State, Local and Private Pensions
by Michael Hudson
_www.counterpunch.com_ (http://www.counterpunch.com) (July 31 2008)
The great economic fight of our epoch is being waged by the FIRE sector
- Finance, Insurance and Real Estate - against the industrial economy
and consumers. Its objective is to maximize property prices and the
volume of debt relative to what labor and industry are able to earn.
Rising debts and real estate prices go together, because asset prices
depend on how much banks will lend. For creditors, the dream is to
obtain an ultimate backup at public expense: government insurance that
they will not lose when debtors are unable to pay. The political problem
is how to get the government to insure and protect bankers rather than
debtors, given that debtors are much more numerous when it comes to the
voting booth. In such cases campaign contributions are the balancing
factor. Governments are "privatized" and "financialized", that is,
turned from democracies into oligarchies. The banking system aims to
make sure that the only losers are the customers it is supposed to
serve: debtors, homeowners and employees of companies being
"financialized" as the economy is de-industrialized. Indeed,
financialization and de-industrialization are becoming almost
synonymous. The trick is to get voters to think they are getting rich
while actually they are being painted into a debt corner, along with
their employers, local government and the federal government too.
For a while the bad-debt overhead can be bailed out by creating yet more
debt, backed by public guarantees in what even the Wall Street Journal
acknowledges is "socialism for the rich", that is, privatizing the
profit and socializing the losses. But when has government been anything
else, for thousands of years before anyone coined the term "socialism"?
The so-called July 30 "housing bill" supports the price of mortgages
that are the major asset base of most banks and other financial
institutions today. What ultimately supports the price of these mortgage
packages is the price of the real estate pledged as collateral. And
despite Mr Greenspan's celebration of soaring housing prices as "wealth
creation", it really was debt creation. As housing prices plunge, the
debts remain in place.
The question is, whose balance sheets are to plunge into negative equity
territory - those of indebted homeowners, or those of banks that have
made the bad loans and the financial institutions (largely pension
funds, I'm sorry to say) that have bought "toxic mortgages"?
Financial bubbles in their early phase inflate asset prices more rapidly
than debts rise. This helps the financial sector encourage a belief that
debt pollution is a quick way to make the economy rich - as long as one
looks at financial balance sheets rather than tracing growth in the
actual means of production and living standards. Living in the short
run, most people do not see the financial war going on, and imagine that
finance and industry, labor and capital are fighting for the same kind
of economic growth and wealth. The reality is a conflict between
financial and industrial growth objectives, subject to the adage that
the solution to every problem tends to create yet new, unforeseen
problems - ones often are larger in scale, requiring yet new solutions
that cause yet larger and even more unforeseen. This is how societies
transform themselves for better or for worse, crisis by crisis.
Usually each side fights for its economic interests. But it is best not
to crow too loudly over victory. The financial bailout is depicted as a
housing bill, not as a giveaway to financial interests. And it is best
not to acknowledge that the financial system's victory now threatens to
push the economy further down the road to insolvency, headed by a
squeeze on state and local finances, and pension funding public and
private. Problems threaten to arise when creditors win too one-sided a
victory.
Here's what has happened so far. Early on the morning of July 30,
President Bush signed the law that the Senate had passed at a special
session the previous Saturday. Its aim was to restore US housing prices
to unaffordably high levels, requiring new buyers to run even deeper
into debts to obtain housing. Rather than rolling debts back to more
affordable levels, the government now will use its own credit to
guarantee payment on whatever portion of the unpayable exponential
growth in debt cannot be sustained by the economy at large.
The new "housing law" (a more honest title would have been the
"financial bailout and giveaway act of 2008") authorizes the Treasury
and Federal Reserve Board to provide unlimited credit to Fannie Mae and
Freddie Mac, and infuse new lending power to the Federal Housing
Administration (FHA) and localities to support the "real estate market".
This is a euphemism for saving mortgage lenders from the traditional
response to falling property prices - defaults and walk-aways. The idea
is for government loans to replace the bad loans that existing mortgage
holders are stuck with, and to do so before property prices sink by
another 25 percent.
The cover story highlighted in the first line of the press release was
that the new act was "intended to provide mortgage relief for 400,000
struggling US homeowners and to stabilize financial markets". The real
aim is to help struggling banks and institutional investors, with little
likely aid for homeowners. Mortgage defaults and foreclosures were
threatening to wipe out the collateral valuations for the loans packaged
and sold to US pension funds, other institutional investors and foreign
banks - including the $1 trillion in Fannie Mae and Freddie Mac
securities to foreign central banks and sovereign wealth funds.
Piercing the cloud of public relations rhetoric, the actual impact on
strapped mortgage debtors is that the increased funding for Fannie Mae,
Freddie Mac and FHA are part of a $1.4 trillion emergency supply of
government credit intended to keep housing prices from falling back to
more affordable levels. An alternative use of this funding would have
been to save individual debtors from foreclosure and re-set their
mortgages at more realistic levels. But the constituency of the Treasury
and Federal Reserve is Wall Street, not homeowners. This is not a
constituency whose interests reflect those of the economy as a whole
over the long run.
Finance and real estate extract interest and rents from the rest of the
economy, shrinking rather than expanding it. This causes property prices
to fall. Speculators (who have made up about fifteen percent of the
housing market in recent years - one out of every six buyers) stop
buying, while an over-supply of foreclosed or abandoned properties come
onto the market. Falling prices push debt-leveraged homeowners into
negative equity, followed by banks and the hapless buyers of the
mortgages they have sold off.
During the real estate bubble homeowners, commercial speculators and
corporate raiders were able to borrow the interest charges by
refinancing their properties at higher and higher appraisals. But banks
now are pulling back from mortgage lending, largely because buyers of
packaged mortgages find themselves stuck with paper that is a far cry
from the security its AAA bond ratings implied. Companies that have
insured these mortgages are far undercapitalized to sustain the risks,
and themselves are threatened with bankruptcy. So the mortgage packagers
and insurers Fannie Mae and Freddie Mac are being kept in business to
"save the real estate market", by which is meant the exponential growth
of debt.
The parties being bailed out are the large institutions that hold the
bad mortgages extended and packaged in recent years, and companies on
the hook for having insured the face value of these mortgages. The
growth of real estate debt has been achieved by the semi-public Fannie
Mae and Freddie Mac providing "liquidity" not just by buying up and
packaging mortgages in bulk, but by insuring their income streams. As
William Poole, head of the Saint Louis Federal Reserve Bank from 1998 to
2008, points out: "Fannie and Freddie exist to provide guarantees for
mortgage-backed securities trading in the market. The business is simply
insurance." This insurance against mortgagees defaulting (and ultimately
against banks and mortgage brokers making bad loans beyond the home
buyer's ability to pay) is what has made their sale so irresponsibly
liquid. And matters have reached the point where between two and three
million US homeowners are still expected to default this year, leading
to foreclosures.
Mr Poole adds that the government's assumption of the mortgages
underwritten and guaranteed by these two public agencies technically
doubles the federal debt, from five to ten trillion dollars. The asset
side of the government balance sheet also rises, but there may be a
substantial shortfall. Private bondholders and stockholders of Fannie
and Freddie also have claims on these assets, so any attempt at
real-world accounting becomes thoroughly tangled.
A deeper problem is that Fannie and Freddie underwrote and insured a
debt increase whose continued exponential growth is unsustainable,
because it causes domestic debt deflation. What Mr Greenspan called
"wealth creation" - pumping up housing and stock market prices on credit
- was actually debt creation. Asset prices are a function of how much
banks will lend. If they lend more money on easier and easier terms,
property prices will continue to soar. This is why the economy is facing
debt deflation. More and more money will be diverted from being spent on
consumption and paying taxes, in order to pay creditors. This will
shrink the domestic market, squeezing profits, and also will squeeze
state and local finances.
The government will not solve this problem by providing yet more loans
for stronger parties to buy the existing supply of homes otherwise in
foreclosure. The dream is to keep housing high-priced to support the
mortgage lenders, not for prices to fall so that new buyers do not need
to run so heavily into debt to afford housing.
Supporting real estate prices thus entails keeping the existing volume
of debt on the books, and indeed running up even more debt. This levies
an enormous charge on the economy to pay interest and amortization.
These payments leave less available to be spent on goods and services or
paid in taxes. The economy shrinks, leaving it even less able to carry
its debt burden. Many individuals no doubt will default on their credit
card debt, auto debt and other debts, but the largest remaining debt
consists of pension and health care obligations to the private and
public sector work force.
This problem has been growing beneath the view of most public media.
Private-sector pensions are insured by the federal Pension Benefit
Guarantee Corporation (PBGC), which is substantially undercapitalized. A
much larger problem is state and local pension programs. not only are
underfunded; they have no insurance at all. The expectation was that
public-sector pensions would be paid out of rising property tax revenues
and capital gains. But taxing property now threatens to cause defaults
on mortgage payments. This is the corner into which the economy has
painted itself by trying to preserve the exponential growth of mortgage
debt.
To cap matters, this threatens to push state and local budgets into
deficit at a time when their pension and medical insurance payments are
soaring. On the expense side of their balance sheet, localities must
spend more money to cope with the consequences of empty houses being
stripped of building materials, occupied by squatters, burned down and
generally becoming a source of blight. On the fiscal income side, states
and localities are facing populist political pressure crafted by large
real estate interests and promoted with the usual flow of crocodile
tears on behalf of retirees and other homeowners whose debt squeeze
prompts them to support politicians promising to reduce property taxes.
At first glance the connection between bailing out Fannie Mae and,
behind it, the real estate market to keep prices high for American
homeowners might not seem closely linked to corporate, state and local
pension plans. So let us trace the linkage. Bailing out mortgage lenders
ultimately must be achieved at the expense of state and local property
tax revenues. Revenue that is used to pay interest is not available to
pay taxes. If debts are to continue to grow exponentially and extract
more carrying charges, this forces a tax shift onto labor and industry.
For the past century the financial sector has made steady incursions to
take over what used to be the role of government. Today's libertarian
anti-tax "free market" rhetoric is simply a cover for the financial
sector's replacement of elected democratic government. Forward planning
is being distorted to serve the financial sector, not aiming to promote
long-term growth and raise living standards, and certainly not to
protect the public sector's fiscal position.
One of the lesser-known features of this week's real estate bailout is
the endorsement of "negative mortgages". These debt agreements add the
accrual of interest onto the principal. The cover story is that this
enables low-income homeowners to keep their houses with a lower carrying
charge, borrowing the interest rather than paying it. But this means
that what used to accrue to homeowners or their heirs as a "capital"
(land-price) gain henceforth will accrue to the mortgage lender. For
over a century, the main way that most American families have become
rich has been by the free lunch of exponentially rising land prices.
What is to rise exponentially in years to come is now their debt
overhead. It is the financial sector that will get the free lunch of
land-price gains.
Adding the interest charge onto the principal is how Ponzi schemes work.
They cannot work for long, because no real economy can keep up with "the
magic of compound interest". The Bush-Paulson bailout plan calls for
mortgages to become larger and larger, regardless of whether property
prices keep pace. The interest is to accrue to the federal government as
mortgagee at first, but this innovation is really a test run. It is the
path of least resistance for private banks to start making mortgage
loans that give them a return in the form of "capital" gains as well as
interest.
These gains consist of the inflation of land prices in cases where
state, local and federal government fails to capture this gain for the
economy at large. So the scheme obliged the public sector to turn
elsewhere than property for its revenues - namely, to consumers and
industry.
Who is not going to get paid: bankers and bondholders, or pensioners?
>From corporate balance sheets to today's state and municipal fiscal
crises, what appears at first glance to be a pension and Social Security
problem turns out to be a financialization (debt) problem. In an attempt
to maximize dividend payouts, companies in the auto, steel, airline and
other industries made a bargain with labor to take its wages in the form
of deferred pension and health-care payments. And labor - being much
more farsighted than corporate financial managers - chose to defer the
latter.
In the case of public sector pensions, the problem is the anti-tax
ideology promoted by the financial sector, which prefers government to
borrow from the wealthy rather than tax them. Cities from New York to
San Diego chose not to raise taxes but to promise public sector
employees future retirement income and health care. Also like companies,
they chose to finance their budgets by borrowing, by issuing bonds
rather than by taxing their traditional real estate tax base. In a
nutshell, they chose to borrow from the rich rather than tax them.
Corporate and public bond issuers point out that there is not enough
revenue to pay all claimants. But rather than blaming the lenders for
making loans to be paid by carving up and selling off assets rather than
by producing more, financial lobbies are taking a neo-Malthusian
position. They are blaming the corporate and public sector cost squeeze
on pension obligations stemming from the fact that people are living
longer. The number of retirees per employee or taxpayer is rising - and
the much-vaunted rise of science, technology and productivity is not
supposed to be able to carry this extra load.
Or rather, economies cannot carry this load and also pay exponentially
rising debt service and money-management fees. But this blame-the-victim
logic ignores the fact that today's debts - and property prices - are
growing at compound interest, beyond the ability of economies to produce
a net economic surplus to pay. Something has to give. For the financial
sector, what gives is supposed to be labor's wages, industry's profits
and the government's taxing power.
We got into this mess by giving special tax breaks to real estate and
finance at the expense of labor and industry, and warping the tax system
to favor debt over equity. Financial managers and politicians conformed
to type by living in the short-run. Labor did not demand that government
take responsibility for what is commonly provided to employees and
retirees in most civilized countries: a living income and health care.
Instead, both labor and its employers took this responsibility on the
private sector itself. It was a cost that other countries are spared
from having to bear - and from having to "financialize" by pre-saving in
the form of financial speculation, to pay pensions and health care out
of capital gains that are to be ensured by the government cutting taxes
to leave more profits and other revenue to capitalize into yet higher
loans to bid up asset prices. The entire detour of financialization has
added a vast non-production cost to the expense of doing business and
hiring labor in America. To put matters bluntly, we have taken a wrong
path - yet hardly anyone in authority is explaining how to retrace our
steps to get out of the present dilemma.
As long as one believes that government can only add to overhead waste -
and that the financial sector can only "economize" and make the economy
more efficient - there will be little motivation to seek an alternative.
Without doubt, one can point to exorbitant retirement giveaways such as
New York City's pension arrangements for public transport workers,
policemen and firemen. Their craft unions obtained pension and health
care rights substantially above those of the labor force in general. But
such deviations from the norm are inevitable in a system where pensions
and health care are left to company-by-company, city-by-city and
state-by-state negotiations rather than negotiated nationally as is the
case in social democracies. The situation is the same with taxes
negotiated at the local level. Companies and real estate investors play
states and cities against each other to extract special tax breaks for
locating in their areas. Political lobbying and insider dealing become
rife under such conditions.
At the root of America's pension and health care problems is an
ideological opposition to public services and taxation at the national
level. In the aftermath of World War II, corporations opposed
"socialized medicine". This left companies to pay for health care out of
their earnings rather than leaving it to government to organize and pay
out of the general tax base. This probably made sense to the vested
interests when they bore the brunt of progressive taxation. But they
seem not to have noted that this attitude has ceased to be self-serving
now that the richest families have shifted the taxes onto the lower
brackets. General Motors recently has protested that health care costs
more money per auto than steel. Yet someone must pay for health care and
retirement. If not the government, then who - besides one's employer? So
one wonders just what General Motors wants more: the luxury of an
obsolete anti-Bolshevist rhetoric, or to make consumers pay for their
health care and Social Security as "user fees" without the upper tax
brackets taking the responsibility that they take in countries with more
progressive tax systems.
In retrospect it would seem that companies did not act in their
self-interest when they insisted on taking responsibility on themselves
for providing medical care whose price has soared, largely because the
medical profession itself has been taken over by financialized health
management organizations (HMOs) in the insurance sector (an increasingly
prosperous element of the FIRE sector). They have put doctors as well as
patients on rations - fee-for-service in the case of physicians, and
rationed care for the hapless insured. And this is supposed to be the
free market alternative to centralized planning!
The explanation for companies acting this way is to be found in the era
of progressive taxation. More than two centuries of classical economic
analysis had shown the logic of taxing predatory wealth (land ownership,
monopoly rights and financial claims on the economy) rather than labor
and industry. The objective was to tax all forms of income that were not
necessary for production to take place. Above all were rights to land,
which is provided by nature, for the purpose of charging an access fee,
and other extractive property rights and financial charges loaded on top
of what actually is needed to be spent on production.
The early income tax captured such "unearned income". The wealthy
classes thus opposed public provision of services, including medical
care as well as basic infrastructure, in an epoch when they were the
major parties being taxed. But being sclerotic and rigid, the rentier
classes failed to shift their attitudes toward public service as they
moved to free themselves from taxation. Ever since the United States
enacted its first modern income tax in 1913, finance and its major
clients - real estate and monopolies - have lobbied to distort the tax
code to make their gains tax-exempt. Rather than declaring taxable
income, they count as a cost of production interest and
over-depreciation for real estate, as well as payments to corporate
shells in offshore tax-avoidance centers. The finance and property
sectors also take their returns in the form of capital gains rather than
as profits, trading through financial hedge funds whose revenue is taxed
at only half the rate of normal income.
The wealthiest one percent take their returns in the form of bonuses,
not wages, and enjoy a cut-off point of only $102,000 for FICA Social
Security and Medicare wage withholding. When Wall Street Journal
editorials assert that the richest one percent earn "only" a small
portion of taxable income, all this really means is that a shrinking
portion of their economic returns are deemed subject to the income tax.
Their buildup of wealth takes a form not classified as "income".
Inherited wealth meanwhile is the great loophole for avoiding ever
having to pay capital gains that have accrued on real estate and other
assets rising in price.
If the rentier classes act flexibly, they will see that as they shed
their national, state and local fiscal burden, it is time to "socialize
of the risks" as a travesty of true socialism by passing the costs of
pensions and health care off of companies and localities onto the
federal government. After all, now that labor and consumers are paying
the lion's share of taxes, is it not all right to extend public spending
to take over areas of cost hitherto borne by corporate business and
other private-sector employers? This promises to be the next big
political fight.
But ideological sloganeering dies slowly, and corporate business and the
financial sector continue to oppose "big government" even as they are
un-taxed. That is the problem with the vested interests: they live only
for themselves in the short run. The financial mentality is
opportunistic ("after me, the deluge"), caring little about the future.
Labor cannot enjoy this luxury. It needs to look to how it will live
after its working years end and health care becomes a rising expense.
This perspective involves a more far-sighted economic and social contract.
Meanwhile, property taxes continue to be phased out as the basis for
state and local finance. The tax burden is being shifted onto income and
sales levies that fall on consumers, not on the preferred tax status of
high finance and property. For many years now, the political drive to
un-tax real estate led cities such as San Diego and entire states such
as New Jersey to pay their work force in the form of retirement and
health care obligations rather than current wages, while borrowing from
the rich rather than taxing them. The income hitherto paid as property
tax was available either to pledge to bankers for loans to buy property
rising in price as it was untaxed.
All this was fiscal and economic madness from a long-term vantage point
- not the madness of crowds, but that of self-serving lobbying by the
financial sector. The result has been a trend that cannot go on for
long. But having managed to free themselves from progressive wealth and
income taxation, the vested financial and property interests evidently
believe that they can pull the same trick again and free themselves from
the obligation to live up to the pension and health care promises that
corporate and public-sector employers have made to their work force.
Such evasion requires a populist rhetoric. Malthusian doctrine worked
well two centuries ago, so why not try it once again? Blame population
growth - in this case, not the tendency of the poor to have more
children, but the ability of employees to live beyond the retirement age
at which they were supposed to die if they had conformed to the models
used so hopefully by their employers in explaining their financial
position. The claim is being made that paying business and public-sector
commitments to labor will bankrupt both. There is no mention of debt
payments to bondholders for funds borrowed to cut progressive taxes on
the rich. Nor is the burden of high housing and other real estate prices
that the July 30 bailout of mortgage lenders aims to create.
Something has to give, but it is this old worldview. No doubt when the
next financial crisis hits we will see all the usual journalistic
adjectives: "unexpected", "surprising everyone by the depth of the
problem", et cetera. Give me a break! Can no major media see the obvious
trends at work?
_____
Michael Hudson is a former Wall Street economist specializing in the
balance of payments and real estate at the Chase Manhattan Bank (now
JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson
Institute (no relation). In 1990 he helped established the world's first
sovereign debt fund for Scudder Stevens & Clark. Dr Hudson was Dennis
Kucinich's Chief Economic Advisor in the recent Democratic primary
presidential campaign, and has advised the US, Canadian, Mexican and
Latvian governments, as well as the United Nations Institute for
Training and Research (UNITAR). A Distinguished Research Professor at
University of Missouri, Kansas City (UMKC), he is the author of many
books, including Super Imperialism: The Economic Strategy of American
Empire (new edition, Pluto Press, 2002) He can be reached via his
website, [EMAIL PROTECTED] (mailto:[EMAIL PROTECTED])
_http://www.counterpunch.com/hudson07312008.html_
(http://www.counterpunch.com/hudson07312008.html)
_http://www.billtotten.blogspot.com_ (http://www.billtotten.blogspot.com)
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