“The path to America’s future lies down the middle of the road between the unfettered power of concentrated wealth … and the unbridled power of statism or partisan interests.” Dwight D. Eisenhower
Despite all the sayings that tell us people don’t like change, Americans seem to love it. Whenever, something doesn’t work for a short period of time American’s are keen on changing it. Thus when the economy took a hit due to measures largely beyond our control in the late ’80s under Carter, the American people wanted a change. The prevailing economic philosophy was thrown out the window and we shifted from creating an economic policy focused on growing the middle class and having the economy expand from there to having the rich trickle down there wealth. The argument was that the regulations and “handouts” imposed by the government were inefficient, they unnecessarily bogged down the economy. Supply-Side economics was simply removing those inefficiencies and allowing those with the most resources and expertise to create wealth and jobs that would trickle down to the rest of the economy. Earlier in history, Supply-side economics was plainly seen as a construction of the rich at the expense of the every-man until the economy stumbled in the 70s and some of its ideas snuck into the Carter Administration namely deregulation of the airlines. Then it exploded under Reagan under the new guise of Reaganomics and infiltrated every administration since in some way or another. Therefore, the priority of the government shifted from growth of the economy through stable means that benefit everyone equally to growth at all costs.
This priority shift can be visualized in the intention of the policies put forth by the different administrations. Administrations who favor the economic elites favor policies that discourage wealth distribution while favoring market consolidation and oppose the rise of business costs including labor. While those who favor the middle class advocate policies that encourage even wealth distribution and workers’ rights even at the price of some increasing costs and market inefficiencies. The battlegrounds for these opposing viewpoints are far and wide and ideas from both sides have merit; however, we have shifted too far to the right and need a return to the center. Listed below are the most pressing issues facing our future economic growth today and some solutions to solve them.
How the Rich Gamble with Your Money
One of the ways Administrations show their hand on whom they favor is with financial deregulation. They phrase it ways that make the American people feel are fair and will help them in the long run. Such as we are rewarding hard working American citizens by taking less money from them (lowering income tax rates) which will in turn be distributed across the American people (trickled down). Or we need to encourage risk taking to stimulate growth and not allow our entrepreneurs to be bogged down in expensive and prohibitive regulation. The idea behind this rhetoric seems sound, they want to encourage growth, but the reality is the growth it does create becomes concentrated in the upper echelons. This in turn actually stifles growth, stagnates the middle class, and decimates the poor’s ability to move up. This neo-libertarian philosophy has creeped into both political parties and has lead to numerous pieces of legislation that have pushed forward this philosophy; however below I have outlined the most damaging implementations.
Glass-Steagall or the Banking Act of 1933 was a piece of legislation drafted during the Great Depression in response to the crash of 1929. It had two main provisions: 1) the creation of bank deposit insurance (FDIC) and 2) and the prohibition of combining investment and commercial banking. The crash of 1929 caused the great depression not only because of rampant speculation, but because that speculation was funded by ordinary people’s life savings. When the bubble burst entire families net worth were decimated and their was no insurance to cover it. Glass-Steagall was meant to protect personal savings and to prevent rampant speculation from cratering the entire banking industry again.
Glass-Steagall had a few loopholes that allowed commercial banks to still deal in the speculative markets. Namingly using Savings and Loans deposits to speculate on markets which lead to the Savings and Loans Crisis of 1989. However, that crisis was overlooked and big business wanted more freedom to gamble with capital and as a result the Gramm-Leach-Bliley Act repealed the portion of Glass-Steagall that restricted commercial banks from participating in the securities and speculative markets At the time Glass-Steagall was called irrelevant and repealing Sections 20 and 32 which didn’t allow commercial banks or their officers from being affiliated with securities was seen as inconsequential. In the wake of this law new mega banks formed the J.P. Morgan Chases, the Bank of Americas, and the Citigroups. This consolidation was sold as more efficient because it allowed consumers to use one bank to service all their banking and investment needs.
Commodity Futures Modernization Act
Although, the effect of Gramm-Leach-Bliley on the financial crisis of 2008 is still debated, the spirit of deregulation and the market’s ability to regulate itself is directly responsible for the crash. The next Gramm sponsored bill the commodity future modernization act is universally recognized as the fuel for the 2008 crisis. The Commodity Futures Modernization Act deregulated credit default swaps and derivatives, removed the CTFC and the SEC from any regulatory duty and also included the infamous Enron loophole which had special regulatory exclusions for energy derivative trading. Enron took quick advantage of this loophole and was consumed by one of the biggest corporate scandals of the past few years which had problems ranging from designed rolling blackouts to massive corporate fraud.
However, more relevant to an even more recent and disastrous situation this act allowed the derivative and credit swap market specifically with regards to mortgage backed securities to run wild and unchecked. Lax regulations, predatory business techniques and downright fraud in the mortgage industry led to unstable mortgages being underwritten and approved. Similar to how the crash of 1929 devastated not only Wall Street, but the whole of America because their gambles were being funded by regular people’s personal savings; the financial crisis of 07-08 was funded by regular people’s mortgages and the crash devastated their credit and in a lot of cases left people homeless. By securitizing mortgages specifically bad mortgages which fall within the realm of commercial banking and then creating products for investment banks to speculate on these instruments all while assuring customers that they are Triple A rated, Wall Street created a tangled web of banking products that eventually collapsed under its own weight.
Dodd-Frank and the Vockler Rule
In the aftermath of the financial crisis the government bailed out the banks to prevent the financial system of the United States to further degenerate. The bailout although arguably good intentions signaled to Wall Street that their banks are too big to fail, vindicating them of the responsibility for their risky and in some cases illegal behavior. Even worse some people argue that if they had been allowed to fail other companies that had been virtually barred from the banking industry would have been able to enter the credit market and buy the debt of the newly bankrupted banks at true market prices. Instead, the banks were saved and their bad assets were acquired for significantly more than they were worth and the barriers of entry to the banking industry were raised further consolidating the industry. Nonetheless, the need for reform was obvious and the Dodd-Frank Act had a number of measures in response to the Great Recession. It created new regulatory agencies for mortgages, brought derivatives onto exchanges, created a consumer protection agency, and gave the Fed more regulatory responsibility. The Volcker Rule was presented as a return to Glass-Stegall by placing restrictions between the combination of commercial and investment banking specifically by restricting banks from making proprietary investments.
However, it is known as Glass-Stegall lite and many have criticized that Dodd-Frank even with the Volcker Rule is not enough. Critics argue that out of its three main tasks (protect consumers from predatory practices, curb dangerous risks taken by banks, and end too big to fail) it has only partially succeeded in some areas while completely failing in others. Banks are only getting bigger and the “excessive” regulation stifles smaller banks, labeled as big by having a relatively small amount of assets, with compliance costs they can’t shoulder as well as their bigger brethren which in turn encourages more consolidation. Also Freddie Mac and Fannie Mae remain largely the same despite their role in the financial crisis and Section 20 and 32 of Glass-Stegall have not been reinstated. Nonetheless, despite its flaws and limitations Dodd Frank is still effective enough to generate considerable backlash from the right as too heavy handed. That in itself tells us that even if it isn’t perfect it is a huge step in the right direction.
Stock Buybacks and Corporate Debt – Rule 10b-18 and stock manipulation
While not likely to collapse the entire economy stock buybacks are another type of financial manipulation that affects American lives. Rule 10b-18 adopted in 1982 during the Reagan administration loosened the rules against corporate stock manipulation. Before that a company could not buy its own shares on the open market and if they did it was considered stock manipulation and was punishable with harsh fines. However, under Rule 10b-18 shares up to 25% of the average trading value are excluded from charges of stock manipulation. Combining this new rule with the new pervading philosophy that the CEOs job is to maximize shareholder value and an alarming tendency of a company’s board to encourage this philosophy by tying compensation to share price, has lead to rampant stock manipulation.
CEOs to meet their target Earnings per Share values at the end of the quarter will buy large amounts of their own stock to raise the price to meet the benchmark which their compensation is tied to. Sometimes if they do not have the cash on hand they will borrow to buy the amount of stock needed to raise their share price to the appropriate level. It helps that interest on corporate debt is actually tax deducible. This has lead to the explosion of corporate debt in recent years. In fact companies spend more on these stock buybacks then they make and take on debt from each other to fund these buybacks. So instead of borrowing money to expand companies borrow money from other companies to buy more of their own stock then they made in revenue that year. This has lead to an explosion of corporate debt that has led to a loss of credit worthiness by many companies and many believe will lead to a recession.
Stock buybacks are sold as a way to share the profits with the shareholders or as good investments when the company has run out of ways to invest its profits. However, it has effectively crippled money companies could put towards increasing its workers pay or possibly even more important R&D for new innovations and products. Instead CEOs pay has skyrocketed, wages have stagnated, and innovation has all but disappeared.
The United States is developing a major problem keeping up with the new emerging technologies because the profits that historically went towards innovation, educating their workforce, and retaining their workforce by giving them higher wages has been redirected towards buy their own stock. CEOs and large shareholders who are mostly billion dollar hedge funds benefit immensely from this zero sum game; however, the average American and eventually America herself all suffer by this misuse of investment. The stock price of a company is meant to reflect the underlying value of a company’s assets. Assets that are created through innovation and sales; however, to ensure their ludicrously high salaries CEOs use stock buybacks to force the stock price to be the right number.
Along the same vein of manipulating the system at the expense of innovation are patent laws. A patent is basically a government approved monopoly for a period of time as a reward for creating a novel and non-obvious product or solution. Nonetheless, today’s patents are hardly novel and the more obvious and broadly applicable a filer can get away with the better. Patents are now abused to either eliminate competition or to steal another companies profits by suing them for patent infringement.
Patent’s original purpose of encouraging innovation and increasing productivity has been all but lost and even worse has gone the opposite way. There have been no signs that new patents help improve innovation. Also by innovators running into existing patents that are broad and loosely defined and then being sued by the companies for using that idea, innovation has suffered. R&D budgets now must take into account the vast legal costs associated with defending their innovations or suing other companies. In fact new innovations rarely come from the bigger companies they simply try to find ways to extend their existing patents rather than take the risk of creating new innovation. The way they acquire new knowledge now is by acquiring smaller companies who have come up with new ideas, but have hit a wall of scaling up because of the vast patent spider web they would have to transverse to make their idea useful.
Drug companies defend their extremely high prices in the States by saying they need to charge the higher prices to make the money back from R&D. However, the amount of their profits that goes to R&D after the stock buybacks and marketing is slim. In fact the marketing budget alone of most pharmaceutical companies far exceeds its R&D budget. As a result, most of the new drugs created over the last decade or so have come from government funded research and universities or the like and then have been sold to pharmaceutical companies. Furthermore most of the new patents that pharmaceutical companies have created in house are simply slight alterations of existing drugs that extend the patent life of an already existing drug keeping the price artificially high and hurting health outcomes across the globe who depend on cheap generic medicine. Almost all new innovation in the pharmaceutical industry has been bought from sources outside of the large corporations.
With patents declining ability to encourage innovation and the rise of patent trolls people are beginning to see patents as a big corporation’s ploy to stifle competition and keep prices for goods high. One of the biggest complaints about the Trans-Pacific Partnership is that it gives too strong of a protection to patent laws which could be disastrous to public health if cheap drugs are prevented from entering the market in high risk places.
This isn’t the first time patent laws have obscured innovation and stalled growth. As part of FDR’s fight against monopolies he noticed a consolidation of patents among big firms and enacted reforms to loosen the intellectual property hold of these major players. He forced them to license out the patents they weren’t using often for free and as a result the semiconducting transistor was licensed to Texas Instruments which was a precursor to the microchip and the dawn of the computer age. Like any system the patent system can be gamed and to prevent that the government must act.
To encourage competition and true innovation patent law needs to be reformed. However, whenever a new law or executive order is introduced to curb some of the harmful practices of patent law it ends up doing more harm than good. A complete overhaul of the patent system needs to be implement that can restore competition to the marketplace while rewarding and encouraging true innovation from sources big and small.
Due to the financial collapse of ’07-’08 Wall Street has faced a mild backlash to some of their practices. They nearly took down the economy by gambling with people’s money and mortgages and lying about the risk associated with that. The political and economic culture of the times allowed for this type of gambling by deregulating the industry with the repeal of Glass-Stegall via Gramm-Leach-Bliley. However, after the crisis the Dodd-Frank Act and the Volcker Rule put some of the safeguards back in place. Nonetheless, the rich still use other means to reward themselves at the expense of the American people such as stock buybacks. Furthermore, they also limit competition and by extension innovation by abusing the patent system. Reform is need to counteract some of these more egregious and harmful practices; however, it is remains a culture problem. Until government leaders shift their priorities from the rich to the middle class disastrous policies will continue to be written into law faster than we can repeal and replace them.
Stagflation: What Really Happened in the 70’s