Introduction and Transcript:
Left Out, a podcast produced by Paul Sliker, Michael Palmieri, and Dante Dallavalle, creates in-depth conversations with the most interesting political thinkers, heterodox economists, and organizers on the Left.
In this episode of The Hudson Report, we speak with Michael Hudson about the implications of the flattening yield curve, the possibility of another global financial crisis, and public banking as an alternative to the current system.
‘The Hudson Report’ is a Left Out weekly series with the legendary economist Michael Hudson. Every week, we look at an economic issue that is either being ignored—or hotly debated—in the press that week.
Paul Sliker: Michael Hudson welcome back to another episode of The Hudson Report.
Michael Hudson: It’s good to be here again.
Paul Sliker: So, Michael, over the past few months the IMF has been sending warning signals about the state of the global economy. There are a bunch of different macroeconomic developments that signal we could be entering into another crisis or recession in the near future. One of those elements is the yield curve, which shows the difference between short-term and long-term borrowing rates. Investors and financial pundits of all sorts are concerned about this, because since 1950 every time the yield curve has flattened, the economy has tanked shortly thereafter.
Can you explain what the yield curve signifies, and if all these signals I just mentioned are forecasting another economic crisis?
Michael Hudson: Normally, borrowers have to pay only a low rate of interest for a short-term loan. If you take a longer-term loan, you have to pay a higher rate. The longest term loans are for mortgages, which have the highest rate. Even for large corporations, the longer you borrow – that is, the later you repay – the pretense is that the risk is much higher. Therefore, you have to pay a higher rate on the pretense that the interest-rate premium is compensation for risk. Banks and the wealthy get to borrow at lower rates.
Right now what’s happened is that the short-term rates you can get by putting your money in Treasury bills or other short-term instruments are even higher than the long-term rates. That’s historically unnatural. But it’s not really unnatural at all when you look at what the economy is doing.
You said that we’re entering into a recession. That’s just the flat wrong statement. The economy’s been in a recession ever since 2008, as a result of what President Obama did by bailing out the banks and not the economy at large.
Since 2008, people talk about “look at how that GDP is growing.” Especially in the last few quarters, you have the media saying look, “we’ve recovered. GDP is up.” But if you look at what they count as GDP, you find a primer on how to lie with statistics.
The largest element of fakery is a category that is imputed – that is, made up – for rising rents that homeowners would have to pay if they had to rent their houses from themselves. That’s about 6 percent of GDP right there. Right now, as a result of the 10 million foreclosures that Obama imposed on the economy by not writing down the junk mortgage debts to realistic values, companies like Blackstone have come in and bought up many of the properties that were forfeited. So now there are fewer homes that are available to buy. Rents are going up all over the country. Homeownership has dropped by abut 10 percent since 2008, and that means more people have to rent. When more people have to rent, the rents go up. And when rents go up, people lucky enough to have kept their homes report these rising rental values to the GDP statisticians.
If I had to pay rent for the house that I have, could charge as much money as renters down the street have to pay – for instance, for houses that were bought out by Blackstone. Rents are going up and up. This actually is a rise in overhead, but it’s counted as rising GDP. That confuses income and output with overhead costs.
The other great jump in GDP has been people paying more money to the banks as penalties and fees for arrears on student loans and mortgage loans, credit card loans and automobile loans. When they fall into arrears, the banks get to add a penalty charge. The credit-card companies make more money on arrears than they do on interest charges. This is counted as providing a “financial service,” defined as the amount of revenue banks make over and above their borrowing charges.
The statistical pretense is that they’re taking the risk on making loans to debtors that are going bad. They’re cleaning up on profits on these bad loans, because the government has guaranteed the student loans including the higher penalty charges. They’ve guaranteed the mortgages loans made by the FHA – Fannie Mae and the other groups – that the banks are getting penalty charges on. So what’s reported is that GDP growth is actually more and more people in trouble, along with rising housing costs. What’s good for the GDP here is awful for the economy at large! This is bad news, not good news.
As a result of this economic squeeze, investors see that the economy is not growing. So they’re bailing out. They’re taking their money and running.
If you’re taking your money out of bonds and out of the stock market because you worry about shrinking markets, lower profits and defaults, where are you going to put it? There’s only one safe place to put your money: short-term treasuries. You don’t want to buy a long-term Treasury bond, because if the interest rates go up then the bond price falls. So you want buy short-term Treasury bonds. The demand for this is so great that Bogle’s Vanguard fund management company will only let small investors buy ten thousand dollars worth at a time for their 401K funds.
The reason small to large investors are buying short term treasuries is to park their money safely. There’s nowhere else to put it in the real economy, because the real economy isn’t growing.
What has grown is debt. It’s grown larger and larger. Investors are taking their money out of state and local bonds because state and local budgets are broke as a result of pension commitments. Politicians have cut taxes in order to get elected, so they don’t have enough money to keep up with the pension fund contributions that they’re supposed to make.
This means that the likelihood of a break in the chain of payments is rising. In the United States, commercial property rents are in trouble. We’ve discussed that before on this show. As the economy shrinks, stores are closing down. That means that the owners who own commercial mortgages are falling behind, and arrears are rising.
Also threatening is what Trump is doing. If his protectionist policies interrupt trade, you’re going to see companies being squeezed. They’re not going to make the export sales they expected, and will pay more for imports.
Finally, banks are having problems of they hold Italian government bonds. Germany is unwilling to use European funds to bail them out. Most investors expect Italy to do exit the euro in the next three years or so. It looks like we’re entering a period of anarchy, so of course people are parking their money in the short term. That means that they’re not putting it into the economy. No wonder the economy isn’t growing.
Dante Dallavalle: So to be clear: a rise in demand for these short-term treasuries is an indication that investors and businesses find too much risk in the economy as it stands now to be investing in anything more long-term.
Michael Hudson: That’s exactly right. It’s not that the inverted yield curve causes a slowdown. Rather, it’s a symptom reflecting that investors are expecting a further slowdown and non-recovery. The economy is in a debt quandary.
I should add that short-term interest rates are determined by the Fed, and it is pushing up short-term rates ostensibly to show down price rises (its euphemism for the possibility of wage increases). So that is the “given.” Long-term rates have moved up slightly – meaning that their bond prices have declined a bit. There’s so little chance of their going down much (and rising in price), and so much chance of rates rising further (and lowering bond prices) that investors are afraid of taking a loss during the bond’s remaining maturity.
So the Fed is setting short-term rates. Obviously, there are still a lot of takers – but not enough to overwhelm the Fed’s insistence of raising rates. My point is that there’s not going to be a “recovery.”
Dante Dallavelle: OK. So we have prominent economists and policymakers, like Geithner, Bernanke Paulson, etc., making the point that we need not worry about a future crisis in the near term, because our regulatory infrastructure is more sound now than it was in the past, for instance before 2008. I know you’ve talked a lot about the weak nature of financial regulation both here at home in the United States and internationally. What are the shortcomings of Dodd Frank? Haven’t recent policies gutting certain sections of the law made us more vulnerable, not less, to crises in the future?
Michael Hudson: Well, you asked two questions. First of all, when you talk about Geithner and Bernanke – the people who wrecked the economy – what they mean by “more sound” is that the government is going to bail out the banks again at public expense.
It cost $4.3 trillion last time. They’re willing to bail out the banks all over again. In fact, the five largest banks have grown much larger since 2008, because they were bailed out. Depositors and companies think that if a bank is so crooked that it grows so fast that it’s become too big to fail, they had better take their money out of the local bank and put it in the crooked big bank, because that’s going to be bailed out – because the government can’t afford to let it go under.
The pretense was that Dodd Frank was going to regulate them, by increasing the capital reserves that banks had to have. Well, first of all, the banks have captured the regulatory agencies. They’re in charge of basically approving Federal Reserve members, and also members of the local and smaller bank regulatory agencies. So you have deregulators put in charge of these agencies. Second, bank lobbyists have convinced Congress to de-tooth the Dodd Frank Act.
For instance, banks are very heavily into derivatives. That’s what brought down AIG in 2008. These are bets on which way currencies or interest rates will go. There are trillions of dollars nominally of bets that have been placed. They’re not regulated if a bank does this through a special-purpose entity, especially if it does it through those that are in Britain. That’s where AIG’s problems were in 2008. So the banks basically have avoided having to back up capital against making a bad bet.
If you have bets over where trillions of dollars of securities, interest rates, bonds and currencies are going to go, somebody is going to be on the losing side. And someone on the losing side of these bets is going to go under, like Lehman Brothers did. They’re not going to be able to pay their customers. You’re going to have rolling defaults.
You’ve also had Trump de-tooth to the Consumer Financial Protection Agency. So the banks say, well, let’s do what Wells Fargo did. Their business model is fraud, but their earnings are soaring. They’re growing a lot, and they’re paid a tiny penalty for cheating their customers and making billions of dollars off it. So more banks are jumping on the high-risk consumer exploitation bandwagon. That’s certainly not helping matters.
Michael Palmieri: So, Michael we’ve talked a little bit about the different indicators that point towards a financial crisis. It’s also clear from what you just stated from a regulatory standpoint that the U.S. is extremely vulnerable. Back in 2008 many argue that there was a huge opportunity lost in terms of transforming our private banking system to a publicly owned banking system. Recently the Democracy Collaborative published a report titled, The Crisis Next Time: Planning for Public ownership as Alternative to Corporate Bailouts. That was put out by Thomas Hanna. He was calling for a transition from private to public banking. He also made the point, which you’ve made in earlier episodes, that it’s not a question of if another financial crisis is going to occur, but when. Can you speak a little bit about how public banking as an alternative would differ from the current corporate private banking system we have today?
Michael Hudson: Sure. I’m actually part of the Democracy Collaborative. The best way to think about this is that suppose that back in 2008, Obama and Wall Street bagman Tim Geithner had not blocked Sheila Bair from taking over Citigroup and other insolvent banks. She wrote that Citigroup had gambled with money and were incompetent, and outright crooked. She wanted to take them over.
Now suppose that Citibank would had been taken over by the government and operated as a public bank. How would a public bank have operated differently from Citibank?
For one thing, a public entity wouldn’t make corporate takeover loans and raids. They wouldn’t lend to payday loan sharks. Instead they’d make local branches so that people didn’t have to go to payday loan sharks, but could borrow from a local bank branch or a post office bank in the local communities that are redlined by the big banks.
A public entity wouldn’t make gambling loans for derivatives. What a public bank would do is what’s called the vanilla bread-and-butter operation of serving small depositors, savers and consumers. You let them have checking accounts, you clear their checks, pay their bills automatically, but you don’t make gambling and financial loans.
Banks have sort of turned away from small customers. They’ve certainly turned away from the low-income neighborhoods, and they’re not even lending to businesses anymore. More and more American companies are issuing their own commercial paper to avoid the banks. In other words, a company will issue an IOU itself, and pay interest more than pension funds or mutual funds can get from the banks. So the money funds such as Vanguard are buying commercial paper from these companies, because the banks are not making these loans.
So a public bank would do what banks are supposed to do productively, which is to help finance basic production and basic consumption, but not financial gambling at the top where all the risk is. That’s the business model of the big banks, and some will lose money and crash like in 2008. A public bank wouldn’t make junk mortgage loans. It wouldn’t engage in consumer fraud. It wouldn’t be like Wells Fargo. It wouldn’t be like Citibank. This is so obvious that what is needed is a bank whose business plan is not exploitation of consumers, not fraud, and isn’t gambling. That basically is the case for public ownership.
Paul Sliker: Michael as we’re closing this one out, I know you’re going to hate me for asking this question. But you were one of the few economists to predict the last crisis. What do you think is going to happen here? Are we looking at another global financial crisis and when do you think, if so, that might be coming?
Michael Hudson: We’re emphatically not looking for “another” global crisis, because we’re in the same crisis! We’re still in the 2008 crisis! This is the middle stage of that crisis. The crisis was caused by not writing down the bad debts, which means the bad loans, especially the fraudulent loans. Obama kept these junk mortgage loans and outright fraud on the books – and richly rewarded the banks in proportion to how badly and recklessly they had lent.
The economy’s been limping along ever since. They say there’s been a recovery, but even with the fake lying with statistics – with a GDP rise – the so-called “recovery” is the slowest that there’s been at any time since World War II. If you break down the statistics and look at what is growing, it’s mainly the financial and real estate sector, and monopolies like health care that raise the costs of living and crowd out spending in the real economy.
So this is the same crisis that we were in then. It’s never been fixed, and it can’t be fixed until you get rid of the bad-debt problem. The bad debts require restructuring the way in which pensions are paid – to pay them out of current income, not financializing them. The economy has to be de-financialized, but I don’t see that on the horizon for a while. That’s s why I think that rather than a new crisis, there will be a slow shrinkage until there’s a break in the chain of payments. Then they’re going to call that the crisis.
Hillary will say it’s the Russians who did it, but it really is Obama who did it. The Democratic Party leadership is in the hands of Wall Street, and has not done anything to prevent the same dynamics that caused the crisis in 2008 and are still causing the economy to shrink.
Paul Sliker: That’s exactly why I wanted to reframe that question, because I think a lot of people look at economic and financial crises through just the simple paradigm of a bubble and the bubble bursting. But I think you did a fine job of clarifying that.
Well Michael, as always, we could go on but we have to end here. Thank you so much for joining us on The Hudson Report.
Michael Hudson: Well you’ve asked all the right questions.
Paul Sliker is a writer, media consultant, and the co-host of LEFT OUT— a podcast that creates in-depth conversations with the most interesting political thinkers, heterodox economists, and organizers on the Left. Follow him on Twitter: @psliker
Michael Palmieri is the co-host of LEFT OUT — a podcast that creates in-depth conversations with the most interesting political thinkers, heterodox economists, and organizers on the Left.
Dante Dallavalle is a graduate student in economics at John Jay College of Criminal Justice and the co-host of LEFT OUT — a podcast that creates in-depth conversations with the most interesting political thinkers, heterodox economists, and organizers on the Left. Follow him on Twitter @Drax138.