Yves here. As much as Matt Taibbi has regularly been right, early, and outraged at the deserving targets, he nevertheless once in a while gets mired in views that presumably does not recognize as questionable orthodoxy (see here for an example a while back). Here, Richard Vague examines the blind spots about Modern Monetary Theory and the Fed that Taibbi and many others on the left hold.
By John Siman
It is now more than ten years since Matt Taibbi published his revelatory investigative essay The Great American Bubble Machine, which began with these immortal sentences: “The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”
Taibbi collected “The Great American Bubble Machine” along with six of his other investigative essays about the complex thievery which led to the subprime crisis and the Great Recession to produce his 2010 book Griftopia. “The new America…,” he wrote in the first essay, “is fast becoming a vast ghetto in which all of us, conservatives and progressives, are being bled dry by a tiny oligarchy of extremely clever criminals and their castrato henchmen in government, whose job is to be good actors on TV and put on a good show” (p. 33).
So Taibbi established himself as America’s most important financial journalist over a decade ago. And by important I mean writing from a truly democratic — that is, an anti-oligarchic — perspective. Now that we have entered the Corona Crisis, I look to him to be one of America’s populist champions. And I use the word champion the way the plucky underdog Rebecca used it in the Walter Scott novel: “God will raise me up a champion”, she said when things looked bleakest.
Just last Monday (April 6) Taibbi declared his absolute journalistic independence from the corporate media and their coverage of the castrati henchmen and the well-acted shows, from their narrativized exercises in demonization, Maddow vs. Hannity, that now brand their business model: “From now on,” he wrote in an email to his readers, “my online writing will be published on Substack. This is my full-time job now.”
Furthermore, he states that his goal in his newly declared independence is to be an even more critical financial journalist than he was last time around: “Having spent the better part of eight years covering the subprime crisis and its aftermath, I hope to focus in this space on the financial aspects of the coronavirus mess. The moment we’re in right now equates to September 2008, when the world was melting down and historic, transformational decisions were being made at light speed. This time around, I want to catch as much of it in real time as possible, and will do so here on Substack.”
Who better to have fighting for us right now? No one, really. (Well, in addition to Taibbi for the best essays, I’m looking to Thomas Frank for the best books, Michael Tracey for the best Tweets, and Jimmy Dore for the best YouTube content.) But as I read Taibbi’s two most recent essays, Bailing Out the Coronavirus Bailout and Resetting the Bomb, I worry that his moral courage and corresponding moral outrage might get in the way of his being able to analyze possible ways of escaping the second Great Depression which the coronavirus mess might very well cause.
Specifically, in spite of all of his hard-earned knowledge of Wall Street, Taibbi seems to be a little apprehensive of Modern Monetary Theory at a time when, oh-so-suddenly-poof!, MMT, instead of seeming to be some arcane tranche of macroeconomic extremism, now appears to offer us the only workable programs for keeping the wheels of our economy turning.
Now because we have a tremendous amount of under-utilized resources, in the form of idle people and businesses, the Federal government needs to engage in massive spending to prevent a huge deflationary shock from turning into a full bore depression. MMT shows that the Federal government can readily inject trillions of dollars of rescue money because it can freely spend with its only constraint being real economy capacity limits.
However, because the US has outdated budgetary mechanisms, this spending requires issuing Treasury bonds, and most commentators have been indoctrinated to see debt, even the ‘debt for convenience sake only” of a currency issue like the US, as the same when that’s not the case.
Taibbi seems to become, naturally enough somewhat acrophobic when he thinks about it, as you can see 23:20 on his most recent show on YouTube.
So I turned to Richard Vague, Pennsylvania’s acting Secretary of Banking and Securities, to help me evaluate Taibbi’s new essays.
Vague, once a highly successful banker, has become an economic historian and theorist. His most recent book is A Brief History of Doom: Two Hundred Years of Financial Crises, which Steve Keen regards “as the best history of financial crises ever written — far better than Kindleberger and Mackay.” For in it Vague shows how runaway private debt — not government debt! — has been the primary cause of almost all financial crises in major economies over the past two hundred years.
As a sort of homework assignment, Vague has told me to read the second edition of Randall Wray’s Modern Money Theory.
Here is Vague’s first lesson about MMT in a few sentences, for you or me or Matt Taibbi:
A government that has the power to create money never has to default. That doesn’t mean that an unlimited amount of money should be created, but we are currently within the bounds of what’s possible. Here is my critique of unlimited issuance of debt: it is possible, but does further drive down interest rates which in turn exacerbates inequality. All current money creation creates equivalent liabilities/debt, so I’ve been exploring concepts for creating money without creating commensurate debt.
And Richard Vague was so gracious as to answer my questions about Matt Taibbi in great detail:
John Siman: Thank you so much for taking the time to look closely at Taibbi’s new articles “Bailing Out the Bailout” and “Resetting the Bomb.” Also for watching Krystal and Saagar’s “Rising” interview with Taibbi on Friday (Matt Taibbi: Why this bailout is worse than 2008). How do you want to begin to describe what he’s up to?
RICHARD VAGUE: He’s a very savvy reporter. He’s studying the flaws in the Congressional and Federal Reserve bailout efforts and the profiteering he believes will occur. Much of his reporting is on target. But he goes further, saying “the bailout looks like forever” and “we are resetting the bomb again.” As we begin to examine the considerable financial fallout of the Great Pandemic, I want to examine those and a few of Taibbi’s other comments and give them some deeper context and bring them into clearer perspective.
JS: OK, Richard, go ahead. Let’s hear it!
VAGUE: The scale of this crisis is extraordinary, with a projected decline in GDP of above 30% for this quarter. In the Great Recession there was less than a 5% decline for the full year of 2009. In the Great Depression, the cumulative decline was 46% from 1929 to 1933.
Before the crisis, the US economy was the subject of concern due to growth, stagnant wages, and rising inequality. Nevertheless, things improved through the past decade after the frighteningly high privatesector debt levels that brought on the Great Recession. As of December 2019, the privatedebt profile of the economy, though still unacceptably high, had declined from 168% of GDP in 2008 to 150%. Household debt had declined from 96% to 75%, and business debt had risen slightly from 72% to 75%. That was the situation we were in prior to 2020. High enough privatesector debt to slow growth and stultify spending, yes — but no profligate growth in new loans or bad debt, the things required to create a conventional banking crisis.
JS: So what do you want to say about Taibbi’s comment that “the bailout looks like forever?”
VAGUE: This comment belies the fact that we did largely unwind from the last bailout. The Fed unwound much of the market support mechanisms it had put in place, and the total notional value of Federal Reserve swap lines has declined from $583 billion at their peak in the crisis to $349 billion most recently. Total assets at the Fed had decreased from a peak of 25% of GDP down to 19%. In the overall market, credit derivatives declined from $16 trillion in 2008 to $3.9 trillion as of year-end 2019. As noted, the private sector deleveraged somewhat, and the notional value of total overall derivatives, which had peaked at $236 trillion in 2013, had declined to $171 trillion.
Furthermore, we need to note that much of the Fed’s trillions in credit market support were not a giveaway, but instead loans provided to support to those markets through its money creation powers that were calculated to be repaid over a reasonably short period. And most of them were. It is important to differentiate between spending support, such as in a stimulus package, where the money is given and not loaned, and the loans the Fed makes in its role as the emergency lender of last resort.
What was forever about the bailout, tragically, was how lopsided it was in favor of businesses and how much it neglected individuals. That brought us Trump. There is some of that same lopsidedness in the pandemic rescue efforts.
JS: This is where I totally trust Taibbi. On standing up to grifters. He is truly outraged by the injustice, the thievery he sees. But I worry that his moral outrage somehow limits his vision when he tries to make sense of the size of the stupendous piles of money that need to be created.
VAGUE: Yes, Taibbi laments that the Federal Reserve has grown to $5 trillion in assets and may now grow to $10 trillion, with “as much Fed support of mortgage markets in one day as was done across a month at the peak of the last round of Quantitative Easing.” But note that the Fed is not outsized in comparison to the economy or other central banks. At the end of 2019, its assets stood at 20% of US GDP, with the European Central Bank at 40% of Eurozone GDP, the People’s Bank of China at 40% of China’s GDP, and the Bank of Japan at 100% of Japan’s GDP. In fact, even before the Great Recession, the BOJ and the PBOC were larger relative to their respective economies than the Fed is now relative to the US economy.
JS: Well, in fairness to Taibbi, let me ask what happens if the Fed gets insanely huge?
VAGUE: OK, let’s take an extreme case then — let’s say the Fed grows to $15 trillion and the economy drops to $17 trillion. The Fed would still be smaller relative to its GDP that the Bank of Japan. And there’s another way to put the Fed’s $5 or $10 trillion in perspective, and that’s to compare it to the size of the financial markets within the US, such as  the money supply, which is $15 trillion,  the U.S. Treasury debt market which is $22 trillion, and  the total of public and private debt, which is $60 trillion. In fact, total financial assets in the US, including publicly traded equities, are $115 trillion.
This is all to say that, in my view, at $5 or at 10 trillion, the Fed’s total size is not excessive, and it has ample capacity to continue to perform its one original and most important function, which is to serve as the lender of last resort.
And as to whether the Fed will at some point have to shrink? Viewed in the context of markets, history, and other central banks, there is no imperative for the Fed to downsize.
JS: Taibbi writes that “a lot of these markets were already overinflated thanks to post-2008 bailouts and interventions like Quantitative Easing. We’re about to find out that the American economy has been living off dying, dysfunctional, or hyper-leveraged markets for more than a decade.…” That sounds apocalyptic!
Taibbi continues: “A major issue with the post-2008 bailout programs is that they tended to increase rather than decrease the risk in the system. A decade-plus of zero-to-low interest rates and massive central-bank buying programs like QE made traditional safe havens unattractive and pushed investors to chase returns in a variety of not-so-healthy ways.” So scary!
VAGUE: But the low rates and the unhealthy chase for returns we have seen this past decade are not because of the Fed and QE — but rather in spite of the Fed. The Fed has followed the economic trends rather than led them. Contrary to economic orthodoxy, higher debt levels don’t cause rates to go up, they cause rates to go down. (And these low rates have contributed to the rise in asset values that have exacerbated inequality.) It’s an inverse correlation that has played out continuously since 1981. When debt increases, rates decline. It’s one of the least-recognized and least-appreciated economic truths of our time. See the chart below. With debt now set to increase massively as a percent of GDP, we will see rates decline further!
So Taibbi writes that we’ve been living off highly leveraged markets for more than a decade, and, yes, he’s correct, but we’ve been living off highly leveraged markets for a hundred years or more.
What I’m here to tell people is that the governmentdebt component of this is not the problem. The problem has been and continues to be the private sectordebt component of this that is.
In a crisis like this, we have the capacity to fund higher levels of government spending and support much higher levels of government debt. In contrast to private sector debt, government debt to GDP did increase since the crisis, from 73% in 2008, to the current level of 106% as tax revenues fell short and stimulus programs were enacted. A $3 trillion increase would bring that to 120%. That ratio would still be well within the ratio of Japan, so often a harbinger of future trends, which now stands at 238% — and similar to the ratio of France at 99% and of Belgium at 102%. These countries have not seen much, if anything, in the way of adverse consequences from these government debt levels. Even if government debt >grows more than this and GDP declines, the level would still be supportable. It is high levels of private sector debt, not public debt, that most directly brings adverse consequences in an economy. And higher levels of government spending at this time will help mitigate dangerously higher levels of private sector debt.
Most importantly, the issuance of new debt and spending of new money by the Fed means that the private sector is receiving that money — that it ends up as income and wealth in the businesses and households of the country. $3 trillion of additional debt means $3 trillion in more money in the private sector’s pockets. That’s fundamental MMT macroeconomic accounting. And that is exactly what’s needed.
JS: Taibbi expresses concern about the private equity leveraged buyout sector, noting “A few years ago, for instance, the infamous junk-bond ghoul Mike Milken … gushed to Bloomberg that America was in a ‘golden age’ for private-equity takeovers.… ‘You can leverage, you can borrow without covenants, and so for equity holders it affords you a very unusual rate of return.’ … This dynamic spurred a boom in securitized commercial loans not totally unlike the boom in securitized mortgages pre-2008.” I totally trust Taibbi on this kind of reporting.
VAGUE: Yes, he is correct. This is an area of vulnerability for the US economy. But even this is something to be kept in perspective. Debt for this sector is less than $1 trillion out of the $32 trillion in total private sector debt. Real estate loans, in contrast, total $15 trillion ($10 trillion in home mortgages and $5 trillion in commercial real estate), almost half of total private sector debt. It took lending profligacy in a market that big to bring the Great Recession. The buyout sector is comparatively much smaller.
As of year-end, we did not have overleverage or overcapacity in the real estate market. But the pandemic will surely disrupt the real estate market too. Job loss will bring mortgage delinquency. Business failures will bring commercial real estate issues. How widespread that is will dictate much of what the level of damage is in the overall lending sector.
JS: Taibbi writes that we’re “institutionalizing the unfairness economy,” noting that “for instance, the world’s largest asset manager, BlackRock, will oversee the Fed’s new corporate bond-buying program, an arrangement that inspires gallows laughter among analysts.” This just sounds grim.
VAGUE: Again, Taibbi is correct. One of several areas ripe for conflict is the US Treasury’s extraordinary discretion in supporting large corporations. Oversight is lacking.
When something that goes to this scale this quickly, fairness is a casualty and favoritism and profiteering are hard to avoid. The SBA, for example, is being asked to process almost ten times as many loans in a month than is has historically processed in a year.
This is an unfortunate characteristic of every operation that has been required to quickly achieve massive scale — especially war, and the Civil War, World War I, and World War II were rife with waste, inefficiency and even profiteering. Business executives were put in charge of major aspects of each of these. American companies made massive profits in World War I, so much so that in World War II, the goal was to “take the profits out of war,” and Roosevelt promised “no war millionaires.” Roosevelt and the nation failed on both counts. Once the decision to enter these wars had been made, speed was of the essence, and problems such as these could only be addressed after the fact, if ever. That did not make it right. We should rail against it. But it does put it in historical context.
JS: Where do we go from here?
VAGUE: As the threat of COVID-19 abates and businesses start back up, we are going to find enormous financial carnage, with millions of unemployed individuals and thousands upon thousands of businesses that never reopen. The depression that came with the combined impact of reduced spending at the end of WWI and the Spanish Flu may offer a clue. It brought a drop in GDP from $85 billion in 1920 to $73 billion in 1921 and 1922, The economy was not back to its 1920 level until 1923
One of the most punishing aftereffects will be that battered household incomes will make it much harder for those households to pay their debts, which for many will be suffocating in the wake of the pandemic. Government debt will not be the debt bomb Taibbi fears. The private sector debt might very well be.
He laments, appropriately, that we never fix this stuff and that “the size of the bag the rest of the country is left holding get bigger with each cycle.” But we are left to wonder how he would fix things.
JS: Well, his job is to critique things and ask tough questions. Your job is to understand economic history and tell us how to fix things. So what would you propose as a solution to the current crisis?
VAGUE: To continue the what has already being done, adding oversight and fixing the inequities. But we need increased support to individuals, taking it from a single check and extending it to at least three months or more if necessary, and increase the support for small businesses loans from $350 billion to perhaps twice that number.
Longer term, individuals need mechanisms to bring relief from high levels of debt. For example, student debt borrowers need relief, perhaps forgiveness that would come through community service. Underwater mortgage holders need relief, perhaps getting principal reduction in exchange for giving part of the gain on the future sale of the home.
Climbing out of this economic quagmire will take everything we’ve got and more.
JS: So what do you want to say about Michael Hudson’s proposal for a debt write-down/jubilee? He just had a piece in the Washington Post in which he wrote:
The way to restore normalcy today is a debt write-down. The debts in deepest arrears and most likely to default are student debts, medical debts, general consumer debts and purely speculative debts. They block spending on goods and services, shrinking the ‘real’ economy. A write-down would be pragmatic, not merely moral sympathy with the less affluent.
VAGUE: I am an advocate of jubilee. Where the government is the lender, it is feasible, especially if some feature can be added that addresses the issue of fairness. For example, we’ve advocated that student debt be forgiven based on community service. Where the private sectoris the lender, it raises the question of who will take the loss. Again, if the government steps in to take that loss, it makes the idea more feasible. And there could be innovative ways to structure private sector jubilee using tax laws and accounting modifications. For mortgage loans, we’ve advocated letting the lenders of underwater mortgages write the loan down to fair market value, and those lenders 30 years to write off the loss, in exchange for receiving a portion of the gain when the home is eventually sold.
JS: You’ve been so generous with your time, Richard. Maybe, in the larger perspective, all of this — from the global plague right down to the jubilee idea — is straight out of the Bible. I guess we’ll see. But the good people need to take up the lance and fight!