that a lot of good came from the housing boom. Millions of people moved into new or better housing. Most of them (including most sub-prime borrowers) are living in those houses and making their mortgage payments on time.

Why should anyone think that Lehman won't happen again? Elites have learned nothing. This was obvious during the crisis itself, when Nouriel Roubini noted the stark difference between public and private conversations:

And while policy makers and regulators now claim that everything is on the table in terms of reforming a faulty financial system they stress in private that their preferred approach would be one of “self-regulation” and reforms undertaken by private financial institutions rather than new rules and regulation imposed by authorities.

Many people are frustrated that the response to the crisis hasn't been stronger. But it was always obvious that the goal of the crisis measures was to get the financial elites back to ordinary business as quickly as possible. In that context, the most reasonable question in the world is, why wouldn't Lehman happen again? We don't have a persuasive answer to that question. And until we do, we're still in crisis.

Matt Stoller is a Fellow at the Roosevelt Institute and the former Senior Policy Advisor to Congressman Alan Grayson.

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Banks and Business Have Bounced Back, but Consumers Still Struggle to Pay Off Debt

Sep 14, 2011Bryce Covert

While families have made progress paying down credit card bills, mortgage and student debt levels remain stubbornly high.

In the run up to the financial crisis, everyone took on boatloads of debt: banks, corporations, consumers. In the aftermath, most have been eager to pay that debt off and get out from under the burden. Yet some are doing better than others. Corporations are now sitting on cash, having corrected their balance sheets. Banks are faring well after raising capital and selling off assets. But families aren't so lucky.

While families have made progress paying down credit card bills, mortgage and student debt levels remain stubbornly high.

In the run up to the financial crisis, everyone took on boatloads of debt: banks, corporations, consumers. In the aftermath, most have been eager to pay that debt off and get out from under the burden. Yet some are doing better than others. Corporations are now sitting on cash, having corrected their balance sheets. Banks are faring well after raising capital and selling off assets. But families aren't so lucky.

Households have made some progress in lowering credit card debt. According to TransUnion, consumers spent $72 billion more paying those bills than buying things in 2009 and 2010. In the first quarter of 2011, average credit card debt reached a 10-year low of $4,679. And the national delinquency rate (those who are 90 or more days past due on their credit card bill) was at .6 percent in the second quarter of 2011, the lowest level in 17 years.

Overall, household debt has fallen to 2004 levels. But mortgage debt isn't looking as positive as credit card bills. As the Wall Street Journal puts it:

Until the late 1990s, the sum of all American mortgages was about 40% of the value of the underlying homes. Americans borrowed heavily against their houses and then house prices fell. By this metric, the debt burden rose to about 62% -- and hasn't yet come down. (This is an average, of course... About one in five homeowners with a mortgage owes more than 100% of the current value of the house.)

Part of this, the article explains, is that unlike banks, households can't raise capital to pay it down. So to get housing-related debt levels down, consumers will have to see a rise in price appreciation or an increased ability to writedown or modify their mortgages. That, or they'll face foreclosures.

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And we're doing worse than ever before in another category of debt. Student loan debt is set to hit a total $1 trillion this year for the first time ever. Beyond that hefty load, though, default rates are rising. Overall, 8.8 percent of borrowers defaulted last year, up from 7 percent the year before. It gets even worse at for-profit schools, though, where the rate was 15 percent, up from 11.6. And while they only enroll about 10 percent of the nation's undergraduates, those students make up almost half of the defaults. They also tend to serve low-income students, who may already be struggling with the cost of an education.

But the problem doesn't stop there. In fact, it may be worse than those numbers show. The default rates only take a look at a two-year window -- but some studies show that as few as one in five defaults at for-profit colleges occur in that timeframe. Meanwhile, the New York Times reports:

A recent study by the Institute for Higher Education Policy found that for every borrower who defaults, at least two more fall behind in payments. The study found that only 37 percent of borrowers who started repaying their student loans in 2005 were able to pay them back fully and on time.

Banks and corporations may be feeling great about their debt levels, but they would do well to remember that consumers drive our economy. If we're all still buried under a mountain of debt that we can't pay off, the economy will continue to suffer.

Bryce Covert is Assistant Editor at New Deal 2.0.

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China "Cheats" -- and So Should We

Sep 13, 2011Jon Rynn

CB013130If the U.S. wants to tackle climate change and stay competitive in the global economy, it needs to stop playing by the old rules and start making new ones.

CB013130If the U.S. wants to tackle climate change and stay competitive in the global economy, it needs to stop playing by the old rules and start making new ones.

The looming global warming catastrophe could be worse, in the long term, than any war, social collapse, or single famine in human history. We need to scale up renewable technologies as quickly as possible -- by any means necessary. And that is exactly what the Chinese are doing. According to Steven Lacey at Climate Progress, while world solar cell manufacturing capacity was only 100 MW in 2000, it is now 50,000 MW –- and China by itself accounts for 57 percent. But this puts Americans, including Lacey and other environmentalists, in a peculiar position. On the one hand, we desperately want more solar and other renewable technologies. But on the other hand, by scaling up so fast, the Chinese might wipe out the American solar panel industry. Instead of trying to stop the Chinese from doing what they are doing, the U.S. needs to learn from them.

The environmental community has tended to contradict itself when it comes to rolling out renewable technologies. On the one hand, leaders such as Al Gore and my personal favorite global visionary, Lester Brown, call for a World War II-style mobilization to quickly convert our civilization so that we can avert ecological calamity. But the means advocated, such as putting a price on carbon, are not up to the task. We can't afford to wait to see if the market will do what is necessary.

The Chinese are not putting a price on carbon. In fact, they won't even negotiate a target for how much carbon they will output by 2020 or any other date. But they are doing something much more important: They are showing the world how you scale up a technology with a World War II type of effort. Some call it “cheating,” but if this is cheating, let's have much more. What are the Chinese doing right?

First, China has a five-year plan. In the U.S., corporations have five-year plans, and so does the Department of Defense. But imagine a president giving a State of the Union address announcing such a plan. There would be cries of “socialism!” I say, socialism, shmocialism, whatever works. The longer the time range, the better. Congress is now debating a multi-year transportation bill; the same should be done for the entire energy sector.

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Second, many Chinese “banks," if you want to call them that, make money virtually free, and often don't even get their “loans” back. The government gives companies land –- which, by the way, Lincoln and the Republicans gave to railroads when obstructionist Southern Democrats were out of the way during the Civil War. Where would the U.S. be today if the railroad industry hadn't received a huge boost at the dawn of the industrial era, or if the Internet hadn't received a similar boost 100 years later?

Third, the Chinese import foreign technology and require foreign companies that set up factories in China to train Chinese engineers. Ever since the British tried to prohibit their engineers from traveling at the beginning of the Industrial Revolution so that Britain could maintain its dominance, other countries have been trying obtain -- or, as the originating country calls it, steal -- new technology. In a way this, is all part of a 1,000-year cycle, as the West gained many important technologies like the compass, printing, and gunpowder from the Chinese, who are now borrowing technology back.

Fourth, the Chinese are producing hundreds of thousands of engineers for their expanding manufacturing economy. Forty percent of the engineers in the U.S. are involved with manufacturing, according to a New York Times piece by Louis Uchitelle. Uchitelle reports that the Chinese manufacturing sector has either just grown larger than the American one or will shortly do so. As manufacturing declines here, it becomes much less attractive to have a career as an engineer. In China, on the other hand, being an engineer is a clear way to make it into the good life.

The point is not to idolize China. Far from it -- China is in a race to see whether it can switch to clean technologies before its dirty ones overwhelm its ecosystem and cause its economy to collapse, and its currency is much too low. But nations have always learned from other nations. Sometimes, the “teachers” cry “unfair!” when the “students” don't play by the rules. One hundred years ago, the British complained that the Americans were always copying their inventions.

But innovation is not simply a matter of technology; it is also a matter of policy. If something works, use it, even if it offends conventional wisdom. In fact, particularly if it offends conventional wisdom. That's what happened during the New Deal era of the 1930s, when the old policies were clearly failing and new ones had to be put in place (for instance, instead of tinkering with market rules in order to develop the Tennessee Valley, the TVA rebuilt the whole area). With global warming and other environmental problems, such as the end of cheap oil, threatening civilization, we need policy innovations even more than we need technological ones.

Jon Rynn is the author of the book Manufacturing Green Prosperity: The power to rebuild the American middle class, available from Praeger Press. He holds a Ph.D. in political science and is a Visiting Scholar at the CUNY Institute for Urban Systems.

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The CFPB Stands Up to Banks' Overblown Financial Firepower

Sep 7, 2011Bryce Covert

Republicans claim that allowing Richard Cordray to head the CFPB imbues him with too much power, ignoring the immense influence on the other side of the equation.

This week's credit check: The 10 Republicans blocking Richard Cordray's nomination have received over $31 million in campaign cash from the financial sector. The median American family saw yearly earnings fall $5,261 over the past decade.

Republicans claim that allowing Richard Cordray to head the CFPB imbues him with too much power, ignoring the immense influence on the other side of the equation.

This week's credit check: The 10 Republicans blocking Richard Cordray's nomination have received over $31 million in campaign cash from the financial sector. The median American family saw yearly earnings fall $5,261 over the past decade.

The least remarkable part of yesterday's Senate Banking Committee hearing on Richard Cordray, President Obama's nominee to head the new Consumer Financial Protection Bureau (CFPB), was Cordray's testimony itself. In fact, Republicans made it clear that his credentials are not what's up for debate. Sen. Bob Corker (R-TN) called a recent meeting with him "pleasant" and Sen. Richard Shelby (R-AL) said he has a "good background." Rather, they want to debate whether his post should exist at all. Their reasoning? That having one person in charge of this new watchdog will imbue Cordray with far too much power. As Shelby put it, "No one person should have so much unfettered power over the American people."

But what of the power of the opposition, the banks themselves, who stand to have new oversight and regulation from someone on the side of the average consumer? If we're going to talk about power imbalances, we might want to look at what the financial sector can marshal against the American people. Elizabeth Warren herself, the originator of the idea for the CFPB, estimates that it will police a $3 trillion consumer financial services industry. And Wall Street, along with its other corporate counterparts, is doing pretty well compared to the rest of us. Corporate profits have taken in 88 percent of the raise in national income since the recovery began, while household incomes only took in 1 percent.

It's not just profits banks wield in this fight, however. That money can easily turn into lobbying and campaign contributions. As Ari Berman reported in June, "According to the Center for Responsive Politics, 156 groups -- the vast majority representing corporate interests -- lobbied the government about the CFPB in the second half of 2010 and the first quarter of 2011. The list ranged from JPMorgan Chase to McDonald's." The Chamber of Commerce even has an entire division devoted to fighting Dodd-Frank, and it spent $17 million on federal lobbying in the first quarter of this year with a dozen lobbyists focused on just the CFPB.

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Individual Republican Senators are also getting lavish gifts from the financial sector while opposing its newest regulator. The 10 Republican members of the Senate Banking Committee, who signed a letter to Obama in May demanding debilitating changes to the CFPB before any candidate can be confirmed, have received over $31 million in campaign cash from the financial sector during their time in Congress. Meanwhile, Sen. Shelby himself has taken $6.2 million from the financial sector, including about $1 million from commercial banks. His top career donors include JP Morgan ($140,771), Citigroup ($109,199), and Goldman Sachs ($67.600).

Compare all that financial firepower to what's going on for everyday Americans. A new report from the Pew Charitable Trusts shows that nearly one in three Americans who grew up middle-class has fallen out of that group. It's not hard to see why so many people are moving down the ladder when wages have been heading in the same direction. While the financial sector is bringing in $3 trillion, the median American family saw yearly earnings fall $5,261 over the past decade, from $52,388 in 2000 to $47,127 in 2010.

Things are even worse for low-income families. Over the past 10 years, the percentage of children living in poverty has soared, increasing by 18 percent, or 2.4 million more, from 2000-2009. These children and their families are set to fall on even harder times, as states slash vital services to balance their budgets. They face the loss of unemployment benefits, income tax credits, and cash assistance, among other safety net supports.

Those who find themselves in such financial hardship have one place to turn when they can't make ends meet: debt. Credit card companies already employ a variety of tactics to entice middle-class families into debt and keep them there. But those tactics will be under strict scrutiny if the CFPB has its full powers. Low-income families often find themselves prey to unregulated non-banks like payday lenders and check cashers, but those will also come under the supervision of the Bureau.

The CFPB isn't taking on dictatorial powers. It's standing up to the formidable forces preying upon struggling American consumers.

Bryce Covert is Assistant Editor at New Deal 2.0.

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What’s “Perfect” About Perfect Competition? A Prosperous Economy Needs Innovators

Sep 1, 2011William Lazonick

workers-200In the latest installment of his “Breaking Through the Jobless Recovery” series, economist William Lazonick explains why pushing big corporations to transform their products is just what our economy needs.

workers-200In the latest installment of his “Breaking Through the Jobless Recovery” series, economist William Lazonick explains why pushing big corporations to transform their products is just what our economy needs.

To claim that something is "perfect" is to say that it cannot be done better. With the start of another academic year, hundreds of thousands of college students who take introductory microeconomics courses will learn from their professors that the best possible allocation of society's resources occurs when "perfect competition" characterizes the organization of industry.

It is a well worked out theory that has been around for over a century. Unfortunately, the theory of perfect competition is nonsensical when applied to an economy such as the United States, dominated as it is by large corporations. The theory of perfect competition enables economists to ignore the conditions under which, through innovation, business enterprises grow large and often come to dominate their industries. As a result, these economists lack a theory of how government policy should respond when the top executives of the large corporations, upon which we rely for our prosperity, fail to invest in innovation and job creation in the United States.

The theory of perfect competition can be found in any conventional economics textbook. In a nutshell, households, who work and consume, maximize "utility" (their satisfaction) in supplying paid labor services and capital (their savings) on input markets as well as in demanding goods and services on output markets. Firms, which buy inputs to produce outputs, maximize profits on the basis of cost structures -- a combination of technologies and input prices -- available to all firms that want to participate in the industry. "Perfect competition" is achieved when, in a particular industry, all firms have exactly the same cost structures and there are a sufficiently large number of these identical firms so that the output decision of any one firm has no discernible impact on the price at which its product is sold.

The basic problem with the theory of perfect competition is that as consumers and workers, not to mention as taxpayers, we want some firms in an industry to transform technologies to generate higher quality, lower cost products than their competitors. We do not want firms to maximize profits subject to given technological conditions. Firms that can achieve these technological transformations are innovative enterprises that drive a society's economic growth.

By creating new sources of value (embodied in higher quality, lower cost products), the innovative enterprise makes it possible (but by no means inevitable) that, simultaneously, all participants in the economy can share in the gains of innovation. Employees may get higher pay and better work conditions, creditors more secure paper, shareholders higher dividends and stock prices, governments more tax revenues, and the innovative firm a stronger balance sheet, even as consumers get higher quality, lower cost products. Indeed, from this perspective, a key issue for economic analysis is the relation between the generation of innovation and the distribution of its gains among participants in the economy.

There are countless examples of innovative enterprise in the history of the U.S. economy. Think of, to mention only a few prominent ones, General Electric's innovations in electrical power systems and light bulbs in the first decades of the 20th century, General Motors' closed car in the 1920s, Du Pont's nylon in the 1930s, Boeing and Douglas in the modern aircraft in the 1930s, RCA in television in the 1940s and 1950s, IBM in computers in the 1950s and 1960s, Intel in microprocessors in the 1970s and 1980s, Cisco Systems in Internet routers in the 1990s, Amazon in electronic retailing in the late 1990s and 2000s, Google in Internet search engines in the 2000s, and Apple in digital devices in the 2000s.

Today, many of these companies remain substantial resource allocators in the U.S. economy. They are innovative enterprises, not "perfect" competitors. To be sure, there are always small firms in the economy, but through innovation the best among them can quickly become very large. For a few well-known examples, Cisco Systems, founded in 1984, grew from 254 employees in 1990 to 34,000 in 2000; Amazon, founded in 1995, had 33,700 employees in 2010; while Google, founded in 1998, had 24,400 employees in 2010.

More generally, large corporations, some dating back to the 19th century, dominate the economy. In 2010, the top 500 U.S. corporations by revenues had combined sales of $10.8 trillion, profits of $702 billion, and employment of 24.9 million people worldwide. That's a per company average of $21.6 billion in sales, $1.4 billion in profits, and almost 50,000 employees. The operation and performance of these corporations, not "perfect competition," need to be at the center of economic analysis.

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That large corporations dominate the US economy is hardly news (except perhaps to the economics professors who write the conventional microeconomics texts). In 1977, business historian Alfred D. Chandler Jr. published a Pulitzer Prize-winning book, aptly entitled The Visible Hand, in which he documented that already by the beginning of the 1920s, the "managerial revolution in American business" was complete. The innovative investment strategies of these corporations drove the consumer durable boom of the 1920s. At the same time, sectors such as textiles, coal mining, and agriculture that were characterized by large numbers of perpetually small firms were known as "sick industries" precisely because of the inability of a few firms to set themselves apart from the rest through innovation.

Today, in my view, the greatest economic policy challenge is how to keep major business corporations innovative. Once they have become successful, the executives who run these mammoth companies may choose to allocate resources in ways that live off the past rather than invest for the future. Indeed, justified by the free market ideology of "maximizing shareholder value," in the United States we reward top executives with unindexed stock options that give them strong personal incentives to do massive stock buybacks to jack up their companies' stock prices even as they eschew investments in innovation.

Here's an example that has recently been in the news. Hewlett-Packard (HP), the world's largest information technology company and an icon of  U.S. business, announced that it intends to exit the personal computer industry, including the rapidly expanding smartphone and tablet segments. HP's top executives deem that the investments required to compete with the likes of Apple pose too great a burden on HP's cash flow. But that's because HP's executives decided to squander $11 billion on stock buybacks in 2010 and another $7.3 billion in the first half of 2011. During the same 18 months, HP spent only $4.6 billion on R&D, just 25 percent of what it forked out to manipulate its stock price through buybacks. Over the past decade, HP has wasted 118 percent of its net income on buybacks. HP was once a great technology company, but in the 2000s it expended only 4.2 percent of sales on R&D, compared with 7.6 percent in the 1990s and 10.5 percent in the 1980s. In 2010, HP's R&D as a percent of sales was a meager 2.3 percent, the lowest in the company's 62-year history.

What determines whether a company invests for the future or lives off the past? Our college students won't find any answers to this crucial question in the conventional economics textbooks. In a world of "perfect competition," there is no room for innovative enterprise. By the same token, the textbooks make the pretense of analyzing "big business" through the theory of monopoly, put forth as the proof of the superiority of perfect competition. The argument is that compared with perfect competition, a firm that has a monopoly restricts output and raises prices to consumers.

To get this result, however, it is assumed that the monopolist firm maximizes profits subject to the same cost functions as perfectly competitive firms. This comparison entails an amazing leap of illogic, ironic for an academic profession that claims to be rigorously scientific: If it is possible for perfectly competitive firms to exist, how did the monopolist get to be a monopolist?

In contrast, in the theory of innovative enterprise a firm can become dominant by transforming its cost structures, gaining competitive advantage over firms that do not. In the process, the innovating firm generally contributes to an expansion of industry output and a reduction of product prices -- just the opposite of what the textbook theory of monopoly predicts.

That the illogical argument of the superiority of "perfect" competition has been ensconced in the microeconomics textbooks for over six decades attests to the failure of orthodox economists to come to grips with an economy dominated by large corporations. Applied to such an economy -- and the United States has been one for over a century -- perfect competition is perfect nonsense.

What then accounts for the persistence of the theory of perfect competition as a linchpin of economics erudition? In brief, there are two mutually reinforcing explanations for what I have called "the myth of the market economy": the ignorance among economists about how the actual economy functions and the ideology that "free markets" can solve all our economic problems. It is about time that we got rid of both.

William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.

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Rob Johnson: American Dream Can't be Restored with Sky-high Inequality

Aug 30, 2011

At a recent event at the Hammer Forum, Roosevelt Institute Senior Fellow Rob Johnson joined Andy Stern to answer the question: Can we restore the American Dream? In his presentation, Rob pointed out that we can't simply return to our past, particularly given how much has changed in the aftermath of the financial crisis. "The challenges are not just simply going back," he points out, "but drawing on the best traditions of our past to create a new vision."

At a recent event at the Hammer Forum, Roosevelt Institute Senior Fellow Rob Johnson joined Andy Stern to answer the question: Can we restore the American Dream? In his presentation, Rob pointed out that we can't simply return to our past, particularly given how much has changed in the aftermath of the financial crisis. "The challenges are not just simply going back," he points out, "but drawing on the best traditions of our past to create a new vision."

So what's changed since the boom times of the American Dream? For one thing, the financial system sucks up about 40 percent of corporate profits. "The servant of finance, which is supposed to serve the economy and the economy and markets are supposed to serve social goals, has become the master," Rob says. Another is our staggering income inequality. Between 1917 and 1978, 70 percent of GDP growth went to the bottom 90 percent of our society. Now that equation has all but reversed. Over the past 30 years, the bottom 90 percent has seen its income growth decline, while "one percent of the population is getting two-thirds of the gains," Rob points out.

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This inequality comes with high costs. Rob points to a study that shows a correlation between high levels of income inequality with such tragedies as higher mental illness, obesity, high school dropout, incarceration, infant mortality, and homicide rates, while public trust declines. Unequal societies are also far less likely to foster social mobility. And the U.S. isn't just slouching along with other unequal nations, but is a real outlier toward bad outcomes, Rob points out.

Yet in the face of all of this, the government continues to be in Wall Street's pocket, enforcing an austerity agenda even with soaring unemployment rates. So Rob has some sympathy with some of the Tea Party's motivations. "They look at the government as an insurance agency for the rich and the powerful with the premiums paid by them," he says. "Can you imagine belonging to a golf club where you paid dues but only the rich and powerful got to play the course?" DC should take a hard look at FDR's Second Bill of Rights, particularly given our high levels of unemployment. Otherwise, we have a big problem on our hands.

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Reptilian Cotillion: Financiers Party While Economy Plunges

Aug 19, 2011Lynn Parramore

A full moon rises over the Hamptons as the crocs come out to play.

While the world economy trembles and their fellow Americans face blown-up 401Ks, foreclosure threats, and fruitless job searches, financiers are embracing our current feed-the-rich/screw-the-rest mentality with renewed zest.

A full moon rises over the Hamptons as the crocs come out to play.

While the world economy trembles and their fellow Americans face blown-up 401Ks, foreclosure threats, and fruitless job searches, financiers are embracing our current feed-the-rich/screw-the-rest mentality with renewed zest.

The NYT reports that last Saturday night, in the fabled NYC frolicking ground of Southampton, billionaire financier Leon D. Black threw himself a jaw-droppingly expensive 60th birthday bash. Two hundred well-heeled guests reclined on cushions Satyricon-style nibbling seared fois gras as Sir Elton John -- earning a cool million bucks  -- sang 'Crocodile Rock.' Joining this Reptilian Cotillion were Martha Stewart and fashion designer Vera Wang, who partied alongside some of Wall Street's most notorious denizens, including junk-bond pioneer Michael Milken, Blackstone's buyout king Stephen A. Schwarzman (who became a symbol of greed when he threw his own $3 million b-day bash back in bubblicious 2007), and Lloyd "God's Work" Blankfein of Goldman Sachs.

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Mayor Bloomberg was among the revelers, as was NY Senator Charles Schumer, who must have been feeling grateful for his host's generous political contributions as he soaked in the expansive view of moonlit Schinnecock Bay.

A fellow like Leon Black needs all the influential friends he can get because, like other private equity tycoons, he enjoys a ridiculously low 15% tax rate on "carried interest" (the share of profits that hedge fund managers get as part of their stratospheric compensation). Chances are the persons who, say, cook for Mr. Black or landscape his yard pay something more like 35% in taxes for the money they earn doing actual work.

In fact, if we got rid of this George W. Bush giveaway, we'd have $21 billion over the next decade. That's enough money to pay a million jobless Americans $20,000 for a year's work doing productive things like rebuilding schools or repairing bridges. That would be a lot more helpful to our country than proliferating casinos, which is Black's line of work. His Apollo Global Management manages $72 billion in assets, including the largest gambling operation on Earth, Caesars Entertainment. He's also into plastics.

Black, incidentally, is the 160th richest person in the United States. He is also the son of Eli M. Black, once head of the United Brands Company, whose career presents a tragic tale that we would do well to learn from a time of unchecked excess.

Lynn Parramore is the editor of New Deal 2.0, Media Fellow and Deputy Director of Communications at the Roosevelt Institute, co-founder of Recessionwire, and the author of Reading the Sphinx.

**Follow Lynn Parramore on Twitter at http://www.twitter.com/lynnparramore

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Getting What You Pay For: Super Committee's Super-Close Ties to Banking & Finance

Aug 16, 2011Lynn Parramore

Quelle surprise! Bankers and financiers will be sitting pretty when the “Super Committee” decides where spending gets slashed over the next decade.

This just in: The folks at Maplight have released some disturbing numbers on who has been the most generous to the 12 members of the newly-formed Joint Select Committee on Deficit Reduction, fondly known as the "Super Committee."

Quelle surprise! Bankers and financiers will be sitting pretty when the “Super Committee” decides where spending gets slashed over the next decade.

This just in: The folks at Maplight have released some disturbing numbers on who has been the most generous to the 12 members of the newly-formed Joint Select Committee on Deficit Reduction, fondly known as the "Super Committee."

To recap, the Committee was formed by the last-minute debt ceiling increase deal reached by Congress and the Prez earlier this month. It's comprised of the following senators: Pat Toomey (R-Pa.),  Jon Kyl (R-Ariz.),  Rob Portman (R-Ohio),  Patty Murray (D-Wash.),  John Kerry (D-Mass.), and Max Baucus (D-Mont.) and Reps.  Jeb Hensarling (R-Texas),  Fred Upton (R-Mich.),  Dave Camp (R-Mich.),  Chris Van Hollen (D-Md.), Xavier Becerra (D-Calif.), and  Jim Clyburn (D-S.C.).

Maplight reports that the 10 biggest organization contributors (this includes PACs and Employees) to Super Committee Members are...

Club for Growth $990,066

Microsoft Corp. $810,100

University of California $629,495

Goldman Sachs $592,684

EMILY's List $586,835

Citigroup Inc. $561,081

JPMorgan Chase & Co. $494,316

Bank of America $349,566

Skadden, Arps, et al. $347,356

General Electric $340,935

Hmm. Club for Growth, the biggest spender, is a rabid anti-tax and anti-government group boasting 9,000 members and dominated by Wall Street financiers and executives. And then we naturally find the big banks --the Goldmans, the Citigroups -- filling out the list. Guess how these folks feel about paying their fair share in taxes? The 6 Republicans on the Committee have sworn to block any tax increases, even on the banks that helped bring on the 2008 crash that caused this freaking deficit in the first place! But obviously their feelings take precedence over those of the American public, a quarter of whom are out of a job, underwater with the mortgage, or in foreclosure.

As Roosevelt Institute Senior Fellow Thomas Ferguson pointed out yesterday on this blog:

Congress is listening primarily to those who contribute political money, not the public. As a political slogan “No new taxes” was around long before the Tea Party. It is the mantra not of the public, but of a huge swath of super-rich Americans.

That's why when it comes time for action, squeezing pennies from seniors and sick people and socking it to working Americans will be on the table. Raising revenues from fatcats whose taxes are lower than they've been since Hoover was in office will not.

That's democracy in America, 21st-century style.

Lynn Parramore is the editor of New Deal 2.0, Media Fellow and Deputy Director of Communications at the Roosevelt Institute, co-founder of Recessionwire, and the author of Reading the Sphinx.

**Follow Lynn Parramore on Twitter at http://www.twitter.com/lynnparramore

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