The current economic crisis is different from any recession the U. S. has experienced since the Great Depression. Unlike previous recessions, private sector investment will not be the primary engine of job creation to get us out of this Great Recession. Unless there is a bold and prolonged effort from the federal government to generate several million jobs, we will be looking at the prospect of a “jobless recovery” with unacceptably high levels of unemployment and underemployment for years to come.
There is no quick fix for this jobs crisis. The $800 billion stimulus package passed in early 2009 was a good first step – but only a first step. In the short-term, the new Jobs for America Now coalition is proposing a five-point plan to create jobs: strengthen the safety net and provide relief for those directly impacted by the recession; provide fiscal relief to the states; progressive taxes/revenue to finance job creation and economic recovery; direct creation of public service jobs; and investments on infrastructure, especially school construction, maintenance, and repair. But even if this entire program were enacted this year, it would be a necessary next step, but still nowhere near sufficient to guarantee long-term job growth.
Americans are outraged at the immediate economic crisis, but they are also outraged at the repeated refusal by politicians to address the long-term squeeze on the middle class. The two crises that make up our economic situation – the financial collapse and the lack of long-term job creation and wage growth - are at the root of the populism spreading throughout the country. We need to address these crises head-on.
The private sector won’t create jobs until people start spending, because we have a consumer-based economy. But people don’t have enough money to spend – why? The answer to that question lies in understanding the two-fold crises we face right now.
For a variety of reasons, wage growth has remained stagnant since the 1970s. Since then, the cost of living has increased, especially because energy and health care are too expensive. In order to maintain their standard of living, Americans began to take on increasing amounts of debt, especially in the form of home mortgages and credit cards. For a while, the steady rise in housing prices allowed people to live off debt, and buy homes previously out of reach with a sense of security that they would soon be worth more than they had paid.
As more Americans sought to buy homes, mortgage lenders encouraged people to take on risky loan agreements called “subprime mortgages.” Subprime loans allowed people with bad credit, low income, or few assets to be able to buy homes. Payments for these loans often started at a very low rate, but would increase a significant amount – sometimes 75% or more – after short period of these easy initial terms. Many included higher additional fees than normal loans, on an annual or up-front basis as well as for late payments and going over one’s credit limits. But it was not just people with bad credit who ended up with bad loans.
Many mortgage brokers would be paid more for steering people into subprime loans with higher interest rates, even if their clients had credit that would qualify them for better loans. Aggressive lending and marketing practices, confusing or deceptive loan agreements, lack of oversight of lenders and financial literacy for borrowers, all combined with a direct profit motive that contradicted the interests of borrowers, allowed for people to sign-on to loans they could not pay over the long-term. Lenders used similar practices in marketing credit cards, payday loans, and auto loans. By the end of 2006, 61% of subprime mortgages were held by people with strong credit scores that should have allowed them to get reasonable mortgages. Subprime lending in the U.S. exploded in the past decade: $2.5 trillion in subprime loans were made in 2000-07.
The financial sector got involved in buying up mortgages because they too believed that they were safe, profitable assets. This is where things got complicated: banks that provided the loans to home buyers then sold the loans to financial institutions, which bundled them together into packages. These financial institutions then sold bundled mortgages to investors through the creation of such products as mortgage-backed securities and collateralized debt obligations (these are also called “derivatives”). These financial products allowed investors from around the world to invest in the U.S. housing market. Moreover, hedge funds and investment banks also became sources of credit, but did not face the same regulations as other banks.
The people managing the loans no longer owned them – refinancing and debt forgiveness for people who couldn’t afford their homes was complicated because the legal responsibility and ownership became dispersed amongst many parties, and bundled together with other mortgages.
Many people know how the story goes from here. With the assumption that housing prices would rise forever, the financial sector took on billions of dollars in loans that people could not afford, and made other investments against those loans. Housing prices nationally were overvalued by about 50%. When housing prices fell, people began to default on their loans—even people who made significant down payments—and eventually America’s largest financial institutions found that billions of dollars on their balance sheets were worthless.
At this point, the banks needed cash. The damage to the banks’ balance sheets caused by the loss in asset values forced them to sell off other assets. That in turn decreased the value of, and undermined confidence in, many other assets. Banks no longer had cash to cover their bad investments—causing some to fail completely—and they stopped small business and corporate loans.
The financial crisis was a direct result of the fall in housing prices, and the lack of regulation of financial institutions and their lending and investing practices described above. The root of the problem has to do with the stagnation of real wages for Americans, which pushed people to take on more and more debt in order to maintain their standard of living.
We have to seize every legislative opportunity we can in the first months of 2010 to press Congress and the Obama Administration on our immediate five-point program. Tactically, this should be the highest priority for progressives right now. Similarly, in the months leading up to November, our tactical priority will shift to making the urgency of job creation the central frame for the Congressional elections.
But, these tactical priorities are embedded in a larger strategic context. We need to build a broad-based movement for a new era of mass prosperity, while assuring that those who have historically been excluded from the prior era of prosperity, particularly communities of color, are central to this new movement.
Concurrently, we need to win the battle of ideas that mass prosperity cannot be achieved without structural reforms in the overall economy. These reforms have two dimensions. For the financial sector, it means not only regulatory reforms but also containing and rolling back the size and scope of the largest financial institutions and preventing spurious economic growth based on financial bubbles and asset inflation.
For the underlying economy, it means promoting an array of public initiatives that create jobs and strengthen the workforce: winning health care reform, advancing climate change and green jobs, greatly expanding educational opportunities, renewing infrastructure, reviving distressed communities, expanding worker rights, achieving immigration reform, and redressing trade imbalances.
Job creation that benefits the vast majority and that results in a long-term expansion of real income requires both strong government action to prevent a repeat of the current economic crisis, and public investments that lead the way in restructuring and growing our economy.
In my next post, I will evaluate progressive strategy in 2009 to show what we need to do differently this year.
Alan Charney is Strategy and Policy Director at USAction.
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