Current U.S. financial policy sustains an unbridgeable gap between the demands of those who owe and those who are owed. This article explains why things didn’t have to be this way.
The world of passive entitlement
Consider a large and powerful Wall Street investment bank. In the years leading up to the 2008 financial crisis, the bank creates $100 billion worth of tranche-complex and high-risk mortgage backed bond (MBB) investments. Designed for public consumption, MBBs are comprised of residential mortgage-backed securities (RMBS), collateralized debt obligation (CDO) securities and credit default swaps (CDS).
The bank sells most of the bonds to unsuspecting investors, without disclosing the high risk of loss that accompanies them. Then comes the financial crisis, causing homeowners to lose both jobs and property values and bringing on an unsettling wave of mortgage defaults.
To maintain its profits and the fortunes of its MBB investors, the banker advocates public policies – such as low inflation, financial bailouts and subsidies, expansive monetary policies (including quantitative easing and depressed interest rates) and fiscal policies socializing private banking losses. These policies, however, prolong the suffering of mortgaged homeowners even as they help the bankers prosper.
This is, of course, the well-known story of Goldman Sachs, but almost every other major Wall Street brokerage and every major bank (and, therefore, every major mortgage lender) has a similar tale to tell; mortgage borrowers misled, bond market investors defrauded, illegal foreclosures, retaliatory FICO scoring and insider bets against housing loans. Most recently, in July 2011, Bank of America set aside $14 billion to pay MBB investors for unsanctioned securities trading. Illegal? Possibly. Unacceptable behavior? Certainly. But at this point is anybody really still surprised by stories of lender abuse?
More to the point, is anybody surprised by the fact that while the borrowers who make up the largest part of the US population continue to suffer a reduced standard of living due to high unemployment, most abusive lenders continue to succeed and even thrive economically? Citigroup reported profits of $3.3 billion in the second quarter of 2011, and Bank of America would have done similarly well had it not been forced to pay for the extensive legal troubles of its mortgage lending department. [For more on the employment and debt in the recession, see the August 2011 first tuesday article, Jobs are scarce whether or not you can sell your home.]
The fact is, lenders are merely working in their own best interest—and their continued financial success indicates that their strategies are effective.
Different laws for different classes
In a much-blogged-about June report on creditslips.org, Robert Kuttner draws the distinction between the rentier class, made up of those who lend money or let real estate, and the debtor class, comprising those who borrow or rent. The rentiers exist in opposition to renters: the latter pay, and the former collect.
Do you believe the interests of lenders and the "rentier class" are opposed to those of homeowners?
- Yes. (64%, 115 Votes)
- At times, but not always. (22%, 40 Votes)
- No. (10%, 18 Votes)
- I do not believe there are disparate classes in the U.S. (4%, 8 Votes)
Total Voters: 181
Rentiers, Kuttner points out, are largely governed by the laws of large for-profit corporations, which entitle them to participate in behavior forbidden to individual members of the general public. [For the full analysis, see Kuttner’s article, Debtors’ Prison.]
At the bottom of the bankers’ advantage, Kuttner says, is a fundamental contradiction. Banks are given access to money at extremely cheap rates by their unique ability to borrow from the Federal Reserve (the Fed), the initial source of all U.S. currency.
To stimulate spending in this recession, the Fed has consistently lent money to banks at essentially zero percentinterest rates. In return, the banks are expected (though not required) to increase their own lending to private borrowers. Meanwhile bankers are able to escape their debts by passing them on to the Federal Deposit Insurance Commission (FDIC), or, in extreme circumstances, by receiving massive government bailouts (recapitalization) funded by the U.S. Treasury.
When banks escape financial obligations they are unable to pay due to their own mistaken calculations and harmful behavior, it is considered a legitimate corporate business strategy.
In contrast, mortgage-holding homeowners are left to repay their mortgage debt, as bankers steadfastly resist any congressional attempts to make it easier for homeowners to escape even the most egregious amounts of debt.
When homeowners push for the same right as banks, through cramdowns orchestrated in bankruptcy court or by just walking away from an underwater mortgage, the decision to escape debt is at best called a moral failure and at worst a legal impossibility (although not in antideficiency states, like California). [For a review of the need for bankruptcy-ordered cramdowns to right California’s economy, see the January 2010 first tuesday article, Cramdowns, cramdowns, cramdowns!]
As a result, the nation is divided into two separate and adverse economic classes, each of which depends upon the other. Class warfare seems to be the inevitable result of this dichotomy, but the economy has not always been so clearly divided. In reality, it is not at all difficult to envision a society in which the interests of rentiers and borrowers are far more closely aligned. To understand how this is possible, a clearer definition of the term rentier is required.
Who are the rentiers?
Rather than referring to a “lender class,” it might be useful to think of the rentiers as all those who receive fixed income yielded from tangible and intangible assets they own. While most of our population derives its income from the direct production or sale of a good or service, rentiers profit by passively earning income generated by a possession. For example, a mortgage held by a lender or an apartment/nonresidential property held by a property investor (as in passive and portfolio income tax category investments) make the owner a rentier.
On the reverse side of the coin are businessmen, professionals and employees, who are active and earn money for their efforts, as well as speculators (day traders/flippers), who buy and sell property or other assets and profit on the resale. They must go to work each day if they are to have an income flow, since they have not built up wealth which produces income independent of their efforts.
It is not wholly misguided to think of the rentier class as the lords to a set of modern day serfs: the debtor class. The serfs work to gain income to pay for their needs, and their standard of living is set by the success of their efforts. They depend upon their lord for resources, especially shelter. Of course, their labors also go to enrich the idle but moneyed property owners who provide land and protection.
The arrangement is sometimes necessary for the serf — he needs a safe place to grow his crop — but certainly tends to work out better for the lord. Theories such as trickle-down economics suggest that an increase in the strength of the lord will lead to an increase in the serf’s well-being, but evidence has shown time after time that this is not the case.
The political success of the rentier regime in the current post-recession, financial crisis economy, Kuttner says, is indicative of an overall reversal in economic policy from the Keynesian economics in force at the close of World War II (WWII). In that period, the dominant group (the U. S. and allied forces) considered demanding overwhelming repayments from the defeated nation of Germany. However, they instead listened to the advice of John Maynard Keynes, whose Bretton Woods monetary system “emphasized domestic recovery for the defeated as well as the victorious powers.” We grow together from the ruins.
Thus, “a global monetary system was created at the end of WWII in which private financial speculators were denied the power to compel nations to pursue deflation” to pay war reparations. Rather than the victors paying their vast war debt with money demanded from the defeated, the Fed tightly regulated the financial markets to reduce speculation and dramatically lower interest rates. The results were economically beneficial for both the defeated and the victorious: a monetary Marshall Plan.
In an ideal government, the conflicting demands of separate political contingencies—the few rentiers and the many debtors—would be balanced to the benefit of the largest contingency. The austerity measures that are most beneficial to rentiers would be voted against by the much larger group of debtors, made up especially of homeowners, who will benefit from economic stimulus and tighter regulation of lenders. Since the debtors are a huge part of the working population that actively creates items and provides services for sale, the government has an additional incentive to insure their continued well being.
Clearly, this is not the case in the U.S. today. The current political conversation is dominated by calls for reduced benefits to lower-income earners, increased austerity (reduction) in government spending, reduced taxes on the wealthiest and extensive precautions against perceived future inflation. Nobel laureate Paul Krugman is one persistent critic of the extent rentier dominance has taken hold in contemporary U.S. and international politics. [For more on the inconsistency between the needs of the economy and those of rentiers, see Krugman’s June article, The Rentier Regime.]
Krugman and other economists complain that establishment economic policy, which is predisposed to ensure that debts of individuals are honored rather than forgiven or artificially reduced by temporarily high inflation, is misguided and even harmful under the tenets of Keynesian economics. After all, the increased purchasing — of manufactured goods, services and resale homes — necessary for the economy to recover cannot take place when a vast swathe of the population’s income is diverted from the purchase of goods and services to repay principal and interest on underwater mortgages.
This is not to say a secret cabal of rentiers controls U.S. politics. We do suggest, however, that the ideology of the rentiers has ceased to be limited to ideology held by a wealthy elite. Instead, it has insinuated itself into mainstream political thought like an invasive species.
As a result, the rentiers as a class continue to be among the very few to reliably achieve continued financial success in this period of economic stagnation. However, rentier-friendly policies unavoidably pit Wall Street bankers against the needs of Main Street individuals.
Kuttner compares economic policy in the U.S. and the European Union, both of which currently emphasize the unaltered maintenance of debtor obligations (whether they be owed by homeowners or by bankrupt European nations), to the disastrous punitive reparation policies of Britain and France toward Germany after the World War I (WWI). The result in that case, as Keynes then predicted, was another war. The inadvertent result of current world policy, which sets the interests of debtors against those of creditors, is a different form of conflict: class warfare.
Opposing views focus attention
Complicating the issue is a recent report by The Economist, which counters Krugman’s description of the current policy situation. It argues that Krugman’s advocated policies of higher government spending, through programs like an expansion of the Fed’s recent bond purchases (called quantitative easing), are actually no more likely to help debtors than lenders — that is, the distinction between the two, from a monetary policy perspective, is illusory. [For the full Economist opinion, see the June 2011 Buttonwood Notebook.]
The Economist claims “sound money” and “balanced budgets” in times of financial crisis are the defining elements of historical rentier dominance. It supports this claim by reference to the presidency of William McKinley, which was based on maintaining the gold standard and low inflation (Britain did the same after WWI). The Economist contrasts that period of rentier dominance with the current Administration: “two years of quantitative easing, huge budget deficits and negative real rates. 19th century central bankers would regard this era with anathema.”
Federal stimulus projects enacted thus far have indeed done very little to improve the long-term status of homeowners threatened by foreclosure. The recent and ongoing rounds of quantitative easing, which are advocated as necessary Keynesian stimulus to repair the economy, have also had the direct, immediate and pronounced effect of bolstering share prices and commodities markets, but not real estate assets. The sole present beneficiaries are Wall Street bankers and executives — the rentiers — rather than troubled Main Street homeowners with negative equities and few prospects for more jobs. [For more on quantitative easing, see the March 2011 first tuesday article, Home financing, mortgage-backed bonds and the Fed.]
Essentially, these projects are neither properly directed to assist mortgaged homeowners nor sufficiently extensive to make an immediate difference. The policies which would be most valuable to all of society’s participants, and which we are least likely to see, are those which lead to debt forgiveness, even at the rentiers’ immediate expense.
Foremost among these options is temporarily increased inflation, which the Fed can easily manage, as well as the much discussed principal cramdown of mortgage debt to the value of the home it encumbers, which could be addressed by a responsible and focused Congress. [For an analysis of the Fed’s role and its duties, see the June 2011 first tuesday article, Suspect behavior: why and how the Fed creates a recession.]
A harmful artificial distinction
While debtors and rentiers are always troubled by conflicting interests, the current state of conflicting policies is the result of a peculiar set of regulations that apply to banks. Economic blogger Steve Waldman points out that “banks, after all, are not only creditors. They are also the economy’s biggest debtors,” since all deposits they hold are amounts they alone owe their depositors, although guaranteed by the U.S. government.
In a rational world, without the assurance (if not implicit guarantee) of government bailouts, bankers would be as concerned about their own risk of insolvency and bankruptcy as are the homeowners whose mortgage debt they hold. [For a fuller discussion of this perspective, see Waldman’s blog, Interfluidity.]
The advocated solution is a removal of policies which grant artificial security against loss to bankers while denying similar security to homeowners. Such harmful policies include bizarre accounting regulations and the implied guarantee of bailouts behind the “too-big-to-fail” mentality.
These fiscal policies make it easy for banks to obscure their troubled assets from investors (as well as the lack of regulation that makes abuses, like Goldman-Sachs’, possible), which of course they do. That is, rentiers — like homeowners — should know they are at risk of foreclosure by the FDIC if their debts (held by depositors) are not repayable from the value of their assets.
It is important for homeowners to remain aware of which class — rentiers or homeowners — stands to benefit from future changes in fiscal or monetary policy, including those changes which are ostensibly enacted in support of the homeowner. The pace of the economic recovery and the long-term personal financial success of all mortgaged homeowners depend upon the outcome.
If the huge debtor class of homeowners is to preserve its ability to recover from a general financial crisis and create a future for itself collectively, it must emulate the bankers and rally to advocate political positions which allow it the same privileges rentiers take for granted. Perhaps most essential among these privileges is the guilt-free ability to legally walk away from mortgage debt, since within their own households, every homeowner is ‘too big to fail’.