State of the Union: Change of Heart Towards Wall Street Needed

It’s make or break time for Democrats. At stake is Obama’s credibility as an agent for change. Will the party be able to drag Obama away from the Corporate Democrats?

Massachusetts voters who felt duped by Obama’s promise of reform punished Democrats last Tuesday for failing to make a credible start fixing the debt-strapped economy. The President has begged the banks to start lending again. But this means loading the economy down with yet more debt. The $13 trillion bailout was supposed to help banks do this, but they have simply taken the money and run.

The contrast between Wall Street’s recovery and the “real” economy’s failure has enabled Republicans to depict Obama and his party as stalling financial reform. Instead of change, voters have seen continuity with rejected Bush policies. Even the personnel remain the same — like “Helicopter Ben” Bernanke. The Bush-era folks are now back in the White House, and the Democrats have failed every litmus test involving finance, insurance and real estate — the FIRE sector, which remains the major campaign contributor and lobbyist for both parties.

The perception that the administration has continued Bush policies has enabled Republicans to position themselves for this year’s mid-term elections — and 2012 — by reminding voters how they opposed the bank bailout back in September 2008. Now that support for Wall Street has become the third rail in American politics, they may appoint a standard bearer who voted against the bailout.

This is ironic. George W. Bush ran for president saying: “I’m a uniter, not a divider,” and proceeded to divide the country. Mr. Obama promised change, but then decided that he wants to be bipartisan. On Tuesday, he is scheduled to invite Republicans to participate in a joint committee on the budget deficit — to get Republicans on board for tax increases to finance future giveaways to their mutual Wall Street constituency. They probably will say “no.” This should enable him to make a clean break. But then he would not be who he is.

For opportunists in both parties, the trick is how to wrap pro-Wall Street policies in enough populist rhetoric to win re-election, given that the FIRE sector remains the key source of funding for most political campaigns. The contrast between rhetoric and policy reality is the basic set of forces pulling Wednesday’s State of the Union address this Wednesday - and for the next two years. Is Mr. Obama’s promise to make an about-face and back financial reform merely rhetorical, or will it be substantive?

Putting Mr. Obama’s speech in perspective

Spending a year hoping to get Republicans to sign onto health care almost seems to have been a tactic to give Mr. Obama a plausible excuse for stalling on the economy. Subsidizing the debt overhead and the debt deflation that is shrinking markets and causing unemployment, home foreclosures and a capital flight out of the dollar has cost $13 trillion in just over a year - more than ten times the anticipated shortfall of any public health insurance reform or an entire decade of the anticipated Social Security shortfall.

Not only are voters angry, so are the community organizers and Mr. Obama’s former Harvard Law School colleagues with whom I have spoken. Instead of providing help in slowing the foreclosure process or pressuring banks to renegotiate, his solution is for the Fed to flood the banking system with enough money at low enough interest rates to re-inflate housing prices. What Mr. Obama seems to mean by “recovery” is that consumers once again will be extended bubble-era levels of debt to afford housing at prices that will rescue bank balance sheets.

It is an impossible dream. American workers now pay about 40% of their take-home pay on housing, and another 15% on debt service - even before buying goods and services. No wonder our economy has lost its export markets! Debts that can’t be paid, won’t be.

The moral is that the solution to any given problem - in this case, how to make Wall Street richer by debt leveraging - creates a new problem, in this case bankruptcy for high-priced American industry. The cost of living and doing business is inflated by high financial charges, HMO and insurance charges, and debt-inflated real estate prices. This has made Wall Street richer, but as the Chinese proverb expresses the problem: “He who tries to go two roads at once will get a broken hip joint.”

Banks have largely ignored Obama’s urging them to renegotiate bad mortgages. Their profits lie in driving homeowners out of their homes if they do not stay and fight. What is needed is to help debtors fight against junk mortgages issued irresponsibly.

When homeowners do fight, they win. In Cambridge, Massachusetts, I spoke to community leaders who organized neighborhood protests blocking evictions from being carried out. I spoke to lawyers advising that victims of predatory mortgages insist that the foreclosing parties produce the physical mortgages in court. (They rarely are able to do this.) These people feel they are getting little help from Washington.

And last Friday, Nomi Prins, Rob Johnson and other financial insiders voiced fears that the “Volcker Rule” separating commercial banking from casino derivatives gambling will end up being riddled by loopholes. Financial lobbyists have the upper hand in disabling attempts to reduce their power or even to enact simple truth-in-lending laws.

Two opposing lines of advice to Mr. Obama

Over the weekend Sen. John McCain suggested that Mr. Obama should reach out to Republicans in his State of the Union address. Karl Rove advised him to move to “the center” — what most people used to call “the right”.

Actually, Obama is perceived as being too little for change, too centrist while the economy is polarizing. It certainly seems unlikely that he will now turn on his FIRE-sector backers. His plan is that real estate prices can be re-inflated on enough credit — that is, enough more mortgage debt — to enable the banks to work out of the negative equity position into which their loan portfolios and investments have fallen.

The inherent impossibility of this plan succeeding is the main problem that we may expect from this Wednesday’s State of the Union address. Mr. Obama will promise to cut taxes further for working Americans, but his financial policy aims at raise the cost of their housing, their debt service and the cost of buying pensions. Some trade-off!

America’s debt overhead exceeds the means to pay. Rhetoric cannot solve this problem. The solution is too radical for the administration: to write down debts to reflect the capacity to pay under today’s market conditions. This means that some banks and creditors must take a loss.

Obama must now get concrete on change

For starters, Obama must rapidly push through the Consumer Finance Protection Agency before Wall Street lobbyists wield their bankrolls. There is talk in the press about the Democrats not even pressing forward with the Agency, since they can’t get health care done. This is a false worry - or even worse, an excuse to continue doing nothing. Republicans were able to mobilize populist opposition to the health-care bill by representing it as adding to the cost of relatively healthy young adults forced into the arms of the HMO monopolies. But it is much harder for the Republicans to buck financial reform and still appear to oppose Wall Street. Proposing strong legislation against Wall Street will force politicians of both parties to show their true colors. If they don’t support the best and most popular law the Democrats can draw up, their populist stance will cease to be credible.

If the Democrats do not force the debt reform issue, we must conclude that they don’t really want financial restructuring. This is what pollster Celinda Lake said last Tuesday: “When six times more people think that the banks benefited from the stimulus than working families, you’ve got a problem. And it’s not just a problem with what Martha Coakley did in her campaign,” reported Lake. “Voters are still voting for the change they voted for in 2008, but they want to see it. And right now they think they’ve got economic policies for Washington that are delivering more for banks than Main Street.”

Mr. Obama needs to signal a change of heart by replacing his failed deregulatory-era trio of Summers, Bernanke and Geithner with advisors who will focus more on the “real” economy than on Wall Street’s shadow economy.

I don’t see him doing this. I will discuss how to pierce what I expect to be Wednesday evening’s rhetorical fog in Part II of this article.

Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Professor of Economics at the University of Missouri, Kansas City and author of Super-Imperialism: The Economic Strategy of American Empire (1968 & 2003).