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Keeping America Strong

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On Sale: September 08, 2009
Pages: 0 | ISBN: 978-0-307-47559-6
Published by : Vintage Knopf
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When the U.S. financial structure collapsed in fall 2008, it quickly became clear that our system of market capitalism was broken, endangered by decades of absolutist market dogma, shortsighted policies, and the abandonment of America's working people. Now, as the Obama administration seeks to repair the country's economy, one thing is clear: this crisis calls for drastic reforms. Regrettably, the government's response, so far, has been inadequate.

In Saving Capitalism, economist and bestselling author Pat Choate offers six game-changing actions that can strengthen the U.S. economy now and stimulate long-term, self-sustaining, noninflationary economic growth that will create millions of better jobs. Here are proposals for:

• Major tax reform
• All-encompassing financial regulation
• A strong social safety net
• A major infrastructure program
• Ways and means to balance U.S. trade with the rest of the world
• The renewal of national innovation

Urgent and provocative, Saving Capitalism is an accessible and informative dissection of the gravest threat our economy has faced since the Great Depression, and a bold and creative blueprint for the future.


Chapter One


An unending economic hurricane has been ripping apart the U.S. and world economies since December 2007. In the seventeen months between then and April 2009, the number of unemployed Americans increased by seven million. By April 2009, almost 5.4 million of the nation's 45 million home loans, worth more than $717 billion, were delinquent or in foreclosure.

Although the pace of decline seemed to be slowing by the early summer of 2009, far worse is yet to come in 2010. The Treasury Department's stress test of the nineteen largest banks in early 2009 revealed that they could be forced to write off as much as a fresh $600 billion by the end of 2010, increasing their losses to more than $1 trillion. Most of those mortgage defaults will be by people now at work, who once were thought financially immune to such distress, but now are likely to lose their jobs and then their family homes.

The lender of last resort, the federal government, has tried to blunt this depression with unprecedented levels of money infusions into the U.S. economy. Despite federal commitments of almost $9 trillion for direct investments, $1.7 trillion for guarantees, and $1.4 trillion for loans, plus a cut of the Federal Reserve loan rate to banks of almost zero, the prolonged freeze in credit markets cracked only slightly by the spring of 2009.

In the last quarter of 2008 and the first of 2009, auto production fell by half and global trade declined at the fastest pace since the Great Depression. The governments of Europe, Japan, and China are engaged in massive bailouts of their economies. Yet the bottom of this depression is not visible, let alone a domestic or global upturn.

America's money industry is directly to blame for much of the world's economic meltdown. It gambled with other people's money and lost, used faulty risk-assessment tools, and knowingly sold fraudulent assets, including hundreds of billions of dollars of subprime mortgages, for vast profits. The administrations of Bill Clinton and George W. Bush enabled Wall Street's recklessness by scrapping the regulatory safeguards Franklin Roosevelt had erected in the 1930s. Equally significant, the U.S. Federal Reserve System, Securities and Exchange Commission, and Treasury Department failed to exercise their oversight authority adequately.

The salvage program put into place by both the Bush and Obama administrations is designed to restore the U.S. financial system to the way it was before the crash of 2008, with the same oligarchs in control but with a bit more regulation. If that is all that is accomplished, we will have learned nothing and can be sure that we will have a repeat of the behavior that brought us to this crisis.

We must think bigger about what America wants from the money industry and act accordingly. A strong capitalist system requires an equally strong financial sector, whose integrity is safeguarded by strict federal supervision of all money institutions, bans on Wall Street speculation with other people's money, and an adequate and sound currency, thereby ensuring a steady flow of capital and credit to American businesses of all sizes.

We need a money industry that uses the great reservoirs of other people's money that it holds to serve the real economy, as it did successfully for several decades in the post-World War II era, as opposed to the recent exploitation of privileged access for compensation-based looting, speculation, and selfish schemes. American capitalism needs a long era of dull but prudent banking, overseen by suspicious federal regulators.

The free-market absolutism of the past thirty years, most notably the last ten, created such an antigovernment, antiregulatory bias, coupled with the fantasy that the market always knows best and always regulates itself, that the very will to regulate disappeared at the top levels of American government, academia, and business. For sure, other factors affected this crisis, as subsequent chapters will reveal, but it all came together as a perfect storm in the money industry.

Here are the essentials of what happened and recommendations for rebuilding America's financial system.

The Money Industry

The economic origins of the present crash are the oil shocks of the 1970s, when many major oil-producing countries created their production cartel, the Organization of the Petroleum Exporting Countries (OPEC), and radically increased the price of crude oil. The OPEC nations deposited much of their money for safekeeping in major U.S. banks such as Chase Manhattan, Citibank, Chemical Bank, and Bank of America. These banks recycled hundreds of billions of petrodollar deposits as loans for developing countries, eagerly and often imprudently offering high-interest financing to countries such as Argentina, Brazil, Mexico, Nigeria, Ivory Coast, and the Philippines- nations whose leaders repeatedly stole part of the proceeds, wasted part, and used a little for the intended development.

Forgetting how nations defaulted on loans during economic crises in the 1800s and during the Great Depression, Walter Wriston, chairman of Citibank, then considered America's leading banker, proclaimed in the late 1970s that lending to governments was safe because sovereign nations do not default.

Wriston's maxim was totally wrong. In 1982, when Argentina, Brazil, and Mexico defaulted on more than $300 billion of debt, much of it owed to Citibank, the Federal Reserve and Treasury had to scramble to prevent major U.S. financial institutions, including Citibank, from collapsing. By the end of the 1980s, developing nations had defaulted on more than $1.3 trillion of debt, most of which was owed to U.S. banks. A Washington Post Book Company study revealed that more than one thousand U.S. banks were technically bankrupt by 1992.

Despite the rhetoric of market absolutism embraced by every U.S. president from 1981 to 2008, Washington had to bail out the financial services industry eight times, even as it cancelled many of the financial regulations that governed the industry.

1. In 1982, the Federal Reserve and the Treasury bailed out U.S. banks holding Mexican, Argentine, and Brazilian debt.

2. In 1984, Continental Illinois received a $4 billion rescue package.

3. In the late 1980s, the Federal Reserve paid out large loans to save 350 banks that later failed.

4. Between 1989 and 1992, Congress provided $250 billion to support hundreds of insolvent savings and loan institutions.

5. From 1990 to 1992, federal banking authorities provided $4 billion to save the Bank of New England and arranged for Citibank to get capital from Saudi Arabia.

6. In 1994, Congress provided Mexico a $50 billion loan to bail out Goldman Sachs and other U.S. financial institutions that had bought high-yield Mexican debt.

7. In 1997, the Treasury pushed the International Monetary Fund
(IMF) to rescue East Asian currencies in order to save American lenders.

8. In 1998, the Federal Reserve saved Long-Term Capital Management, a massive hedge fund whose investors included leaders from U.S. finance.

Misfeasance, malfeasance, and malversation (corruption of officials) distinguished the finances of this era.

Despite these repeated bailouts and Wall Street's widespread abuse of its clients, federal regulators were extraordinarily tolerant. When a financial institution failed to obey or fulfill a law, regulation, contract, or agreement, punishment was mostly limited to a warning or a fine, sometimes in the hundreds of millions of dollars, followed by a corporate announcement that the company neither admitted nor denied any guilt. Such federal wink-and-nod acceptance facilitated the rise of a gambling culture in the great financial houses where solvency and soundness once reigned.

A Favored Industry

As this lenience suggests, the "money" industry was, and remains, favored in Washington. Although never naming it as such, the federal government in the latter part of the twentieth century put into place, step by step, a long-term national industrial policy that privileged the financial industry over all others, particularly manufacturing. The benefits to finance were enormous, and the consequences to manufacturing were devastating.

By the 1980s, finance dominated the American economy, and what finance wanted was quick cash. Beginning with the merger mania of that decade and continuing through the buyouts, privatization, and outsourcing of subsequent years, our leaders sacrificed the real economy for the financial one. Where our best and brightest graduates had once sought their fortunes in the corporations that created wealth by producing goods and services, these talented young people were soon seeking jobs in financial firms where they sought quick fortunes manipulating paper wealth.

Consequently, the number of jobs in the financial sector (the winner) grew and those in manufacturing (the loser) declined. The math is clear. Between 1981 and 2009, manufacturing employment fell from 18.7 million jobs to barely 12 million, a 40 percent loss, while finance grew from 5.1 million jobs to 8.1 million, a 60 percent increase. America lost almost three jobs for every one it gained in that exchange.

In the process, the Wall Street-driven outsourcing of industrial and service jobs over the past three decades has devastated America's middle class. First, families tried to cope by having both adults work outside the home. When joint incomes were insufficient to maintain family lifestyles and pay bills, families went into debt to credit card companies at usurious rates. During this time, banking institutions financed hundreds of thousands of mortgages, often to unqualified borrowers. Then millions of families borrowed against the equity in their homes to pay off other debts, putting themselves on the financial edge. Millions of those mortgages were "subprime" because the money industry made them to people without the means to service the debt, which the lenders knew.

As many in the American middle class increasingly found themselves in a financial bind, elected federal leaders actually worsened the situation in 2005 by enacting changes in laws that prevented borrowers from discharging credit card and other debt they owed through bankruptcy. Consequently, starting over became impossible for millions of Americans who became legal "debt slaves" to the money industry. When some in Congress tried in 2009 to reverse these bankruptcy laws on credit cards, plus allow bankruptcy judges to alter mortgage terms, they were defeated. But when the money industry crashed because of its greed and incompetence, the same elected officials rushed to bail it out with unseemly, and ultimately costly, haste.

The money industry's demonstrated capacity to obtain trillions of dollars in bailout grants and loans from Washington reflects its extraordinary political power. Indeed, no other special interest has similar influence with the White House, Congress, and both political parties. The fountainhead of that influence is their massive political contributions and lobbying expenditures. Senator Dick Durbin, assistant Senate majority leader, described the dynamics bluntly in an April 2009 radio interview: "And the banks-hard to believe in a time when we're facing a banking crisis that many of the banks created-are still the most powerful lobby on Capitol Hill. And they frankly own the place."

In March 2009, two watchdog groups, Essential Information and the Consumer Education Foundation, released Sold Out, a report that documents $1.7 billion in campaign contributions made by the finance industry from 1998 to 2008, plus another $3.4 billion spent on lobbying. Year by year, company by company, politician by politician, the report identifies who gave what to whom. It also identifies former congressional staff members, ex-members of the House and Senate, and former White House and other executive branch officials whom the finance industry hired as lobbyists and what they did.

Such lobbying is Washington's growth industry, producing about $10 billion in business annually. It is changing the very concept of public service. Over the past decade, for instance, more than thirty- three thousand people registered as lobbyists with the Senate Office of Public Records, including half of all senators and representatives who left office. Washington's revolving door is simply out of control.

The Money Industry's People

Money buys access and position in Washington. Thus, our political leaders regularly appoint money people to senior positions in both Republican and Democratic administrations.

For instance, President Clinton's principal economic advisor and later treasury secretary was Robert Rubin, former cochairman of Goldman Sachs and subsequent director and senior advisor at Citigroup. Rubin mentored Lawrence Summers, who succeeded him as treasury secretary in 1999, and Timothy F. Geithner, who worked for both Rubin and Summers.

While advising candidate Obama in the 2008 elections, Summers also worked as a part-time managing director at the $30 billion hedge fund D. E. Shaw, which paid him $5.2 million for one-day-a-week's work over a two-year period. He also received $2.7 million for forty speeches, primarily to large Wall Street companies including Citigroup, JPMorgan Chase, and Goldman Sachs, later beneficiaries of the federal bailouts that he now oversees.

Geithner became chairman of the Federal Reserve Bank of New York in November 2003, was responsible for overseeing the New York banks, and was intimately involved in the federal bailouts of Wall Street financial institutions when they failed. President Obama appointed him treasury secretary in 2009, and the U.S. Senate confirmed him for the position. His chief of staff is Mark Patterson, who left his job as a top lobbyist for Goldman Sachs in April 2009. Michael Paese, who had been the top staffer at the House Financial Services Committee, which helped structure the bailout of Wall Street in 2008, filled the resulting vacuum at Goldman's Washington office.

After leaving office in 2001, Bill Clinton advised several Wall Street investment funds, while his vice president, Al Gore, is cofounder of Generation Investment Management with David Blood, an investment banker formerly of Goldman Sachs. Lombard Odier Darier Hentsch & Cie, a Swiss bank, is the largest investor in the fund, whose assets include stock in companies such a Novo Nordisk A/S, the world's largest insulin maker, and Johnson Controls, which makes auto seats and batteries.

The giant hedge fund Paulson & Co. in 2008 hired Alan Greenspan, former chairman of the Federal Reserve (1987-2006). This fund made a reported $15 billion profit in 2007 by shorting stocks of those holding subprime mortgages.

The Bush family has long been connected with Wall Street; Prescott Bush, father of George H. W. Bush and grandfather of George W. Bush, headed the investment firm Brown Brothers Harriman in the 1930s and 1940s. After George H. W. Bush left the presidency, he advised the Carlyle Group, a major investment fund, and Citigroup.

John W. Snow, who was George W. Bush's treasury secretary from February 2003 to June 2006, became chairman of Cerberus, a private investment firm that does billions of dollars of contract work for the federal government, owned Chrysler, and was the recipient of $4 billion in federal rescue funds in late 2008. Henry Paulson, the ex- chairman of Goldman Sachs, replaced Snow at the Treasury and led the bailout of the financial industry, including Goldman Sachs, which got a $10 billion investment by the Treasury at about the same time investor Warren Buffett bought into the firm for $5 billion. The deal Paulson negotiated with his old firm gave taxpayers less than half what Buffett got, but at twice the price.

• Buffett received 43.5 million options worth $1.8 billion for his $5 billion. Taxpayers got only 9.5 million options worth $500 million for their $10 billion investment.

• Buffett is being paid 10 percent interest on his preferred stock. Taxpayers get 5 percent for five years and then 9 percent for five years.

• Buffett has a 10 percent call premium. Taxpayers have no premium rights.

• Buffett got $5 billion of present value for this $5 billion investment. Taxpayers have $4.9 billion of present value for their $10 billion.
Pat Choate|Author Q&A

About Pat Choate

Pat Choate - Saving Capitalism

Photo © Kay Casey

Pat Choate is a political economist, policy analyst, and the author of the books Agents of Influence, Preparing for War (forthcoming from Knopf), and, with Ross Perot, Save Your Job, Save Our Country. In 1996, he was Ross Perot’s ReformParty vice presidential running mate. He lives with his wife outsideWashington, D.C.

Author Q&A

Q: Why did you write this book?

A:  My goal in writing this book is to create a clear and concise overview of the situation we are in and put forth positive solutions.
    The book goes beyond questions of whether the stimulus is too big or not big enough.  It proposes creative reforms that will strengthen the economy overall, and for a long time to come.

Q. How grave is the economic situation, really? Many economists are saying the worst is over.

A:  The arithmetic of our state of affairs is stark.   Over the past 28 years, the United States has gone from being the world's largest creditor nation to its largest debtor.  Our federal budget deficits are doubling the national debt every 8 years and our trade imbalance with the rest of the world since 1981 has created a cumulative deficit of more than $6 trillion, which constitutes the largest unilateral transfer of wealth in world history. The financial sector, moreover, has more than a half trillion dollars of sub-prime loans that have yet to be reconciled on their books; almost $170 billion of the $1 trillion of unsecured credit card debt is in default, the commercial real estate sector has an equal financial overhang; 6 million home mortgages are in default or in foreclosure; and the Federal Deposit Insurance Corporation's reserves are depleted.

    No one in public life believes that the U.S. debt accumulation and these massive trade losses are sustainable for much longer.  Yet, the competing economic and political interests in our society have created a political gridlock in which these twin deficits go unaddressed.

    My hope is that this book will stimulate a substantive discussion on what we need to do to save our economy.  I have put forth six game-changing proposals that are within our political and fiscal capacity.  They are a good starting point.

Q. You write that the economic stimulus plans enacted by Congress in late 2008 and in 2009 do not go far enough. Are we going to need more bailouts?

A:  Yes, more bailouts will be required to keep the nation out of deep depression at least as far into the future as the U.S. continues its policies of market absolutism that prevent the nation from dealing pragmatically with changing global realities.

    The financiers, and their lobbyists, want government out of their business, and its in their interest to keep alive this notion that the system works best with little or no regulation, and that it has thrived without it.  But, this is not true.  The present financial crisis is the 9th since 1982.  In each instance, the money industry gambled, lost and then passed the cost onto U.S. taxpayers.  Since 1982, the bailout policies of a succession of Administrations, including the present one, have been to restore the industry to the way it was before the crash, including retaining the same people in charge and even paying them enormous bonuses despite their failures.

    Until the U.S. government regulates the financial industry in its entirety, sets prudent bounds on its risk taking, requires sound capital reserves, and rids the industry rids of those whose misjudgment created this crisis, another spectacular financial failure, the 10th, is inevitable.  The only question is when.

    Until we make basic structural changes, such as I propose, in our trade, financial, innovation, infrastructure, budgetary and related policies, we are years away from creating long-term, self-sustaining, non-inflationary economic growth.

Q. You blame "free market absolutism" for much of what happened in the recent financial crash. What do you mean by that?

A:  U.S. economic policy has been under the control of those who fervently believe in the concept known as the "efficient market hypothesis," which is an academic theory that says that the decisions of millions of independent participants in the economy, always acting to gain their own narrow advantage, creates a market whose decisions are always right.  Under this market absolutism, the U.S. government since 1981 has aggressively deregulated many parts of the economy, including trade laws and the Depression-era controls imposed on finance.

    I open the book with quotes from a Congressional hearing in October 2008 in which Allan Greenspan, former Chairman of the Federal Reserve System, told a Congressional Oversight Committee that he was shocked to find that his view of the world (efficient market ideology) was not right and was not working.

Q. In your book, you call for major reform to the United State health care system. What specific changes would you like to see and what do you think of the current proposals Congress is debating?

A:  I call for expanding Medicare to include the entire U.S. population.  It would be far more efficient than any proposal now before Congress, since the administrative costs of Medicare are about a third that of all other alternatives.  The Medicare model requires broad-based financing from individuals and employers, allows choice, and enables savings from mass purchases.  For decades, Medicare has been  nothing more than a government-operated insurance company.  Contrary to much of the current debate, Medicare beneficiaries are overwhelmingly pleased with the assured accessibility and modest costs.

    The current proposals in Congress would keep the U.S. insurance industry in control of health care in the United States.  Costs will remain high, those corporations will continue ration care to keep profits high, and millions of Americans will be without any care other than at public emergency rooms.  Contrary to public misconception, the U.S. health care system is providing poorer service overall than in most most other developed countries and at a far higher cost.

Q. You advocate for a drastic change in the tax system by adopting a Value Added Tax. Can you briefly describe what the VAT is and why it will help?

A:  More than 150 other nations use a Value Added Tax (VAT).  Producers and vendors pay the tax at each successive stage of production and on final sale.  Their payment is only on that discrete amount of value they add to the price of the good or service.  Administration is easy, much like the collection of sales taxes.  I propose that the U.S. eliminate the existing corporate and personal tax systems.  The VAT would apply only to consumption.  All savings would be untaxed.  The administrative burden on taxpayers would disappear as there would be no need to file annual tax returns and there would be no more IRS audits.
Equally significant, current global trade rules allow nations with a VAT to rebate the tax on all exports from that country and impose a VAT-equivalent tax on all imports from the United States.  In 2007, U.S. exporters paid more than $135 billion in VAT equivalent taxes to other nations.  Adoption of a VAT would save every penny of that for U.S. exporters, creating a strong incentive to keep jobs in America.

    Other nations have adopted small VAT rates on essentials such as food, medicine, clothing and housing, thereby eliminating tax regression.  Tax reform, and a VAT, are essential to any long-term U.S. economic recovery.

Q. With increasing competition from around the globe, how can America continue to remain a leading innovator in business and technology?

A:  America's intellectual property laws are the secret to the success of American innovation.  The U.S. Constitution gives authors and inventors the right to exclusive use of their creations for a time set by Congress and the means to defend that right in federal courts.

    The U.S. system of patents, copyrights and trademarks is the strongest in the world.  Creative people from around the globe come here for those protections, so much so that half of all patents issued now go to foreign inventors.
Over the past 15 years, administrative incompetence and the political diversion of patent fees collected by the Patent Office have greatly weakened our patent system.

    Also, a group of 15 Big Tech corporations that have been sued more than 1300 times between 1996-2008 for patent infringement and anti-competitive practices banded together in 2005 to change U.S. patent laws so that infringers would pay less and could more easily challenge the validity of patents issued.  I tell that story and present new data  on their efforts and their success.
After interviewing many leading inventors, patent examiners, venture capitalists, and successful large corporations that rely on patents, I have developed and put forth in the book several recommendations that will encourage more invention, investment and job creation in America, and make the innovation process much faster, certain and inexpensive.

    Invention is America's competitive edge.

Q. What role does infrastructure investment play in your proposed six-point plan?

A:  It is a key part.

    If innovation is the brains of America's economic system and finance its heart, then infrastructure is its backbone.  Yet, America's public facilities, its domestic civil works, are wearing out faster then they are being repaired and replaced.

    This book calls for the massive rebuilding of America's public infrastructure over the forthcoming five years – a $2.2 trillion commitment equal to that made in the mid-1950s to build the Interstate Highway System.  A five-year, $440 billion program would create 7 million new jobs for the five-year period.  Of these, 4.6 million would be directly involved in the rebuilding work and another 2.4 million would be working in the manufacturing and support industries, such as steel and controls.

    To guide this massive investment, the book also calls for the creation of a national capital budget that would be limited to civilian public facilities.  The General Accountability Office has repeatedly urged Congress to create this basic management and budget tool to provide uniform projections for major federal capital investment programs; a summary of needs assessments; the relationship between such capital investment and economic variable; to assist state and local governments in planning for their major capital investment programs; and to improve legislative oversight over federal capital investments.

    A national capital budget is an essential tool needed in any long-term effort to save our economy.

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