Joseph Stiglitz

Lost in the analysis of our economic crisis is any perspective that what we face is a system failure. Almost every article, every television report and every op ed piece blames people for the mess. This psychology is a marked change from the Great Depression when people tended to blame themselves.

Today an attitude of “it’s not my fault” pervades our society. Take the mortgage crisis. You rarely hear someone take responsibility for a bad decision. Instead you hear people blaming the mortgage companies for duping them or even lying to them (which some of them did). Still, I have yet to hear a mortgage-holder–just as I have yet to hear a CEO–ruefully admit their own greed had something to do with the situation.

Consumers bought more house than they could really afford by seeking out mortgages with liberal terms and few requirements. CEOs have yet to acknowledge that in their zeal to maximize profits (and their own stock options) they were also guilty of seeking out dubious investment schemes that promised high returns.

We live in a pass-the-buck era where every problem is someone else’s fault. Right now Americans are blaming Detroit for building too many gas-guzzling cars, forgetting that these beasts clogged the highways because people bought them. At the top of the list is the Bush Administration which replaced Harry Truman’s “The Buck Stops Here” desk ornament with one saying “Not Here.”

The Blame Game”

Pass-the-Buck has become the new national pastime, the Blame Game. Behind all the finger-pointing lies a belief that someone else is responsible for the mess. In this view, the economic crisis is a people problem, a bad decision problem, a greed run amok problem. In short, we are in this mess because of the failures of other people. As usual, the Republicans blame the Democrats and the Democrats blame the Bush Administration.

But when the failures are so widespread, so massive and so pervasive that is precisely a sign that it is NOT a people problem, but a system problem. We have always had greedy CEOs and consumers looking to save a buck, but we have not experienced a crisis like this for over half a century.

Whenever you have a crisis of this magnitude it should be a warning sign that something is wrong with the system. If just a few people experienced foreclosures or a few companies faced bankruptcy you might blame it on circumstances or bad decisions, but we face something deeper and far more disturbing than a few bad decisions. Nobel Prize-winning economist Joseph Stiglitz began his recent testimony before the House Financial Services Committee by stating:

Our financial system has failed us.

What Went Wrong

If the system failed, what in it failed? In systems terms the answer to that question can be reduced to one word: feedbacks. In systems thinking feedbacks is a term that refers to the ways a system tends to regulate itself.

The easiest way to think of this is the thermostat in your house. It is a computerized electrical device designed to maintain a constant temperature. The feedback is the thermometer in the thermostat. It is part of a feedback mechanism called an anticipator that senses when the temperature is starting to fall and then turns on the furnace so the temperature stays constant.

Without the feedback provided by the anticipator you would either have to pick a low point when you wanted the furnace to start running or turn it on yourself. Since people are not as reliable as the mechanism as an anticipator, your house temperature would jerk wildly back and forth as you tried to keep it the same.

In essence that is what happened in this current economic crisis: the anticipator broke down, the furnace did not kick in when it needed to and now we are in danger of being out in the cold.

Feedback Failure One: Concentration Inhibits Information

Contrary to the conventional wisdom that concentration promotes efficiency it can reach a point where there is too much concentration and the system actually becomes inefficient. To go back to the thermostat analogy, it would be as if the anticipator were set within such a narrow range that your furnace was constantly cycling on and off, which raises your utility bill because turning the furnace motor on and off too much wastes electricity.

The reason concentration can become counter-productive is because it lowers the number of feedbacks in the system. The fewer financial institutions there are, the fewer options the system has and the less information the system gets. With fewer options and less information there is obviously a greater potential for failure. That is one reason why centralized, planned economies such as that of the former Soviet Union tend to not be as productive as those of a more open market.

Economist Joseph Stiglitz terms the access to information “transparency” and his research on the impact of information on markets won him the Nobel Prize. Since he wrote the technical papers that won him the award, Stiglitz has been a forceful advocate for open information, pointing out the negative consequences of what he terms “information asymmetry,” which the Nobel Committee explained as follows:

Agents on one side of the market have much better information than those on the other side.

This imbalance can be potentially dangerous, which is why Stiglitz has argued forcefully for open information by both government and corporations. In perhaps one of his most cogent defenses of open information Stiglitz notes:

To me, the most compelling argument for openness is the positive Madisonian one:meaningful participation in democratic processes requires informed participants. Secrecy reduces the information available to the citizenry, hobbling their ability to participate meaningfully.

In his testimony Stiglitz explained just how this operated in the current financial crisis:

The success of a market economy requires not just good incentive systems but good information—transparency…More recent research has shown that markets often fail to produce efficient outcomes (let alone fair or socially just outcomes) when information is imperfect or asymmetric—but information imperfections and asymmetries are at the center of financial markets…And we should be clear—this non-transparency is a key part of the credit crisis that we have experienced over recent weeks.

Before the repeal of the Glass-Steagall Act in 1999, there was less concentration in the financial world. All of us can verify that from a personal point of view: once we had several banking options or our bank was a local or regional institution rather than a national one. In essence what happened in banking is what has happened in retail stores, hardware stores, and even specialized niches such as office supply.

Of course, trusting your personal impressions can be dangerous.  According to 2008 FDIC data:

The number of commercial banks and savings & loans in the United States has fallen in the past 20 years to 8,451 as of June, compared to 16,574 in 1988.

In 2004 the FDIC pointed out:

At the end of 2003, the 25 largest insured banks and savings institutions held 56 percent of total industry assets, with the 10 largest holding almost 44 percent, up from 19 percent in 1984.

MSNBC reports three “superbanks”–Bank of America, JPMorgan Chase and Wells Fargo–now control 32.7% of the financial market, so much that all three exceed the current law that says that no bank can have more than 10 percent of the domestic deposit market.  Currently there are no plans to take action against any of the three. Third-ranked Morgan’s share of the market is almost triple that of fourth-ranked Citigroup.

In an uncanny statement supporting the feedback theory, Amar Bhide, a professor at the Columbia Business School notes:

Large institutions are impossible to manage prudently, let alone regulate.

Stiglitz explains how concentration made the feedbacks associated with mortgages more complex:

In the old days, those originating mortgages held on to them; banks knew the families to whom they had lent money. When there was a problem in repayment, they could understand its nature and work with the family on a payment plan.

Feedback Failure Two: Deregulation

With deregulation, especially the repeal of Glass-Steagall, came a redefining of the information financial institutions had to share with the government and the public. Stiglitz testified:

There is always going to be some circumvention of regulations. However, that doesn’t mean that one should abandon regulations. A leaky umbrella may still provide some protection on a rainy day. No one would suggest that because tax laws are often circumvented, we should abandon them. Yet, one of the arguments for the repeal of Glass-Steagall was that it was, in effect, being circumvented. The response should have been to focus on the reasons that the law was passed in the first place, and to see whether those objectives, if still valid, could be achieved in a more effective way.

The FDIC zeroes in particularly on Gramm-Leach-Bliley, the bill that gutted much of Glass-Steagall:

The Gramm-Leach-Bliley Financial Services and Modernization Act of 1999 (GLB) allowed the largest banking organizations to engage in a wide variety of financial services, acquiring new sources of noninterest income and further diversifying their earnings.

Here now we begin to see the impact of deregulation for not only did it not erase government oversight and hence transparency, it allowed the creation of complex financial arrangements that even the most sophisticated economists have trouble understanding.  This creates a feedback loop with negative consequences: complicated financial arrangements inhibit understanding, lack of understanding limits transparency, lack of transparency makes it more difficult to determine the impact of these new financial instruments, which finally makes it all but impossible to regulate them.

“The Future of Banking: The Evolving Role of Commercial Banks in U.S. Credit Markets,” a 2004 FDIC report, notes how with deregulation has come a profound shift in the financial markets. The term used by those in the banking industry for these changes is that the system became “securitized.” The FDIC explained there has been:

A dramatic increase in the extent to which lending to households and businesses became securitized—that is, standardized, pooled, and funded by the issue of securities.

In their summary report on “The Future of Banking” the FDIC pointed out how securitization has changed the market:

Asset securitization (the pooling of loans and their funding by the issuing of securities) has allowed loans that used to be funded by traditional intermediaries, including banks, to be funded in securities markets.

The first report discusses the impact of this on banks:

Thus, although commercial banking’s on-balancesheet activity has declined as a piece of the credit-market pie, the industry’s off-balance-sheet activities are a growing source of income.

Stiglitz explained the consequences of this in his Congressional testimony:

Some of the “innovations” in the market, e.g. securitization and derivatives, in recent years have made these problems worse. Securitization has created new asymmetries of information…Mortgage originators didn’t have to ask, is this a good loan, but only, is this a mortgage I can somehow pass on to others. Our financial markets have not only exploited these information asymmetries, but they have often also exploited the uninformed and the poorly educated.

Even the experts at the FDIC admit these new financial arrangements have caused problems:

The funding of loans through private securities markets and the additional layers involved in modern credit flows have made it more difficult for researchers to track the flow of funds between primary lenders and primary borrowers.

At the same time, the commoditization of credit markets—that is, the standardization, unbundling, and repackaging of payments and risks associated with credit flows—makes it harder to measure the importance of banks as well as other intermediaries in providing credit-related services.

Now if the FDIC stated four years ago that not even researchers can track money in this crazy system that has evolved since the repeal of Glass-Steagall and that they can’t even do something as simple as measuring the impact of banks and others on credit, what are ordinary citizens or even people in Congress going to do? This isn’t information transparency it is an information nightmare.

The 2004 summary report made it clear:

Large, complex banking organizations may pose difficult supervisory issues.

In 2004 the FDIC all but laid out the scenario for what would occur in the following years, although it wrote that such developments were unlikely:

Bank failures would be few in number and idiosyncratic in nature—typically caused by managerial and internal control weaknesses, excessive risk taking, or fraud, rather than by broader economic forces.

However, the economy is not immune to speculative bubbles like those occurring in the energy, commercial real estate, and agriculture sectors in the 1980s.

Feedback Failure Three: Too Big to Fail

As I have written before, included in Gramm-Leach-Bliley was the infamous “too big to fail” clause. This created additional feedback problems because, to use Stiglitz’s language, it made them immune from any attempts at transparency.  These institutions became big black holes into which no one could see, but which sucked into them all sorts of strange financial objects that never emerged again to see the light.

“Too big to fail” took these institutions out of any feedback loops in the system. Curiously, the FDIC all but recognized the impact of this on the system back in 2004:

Some studies have also concluded that banks may seek growth in an attempt to be regarded by the market as too big to fail. According to this view, the funding costs of a bank would be lower if holders of uninsured deposits, bonds, and other credits assumed they would be protected if the bank failed.

The emergence of megabanks has raised the possibility, however remote, that failures could deplete the deposit insurance funds,  require large premium increases that place a heavy burden on the remaining banks, disrupt financial markets, and undermine public confidence. Financial and technological risks arise partly from the problems of monitoring and controlling multiple business lines, geographically dispersed operations, and complex corporate structures. Furthermore, the diversification of large banks into new financial areas exposes these institutions to new reputational risks.

I have been writing about the financial crisis for some time, so I have become somewhat numb to reading the latest doom-and-gloom scenario, but nothing I have read in this entire two-year investigation has floored me as much as the second paragraph. It all but proves the FDIC and hence the Bush Administration and Congress knew that there was a possibility that all this deregulation and concentration would backfire on them.

The Smoking Gun that Signals Systemic Failure

To prevent this the FDIC, to its credit, recommended the following actions in 2004:

Among these are the assessment provision of the systemic-risk exception for large-bank failures, the authority for the FDIC to create different premium systems for large and small institutions, and the authority for bank regulators to require more capital based on risk.

None of these was implemented. Had Congress, the Administration or the Federal Reserve instituted even one, the crisis might have been averted or its impact muted. I put that statement in bold because it may well be the smoking gun in this entire mess. If only the third one had been implemented we would not have needed a bailout bill.

Note that virtually all of these recommendations are feedback–”transparency”–solutions: more assessment of “systemic risk,” recognition of the transparency problems of large institutions, and the requirement of carrying more capital based on risk.

So Gramm-Leach-Bliley created the unintended consequence of encouraging financial institutions to consolidate and grab a bigger share of the market because the bigger they grew the more likely the government would rescue them. The way you grow bigger, of course, is to gobble up other banks and to increase your assets by engaging in questionable activities.

It may have been the biggest rigged game in the history of the American economy: you get too big to fail by enlarging your holdings any way possible, all the time knowing that even if such activity turned out to be questionable the government would rescue you. And so it has, with a lion’s share of Treasury Dictator Paulson’s “bailout” going to the biggest institutions, which have used them to buy more banks.

Systemic Versus Personal Failure

At this point, if not long before, some of you have probably said, “So it was a people problem and not a system problem.” The FDIC gave us warning and even proposed measures that might have prevented the crisis, but people chose to ignore them. The final paragraph of the 2004 FDIC report proved prophetic:

The existing regulatory structure appears to be increasingly out of alignment with the rapidly changing financial products and markets. The nature of the safety net itself may need to be reexamined to ensure that it effectively accommodates an industry characterized by a few megabanks alongside thousands of community banks.

To some extent the systemic versus individuals question is a chicken-and-egg issue, people, after all a part of systems. They are feedback mechanisms, they can change the system. But the system also neutralizes people. One way it does that is by having insufficient feedback mechanisms. Trying to regulate the current financial mess is like trying to keep your house warm without a thermostat or even a thermometer to help you.

In a way nothing more clearly demonstrates that the system failed than the FDIC report itself. This essay has more quotes than usual because I felt it was important for readers to see what the experts have been saying. In a way it is my own way of shopwing transparency and providing you with feedbacks you can follow to make up your own mind about the crisis.

This evidence shows that by 2004 all the pieces for systemic failure were in place for the crisis and all of them involved feedbacks. To return to the thermostat analogy, it was as if the financial system’s thermostat had broken and the furnace quit running and had us all wondering if we would freeze to death.

Conclusion

If we think merely changing the people in charge will be enough or prosecuting those who may be guilty of causing this crisis, then we will have missed the point. What is required is for us to reform the system in such a way that lessens the possibility that someone can screw things up. Gramm-Leach-Bliley and “too big to fail” were like invitations to disaster.

By removing regulations, encouraging concentration and allowing financial institutions to get into markets they had no business being in, they removed all the feedbacks that might have prevented the crisis.  Financial institutions became less transparent as they grew larger and more complex, the less transparent they became the easier the system made it for them to become even bigger and more difficult to regulate. GLB took the anticipator, the regulator out of our financial system.

In the end it does not matter which institution or which person took advantage of this severing of the feedbacks because the way GLB was written someone would have. By 2004 when the FDIC issued its recommendations the systemic forces had become too strong. So some people literally did get put out into the cold.

A coming essay will propose a radical solution to the crisis, one that differs greatly from what both Congress and the Treasury Dictator have in mind.  In the end the final word goes to Stiglitz:

In this sense, the fall of Wall Street is for market fundamentalism what the fall of the Berlin Wall was for communism — it tells the world that this way of economic organization turns out not to be sustainable. In the end, everyone says, that model doesn’t work. This moment is a marker that the claims of financial market liberalization were bogus.

A dominant theme of recent conservative blogs is that the election of Barack Obama in no way signifies a liberal revival. They continue to insist that the nation tilts right and that Obama won only because George Bush was so incompetent, the media loved Obama, McCain did not appeal to the GOP base, and whatever other reason they can dream up.

As usual they are full of you know what. The country never did tilt to the right. The right turn myth is something this election may hopefully put to bed for good.

Even the Democrats have bought into the myth, as recent statements by Nancy Pelosi seem to imply. Democratic strategy over the last decades has focused on moving to the right. Al Gore in 2000 and John Kerry in 2004 and even Hillary Clinton in 2008, like many Democrats, held to the tenuous assumption that the party had to move right to appeal to a larger number of Americans.  So Democrats became like someone trying to get into an exclusive club who takes on all the airs of an upper class snob, their copycat manners apparent to everyone but themselves. For many Americans this adoption of appearances seemed a cynical move calculated only to win votes, which only fed the mistrust and bad feelings a lot of people had about politics.

Then there is the Democratic Leadership Council which has always predicted itself on the right turn myth. In 1990 Bill Clinton became chair of the DLC. His first act was to preside over the formulation of the 1990 New Orleans Declaration. This document would become the blueprint for Clinton’s future and that of the Democratic Party. The most telling of these principles are:

We believe the Democratic Party’s fundamental mission is to expand opportunity, not government.

We believe that economic growth is the prerequisite to expanding opportunity for everyone. The free market, regulated in the public interest, is the best engine of general prosperity.

Yet what if, in fact, contrary to the Republican myth, the rightward tilt had nothing to do with the Republicans and everything to do with the Democrats? In that campaign Dean was asking a very relevant question: What if the whole Hollywood production that has been titled “America’s Right Turn,” was nothing more than a phantom, a marketing creation, a fad, right up there with Pet Rocks and Cabbage Patch dolls? What if the strategy of the Democratic Party was merely like one of those bad Hollywood sequels, Rocky VIII, Crocodile Dundee Does Kansas City, Superman Redux? What if there was an error on the part of all the pundits who have made American politics a cacophonous squawk like a huge flock of crows descending on a particularly foul and rotting corpse?

Polls over the last decade seem to indicate this theory has some validity, for a majority of Americans consistently have supported measures strengthening Liberal America’s four cornerstones including increasing funding for education, fewer tax cuts for the wealthy, opposition to media concentration, and increased protection of voting rights.

But it is not just the present but the past that the GOP has tried to rewrite. In their zeal to roll back the reforms of the New Deal and the Progressive Era, the GOP has preached a “survival of the fittest” individualism dtraight out of the 1890s. The GOP preaches that government programs do not work, that the New Deal was a fraud and only World War II brought the nation out of the Great Depression.

Much of the recent popular impression of American history has been built around an icon that people worshiped with all the fervor of true believers. The central theme of that icon was rugged individualism, a belief that in our own time has perverted into the anti-government, anti-welfare prejudices that have warped everyone from talk radio zealots to the Bush Administration and both the Republican and Democratic parties.

Historical research is also learning that the myth also may not be true. Perhaps the most influential historical work I have read in the last four year is Delivering Aid: Implementing Progressive Era Social Welfare in the American West by Thomas Krainz. In an impressive series of accompanying tables, Krainz shows that long before the New Deal four Colorado counties provided aid ranging from $4.97 to $30.90 per month to almost 2,000 people. Perhaps the most fascinating table shows the number and percentages of people sent away without aid, with Lincoln County being the highest at 32.91% while the other counties have numbers in the single digits.

A friend is completing a book about North Dakota in which he cites the meeting minutes Big Meadow Township which had a similar program. My friend observed:

The township board also considered charity cases even before a welfare program was systematically organized at the state level. There was a very limited welfare program, but welfare nevertheless. Lack of funds prevented the township from doing much, but even when they did nothing, they gave the requests serious consideration.

The Republicans have never believed in equality. They have believed that somehow “the market” would allow the “best” to rise to the top. We all know what the market did to American workers before the government stepped in to level the playing field. Using government to level the playing field was the idea that created the modern Democratic Party.

In the past year we have again learned that bitter lesson, for a belief in letting the markets run free is what has created the mess we are in just as it created the Great Depression and the Depression of 1893. Contrary to right wing bloggers who insist America is still tilted right, any doubt about that should be erased by the election of Barack Obama and polls showing that the economy was voters’ number one concern.

The writers of those right turn myth articles ought to take a look at that exit poll data. First, it shows only a minority of Americans--around 30%–label themselves as conservative. Second they show that in terms of income the only group that went for McCain was those making over $100,000. In other words, the only people turning right are those who ride in limousines or drive Mercedes while the majority of Americans are traveling in a different direction.

Besides the exit polls there are the opinions of various pundits. There is wordsmith Peggy Noonan’s memorable phrasing:

But let’s be frank. Something new is happening in America. It is the imminent arrival of a new liberal moment. History happens, it makes its turns, you hold on for dear life. Life moves.

George Packer writes in the New Yorker:

For the first time since the Johnson Administration, the idea that government should take bold action to create equal opportunity for all citizens doesn’t have to explain itself in a defensive mumble. That idea is ascendant in 2008 because it answers the times. These political circumstances, even more than the election of the first black American to the highest office, make Obama’s victory historic.:

But where Packer titles his article “The New Liberalism,” there is in fact nothing new about it. Liberalism is quite simply the belief that one function of government is to keep the playing field level. That value lies at the very heart of the American experiment. It serves to level the playing field when those with power and money seek to tilt things in their direction, to assure that the votes are counted fairly, to maintain a free and open “marketplace of ideas,” to stimulate our society to positive ends whether in the arts or research, and to provide an equal education so that every American not only starts from the same point, but also has the same opportunities every step of the way on into college and even professional school and work.

THE fundamental value of equality is THE fundamental American value. If you polled the American people very few would argue with that, making equity the so-called “moderate” or “middle-of-the-road” value. If you don’t know what those roots are then spend some time searching online for the speeches and works of those who made the modern Democratic Party. What you will find running through all of these leaders is a commitment to equity.

The turn to the right is a myth because it never has been true.

Overlooked in the current excitement over Barack Obama’s victory is not only the fact that he is the nation’s first person of color to become President, but he is also only the second President to be elected even though he received a minority of the white vote. In short, people of color elected Barack Obama.

History

The first person to be elected President with a minority of the white vote was Bill Clinton in 1992. He received 39% of the white vote to George H. W. Bush’s 40%, hardly an overwhelming difference, but the harbinger of things to come. In 1996 that margin increased as Clinton lost the white vote to Bob Dole 46% to 43%. In both those elections Bill Clinton piled up African American percentages in the 80s and Latino percentages of 61 and 72. Dole and Bush both won a majority of Asian Americans. To their discredit, the pollsters do not seem to recognize Native Americans in the polling results. For poll data comes from the New York Times which has the best online historical comparison tables.

Barack Obama trounced Clinton’s results. This year 55% of white voters supported John McCain compared with 43% for Barack Obama. Yet McCain lost with Obama winning the popular vote with 53% to 46%. It is those numbers that make 2008 a watershed election that portends a radical change in the American electorate and American politics.

The Denigration of “Minorities”

The popularly accepted term for people of color used to be “minorities.” That was the expression that appeared in official documents, statistics, history books, and the media. Questionnaires would ask, “Are you a member of a minority group?” Schools would record the percentage of “minorities” in their attendance data. Exit polls and pollsters would speak of the “minority vote.” In essence the word quickly became an acceptable form of the n-word.

In fact as we look back on it, the use of the term “minority” is perhaps even more damning than the n-word. Think of all the connotations the term implies. Being a member of a race that is viewed as inferior is bad enough, but being a “minority” is a not-so subtle way to reinforce inferior status.  Of course, what it is about is power.

As a “minority” you would always have to take whatever the “majority” decided to give you–and they expected you to be grateful for anything. Being a “minority” justified making you an after-thought in everything from history books to the casts of movies and television programs. It made you what Ralph Ellison famously termed “invisible.”

How People of Color Elected Obama

This election should put that notion of “minorities” to rest for good. What it showed was that if people of color turned out in enough numbers and heavily supported one candidate, they could control the outcome.

According to Times polling data, people of color made up a quarter of the electorate, yet Obama walked away with a convincing victory in both the Electoral College and the popular vote. How could this happen, say a lot of whites, scratching their heads? Hence all the right wing commentary about the media favoring Obama and even darker conspiratorial whisperings.

The answer is actually right there in the data. Obama won an incredible 95% of the African American vote–a margin far exceeding any that had ever been recorded since exit polling began. In fact the so-called “minority” standing of people of color had pollsters not even tracking their votes up until fairly recently.

In addition to the huge African American majority, Obama won 67% of the Latino vote and 62% of the vote of Asian Americans–a triple victory in proportions no Presidential candidate has ever received before. John McCain won the white vote only because he won the votes of white males–which are now a true minority–but he lost white females 53% to 46%, which coincidentally is exactly the margin of the popular vote.

But the breakdown of McCain’s voters is even more interesting because he won only older white males, while whites aged 18-29 went for Obama 54% to 44%. Among white voters over 30, McCain won 57% of the vote.

If you add Obama’s totals to Clinton’s wins along with the fact that people of color did not support either Al Gore or John Kerry as strongly as they did Clinton and Obama and you have the making of a watershed trend.

A Wave of Color

Jorge Ramos is an analyst on television because of his book The Latino Wave, which should be required reading for all Americans and certainly for all American politicians. Jorge Ramos points out that the Hispanic vote also elected Bush in 2004.  Ramos has written about 2004:

The election was not decided in Ohio. It was decided long before that in states with high percentages of Latino voters. [p.2]

Ramos also points out that Latinos made up 8% of the total vote, a sizeable bloc when one places it in the states where they are especially strong.

In 2008 the Latino Wave grew into a tidal wave. The National Association of Latino Elected and Appointed Officials (NALEO) Educational Fund says this tidal wave helped to reshape not only this election but America’s electoral map. Their study shows:

Exit polls suggest that between 8% and 9% of all voters in the general election were Latino.  With more than 122 million voters participating in the election, the NALEO Educational Fund estimates that between 9.6 and 11 million Latino voters cast ballots this past Tuesday, making it the largest turnout of Latino voters in history.   The census reported 7.6 million Latinos voters in the 2004 Presidential Election.

The study concludes:

The Latino vote nevertheless had a significant impact in reshaping the political map by helping decide the outcome of several key “battleground” states carried by President Bush in 2004.

In addition to the Latino Wave and what can only be termed an African American uprising was a surprising turn in the votes of Asian Americans, who did not support Bill Clinton, but began to turn to the Democrats in the 2000 election when they gave Al Gore 54% of their votes and in 2004 when they gave John Kerry 56%. As with the other communities of color this became a wave in 2008 with 62% supporting Barack Obama.

The New America

Demography backs this up. In short, the percentage of people of color in this country is growing. In fact I have a theory that part of the backlash against immigrants is racial, for many of these new Americans are people of color.

The most recent projections from the United States Census Bureau project that halfway into the new century the nation will have a total population of 439 million. Of that total 59 million or 13% will be African American, 132 million or 30% of the country will be what the Census Bureau terms Hispanic and 34 million or 7% will be Asian American. In other words by 2050 almost half od this country will consist of people of color.

What makes these projection even more dramatic is that in many states people of color will be a majority, especially in the Southwest where Hispanics could outnumber whites some time in the next two decades, depending on projections.

As a nation of immigrants, this means America’s population will come to resemble that of the entire globe, which if you think globally should be a tremendous advantage for this country because our diversity will allow us to operate in a world where power is already shifting from whites to people of color, from West to East.

Lights Out for the GOP?

These changing demographics and the results of elections since 1992 have huge implications for American politics. As anyone who watched the GOP convention noted, Republicans have done little to encourage people of color to join their party and much to discourage them.

By treating people of color as “minorities,” the Republicans could be on their way to becoming a minority party. Every major party in America that has died out–the Federalists and the Whigs–died out in large part because they could not diversify with the times and paid for it at the ballot box.

Now the GOP is in a similar position as the country faces an economic crisis that already is hanging around the Party’s neck like the putrid corpse of an albatross. As in a classic tragedy, its own hubris (think Newt Gingrich) about race and class is in danger of doing it in.

In fact instead of moving forwards the GOP is moving backwards. According to a study released by the Joint Center for Political and Economic Studies, the 2008 GOP Convention had the lowest number of African American delegates in 40 years.  That’s 1968!

Here is what the Center said:

Blacks and the 2008 Republican Convention, released today by the nonpartisan research institution that focuses on minority issues, notes that African Americans will comprise only 1.5 percent of the total number of GOP delegates, substantially below the record setting 6.7 percent in 2004.

The 36 black delegates in 2008 represent a 78.4 percent decline from the 167 black delegates at the 2004 GOP convention.

The report also notes:

According to Joint Center data, there are 14 black Republicans in state office (including state legislatures) and 40 black Republicans in local office across the country. There are approximately 10,000 black elected officials in the United States, but since a majority of elected offices are nonpartisan, there are probably additional black Republican officeholders who have been elected to nonpartisan offices.

Regardless of the report’s attempt to gild this appalling statistic 54 black Republicans out of 10,000 is a figures that defies any other explanation than that the Republican Party deliberately discriminates against African Americans.

A political party with that kind of representation will not survive for long in this century.

The Democrats

The Democrats should not feel too smug about this development for they have also ignored people of color. They need to remember that their party is now in the White House because their candidate was an African American. A white candidate would not have polled those high percentages or the high turnouts among people of color that beat John McCain.

Years from now historians will look back on this watershed election and wonder why it took so long for the Democratic Party to realize this. Fannie Lou Hamer tried to tell them in the 1960s. Shirley Chisholm and Jesse Jackson tried to tell them with their Presidential runs.

Now the question is, will they really get it? The Party hierarchy is still largely white males. People of color hope Barack Obama will change this because they doubt the Democrats understand it any more now than they did in 2000 and 2004 when the Party failed to rally and recruit voters of color.

The tortuous path it took to renew the Voting Rights Act provides an instructive lesson for both parties, for what should have been a slam dunk became mired in contention and at one point was in danger of being gutted beyond recognition.

Obama’s Task

Probably Barack Obama’s most difficult political task will be to take the new coalition that elected him and sustain it. In short, he must bring America into a 21st century where diversity is the key to success not looking down on people as “minorities.”

People of color are not naive enough to believe whites will suddenly have a light bulb moment about this new reality, but they also will not stand for any more of the “same-old, same-old” from an Obama Administration. Their own experiences tell them what Obama faces, yet at the same time their hopes have them expecting change.

That the task is also confounded by generational as well as racial differences will make it even more difficult, for really what the nation faces and what makes this election truly a watershed is every indication that younger Americans, no matter what their race, harbor an entirely different mental model of the world than their elders. Generation O, the trend spotters are already naming them.

Towards a New America

The outlines of this new America can still only be dimly glimpsed, but much as Woodrow Wilson was in many ways our first modern President, so Barack Obama is our first 21st century President. Both Wilson and Obama personify a changing America (which is why Wilson and not Theodore Roosevelt deserves the honor).

Wilson in his first inaugural address acknowledges these changes in one of the more underrated speeches of our century.

We have been proud of our industrial achievements, but we have not hitherto stopped thoughtfully enough to count the human cost, the cost of lives snuffed out, of energies overtaxed and broken, the fearful physical and spiritual cost to the men and women and children upon whom the dead weight and burden of it all has fallen pitilessly the years through. The groans and agony of it all had not yet reached our ears, the solemn, moving undertone of our life, coming up out of the mines and factories, and out of every home where the struggle had its intimate and familiar seat. With the great Government went many deep secret things which we too long delayed to look into and scrutinize with candid, fearless eyes. The great Government we loved has too often been made use of for private and selfish purposes, and those who used it had forgotten the people.

Now we await Barack Obama’s definition of a new America. Wilson also deserves to be acknowledged as the father of the American Century. Barack Obama’s election signifies a different century, one where globalization and interrelationships will be the key to international success nut industrial might.

We must remember we dominated the American Century as much by our values as by our economic power. Now in this new century we must make those values relevant to a changing world. Whether Barack Obama does this or not, someone else will because the times demand it.

If we do not adapt both domestically and globally, quite simply we will go the way of other nations that failed to grasp the climate had altered and they could not lumber like the dinosaurs. Yet America has not survived as long as it has by refusing to change. Sometimes we have done it reluctantly–even been forced into it–but eventually we came around because we are a democracy that believes in a level playing field.

I have no reason to doubt we will continue to do so.

Woodrow Wilson's First Cabinet Meeting

Currently the mainstream media and the blogs are full of speculation about Barack Obama’s future cabinet. It has become DC’s favorite sport, even replacing the Redskins who can garner more coverage than the Nationals even during the height of the baseball season. If you are on the outside, as most of us are, dining in DC can become part of the game as you sit in any of the well-known political hang-outs catching tantalizing names floating above the din of conversation and wonder which of the voices doing the speculating  may perhaps be on to something.

The Game

The Cabinet Game is an old one as this excerpt from David Houston’s Eight Years with Wilson’s Cabinet testifies: Houston tells of riding on the train to New York immediately after Wilson had informed him of his appointment. There were many Democratic Party members on the train and one of them, former Missouri Governor David Francis, pressed him about whether he had been appointed to the cabinet asking if he known Wilson, had he met with Wilson recently, what did he think of Wilson.

Wilson had sworn Houston to secrecy about the appointment, so after the conversation became uncomfortable, Houston excused himself to go to dinner with his wife. The next morning his wife told him:

She had just had an amazing experience; that she was resting, almost napping, after a somewhat sleepless night, when she [heard Francis] say that apparently the President-elect had not yet selected his Secretary of Agriculture; that he was anxious to see President Walters, of the Kansas State College, appointed; and that he thought he could land him at the last moment with the aid of Senator Stone and Speaker Clark. [p.24]

No doubt as I write this there are a few David Houstons who have been given the nod by the Obama team and who also are struggling to keep their names secret.

Houston evokes one of the central rules of the Cabinet Game: the nominee should keep as quiet as possible until the President officially announces the appointment.

One person who does not get this is none other than John Kerry, who made the audacious and boneheaded move of putting his own name forward for Secretary of State. The Boston Globe reported

But despite his office’s attempt to knock the story down, Kerry is not only eyeing the secretary of state’s job, he has emerged as a top contender for Foggy Bottom.: “I think it’s serious - and Kerry wants it,” says one person close to Barack Obama’s campaign.

I have never been much of a Kerry fan, but this one ranks right at the top of Kerry blunders. It is, as they say in Kerry’s circles, bad form. Of course the Cabinet Game can have its subtle maneuvers, so there is the possibility that this “pick me” childish announcement is a trial balloon on the part of the Obama team.

The Powell Enigma

A name you do hear often accompanied by the sound of wishful thinking is that of Colin Powell. There is little question that if Powell were to become Secretary of State, America and the world would applaud the choice. My DC son, however, assures me this will never happen. After hearing Powell speak two summers ago in a special seminar for House interns, my son’s impression was that Powell was done with government and quite happy with his retirement.

Still his tantalizing answer to the question of a possible cabinet post during the famous Meet the Press interview continues to spur speculation.

MR. BROKAW:  Finally, if Senator Obama is elected president, will there be a place for Colin Powell in that administration?  Maybe as the ambassador at large in Africa or to take on the daunting task of resolving the Israeli/Palestinian issue?
GEN. POWELL:  I served 40 years in government, and I–I’m not looking forward to a position or an assignment.  Of course, I have always said if a president asks you to do something, you have to consider it.  But I am in no way interested in returning to government.  But I, of course, would sit and talk to any president who wishes to talk to me.
MR. BROKAW:  You’re not ruling it out?
GEN. POWELL:  I would sit and talk to any president who wishes to talk to me, but I’m not anxious to rule it in.

Other members of the press and pundits are anxious to get in the game. In Minnesota there is talk of Representative Colin Peterson taking David Houston’s post, but with a Republican governor it would mean losing a seat to the GOP in what has long been a swing district. In Iowa Tom Harkin’s name comes up along with that of former Governor Tom Vilsack. South Dakota believes Tom Daschle is in line for a post.

How the Obama Team has Played the Game

What has proven especially interesting is to watch how the Obama team has played the game. First, they seem to have an impeccable sense of timing, They schedule Obama events at intervals that allow news to trickle out in well-organized bits spread just far enough apart enough to heighten public interest yet not so close together as to overexpose the new President. They also seem to have solid control over unauthorized leaks.

There is plenty of time to name the cabinet. Better to allow the game to continue and let the tension build as well as serving to test the public’s appetite for various choices.  Unlike the Clinton Administration, whose transition is still regarded as a Washington disaster, the Obama team so far looks to be in control. I can remember meeting a prominent Democrat at the Democratic Women’s Club shortly before the Clinton inauguration and she was full of disdain for the new team. “They don’t seem to know what they are doing,” was the theme of her remarks.

So as long as everyone else is playing the Cabinet Game, let’s join in. Daschle does seem an obvious choice for some post whether in the cabinet or somewhere else in the administration. As has been true of other recent administrations, diversity will be another key consideration. Finally Obama will need to mollify both the Kennedy and Clinton camps along with another key Democratic group, the Blue Dogs (Peterson is a Blue Dog and Agriculture would be a good position for a Blue Dog).

State

My guess is that the Secretary of State will come from outside the Congress (sorry Senator Kerry). That has been the recent pattern, plus too many in Congress carry the baggage of having voted for the Iraq War or become caught up in debate over other foreign policy issues. So that would point to someone from a think tank, a former official or an academic. There is also the Biden factor, for part of the justification for his appointment was that he would add foreign policy experience to the administration.

I will put forward one dark horse candidate: Woodrow Wilson School Dean Anne Marie Slaughter, whose recent book The idea that is America is one I happen to admire for its emphasis on values. Slaughter, however, does not have diplomatic experience.  My inside candidate is Bill Richardson who does have that experience, having served as Ambassador to the United Nations with distinction. Richardson, like Houston, has not said anything about the cabinet.

Tuesday, he National Hispanic Leadership Agenda urged Obama to nominate Richardson. His nomination would make him the first Hispanic Secretary of State and also reward a key supporter while acknowledging the Latino votes that helped to put Barack Obama in the White House (more on this in a coming essay).

Hillary Clinton also would make an excellent Secretary of State, but she has stated emphatically she would not accept a cabinet post. In addition choosing someone from the Senate becomes especially difficult because the Democrats do not want to endanger their margin.

Treasury

Next to Secretary of State, Secretary of the Treasury has become the second-most important post since the bailout bill gave this person such extraordinary powers that I now refer to it as the Dictator of the Treasury. My guess is that this name will come from the circle of advisors who have been advising Obama about economic policy. Robert Rubin is too tied to the Clintons and his role in the repeal of Glass-Steagall disqualifies him in my book.

Just about everyone on Obama’s group of economic advisors has been mentioned by some publication.  Of the insiders, my pick would be former Federal Reserve head Paul Volcker who opposed his successor’s moves to gut Glass-Steagall and has spoken out recently in favor of tighter regulation of Wall Street. The long shot seems to be Tim Geithner, the president of the New York Federal Reserve Bank.  The reason he is a long shot is his youth and his involvement in some of the bailout measures such as that of AIG.

Others

After that it is perhaps useful to move to people. Either or both Arizona Governor Janet Napolitano and Kansas Governor Kathleen Sebelius are obvious choices to end up in the cabinet.  Cassandra Butts, who was at the Center for American Progress before becoming Obama’s policy chief, seems to me to also be an obvious choice for some cabinet level post. These three women could fill Health and Human Services, Education, Housing and Urban Development, or Attorney General.

I believe Obama will reach out to the unions in his choice for Labor and someone with ties to the environmental movement for either Interior and Energy.  Richard Gephardt has been mentioned by CBS News for Labor and his long support for labor certainly should put him on the short list. CBS also mentioned Richardson for this post. If he does not end up at State, I would put my money on Richardson here or for Interior. In other words, he is in.

Predictions

So here are the people I predict will be in an Obama cabinet in some position:
Tom Daschle
Janet Napolitano
Bill Richardson
Kathleen Sebelius

Treasury is a wild card, but I still would lean towards Volcker because the times demand a “wise old hand” at the helm in these tense economic times. Volcker probably carries the least baggage of the short list. I would not be pleased if Obama were to go with anyone involved in dismantling Glass-Steagall. If nothing else that will bring up some embarrassing questions from the other side of the aisle neither Obama nor the Clintons want to hear.

The others seem wide open, so look for Obama to fill these spots with appointees that he needs to make to satisfy various constituencies.

The Cabinet as an Expression of Values

No matter which nominees Barack Obama finally chooses, they will be symbols of his values. The final mix will be an early indication of the character of his administration. Will it truly be one that follows the “bottom up” principle he articulated in his press conference or will it be largely dictated by political expediency.

Here it is important to remember Bernard Bass’ four dimensions of transformational leadership: Idealized influence, inspirational motivation, intellectual stimulation and individualized consideration.  How much his cabinet reflects those four will go a long ways to telling us what the next four years will be like.

Your Predictions?

As long as everyone is playing this game feel free to add your own choices and voices. I will be interested to hear from you.

This past summer I was privileged to return to my small town in Northern Minnesota while the traveling Vietnam Wall exhibit was there. The town was quite proud of having landed the exhibit and pulled out all the stops to give it a welcome.

My son and I arrived in the evening after the events were over. The dark wall lay like a funereal curtain across the now well-trod grass of the park, stretching between two pine trees. In front of it, just as in front of the real wall, people had left flowers, pictures and other tributes. A few people, some of them proudly wearing floppy boonie hats cinched under their chins, jungle boots or other parts of their Vietnam gear, walked slowly and silently across the wall. Off to one side under a small canopy several visitors talked with one of the supervisors of the exhibit who was linking them to various resources.

There are some who are not fans of the traveling wall, seeing it as inappropriate or even exploitative, but it did not feel that way as the late afternoon sun morphed the wall into a long shadow across the green. My son, who lives in DC, has of course seen the real wall, yet he was as transfixed as those Northern Minnesotans who were seeing it for the first time. I tried to personalize the experience for him, searching for names I knew and talking about their lives and even talking about those whose names I could not find.

Then my eyes lit unexpectedly on the name of Terry Roach, father of Maryscott O’Connor of My Left Wing. He had died in the battle of Khe Sanh, whose story I related in two past essays. I had a friend at Khe Sanh so I have some idea of what it was like to be marooned in the jungle on what some said was a suicide and needless mission, surrounded by the enemy in what some were wondering would become America’s Dien Bien Phu.

In honor of Veteran’s Day I offer this tribute to Terry Roach and all the others who have honorably served their country.  The approximately six thousand troops at Khe Sanh were eventually surrounded by more than triple that number of North Vietnamese troops. In perhaps one of the last great artillery battles, the North Vietnamese began mercilessly pounding the garrison, sending anywhere from a thousand to two thousand rounds a day at the troops who had dug into the red clay soil that was to give the Khe Sanh veterans the name for their newsletter. A thousand rounds a day is 42 rounds an hour–an incoming shell almost every minute.

But, of course, the shells did not come in so neatly spaced, instead they came in waves that pinned the troops into the bunkers they had dug and then fortified sometimes as much as three feet thick with anything they could find including old ammunition cases and other supplies. There they could only lie and wait and hope none of the shells was a direct hit. On the first day of the siege the North Vietnamese created probably their biggest artillery damage on the site when a shell landed on the ammunition dump, resulting in the destruction of 16,000 artillery shells and a large supply of C.S. tear gas which spread over the entire base.

Meanwhile, the bombing response to the siege, which bore the colorful and, in some ways, apt nickname of Operation Niagra poured more conventional bombs on the area around Khe Sanh than had been dropped on all of Japan during World War II.

In reading accounts of soldiers who served at Khe Sanh and knowing one personally, what surfaces again and again is the perilousness of life “above ground” and the rats. The symbolism is inescapable, men who lived like rats found themselves plagued by huge rats who found the bunkers an inviting place. Soldiers had a choice of fighting off the rats that scampered underground or going above ground. At one point, Bruce Geiger remembers,

The B-52 strikes left large numbers of NVA dead around the base perimeter, the rats began feeding on the decaying corpses. A major panic took place when the doctors at Charlie Med identified rats infected with bubonic plague and began giving booster shots to large numbers of Marines.

Accounts of Khe Sanh have about them the flavor of the trench warfare of the First World War. In fact, the North Vietnamese began digging their own trenches outside the perimeter, trying to get them as close as they could before American aircraft could bomb them. One trench almost succeeded in reaching under the airfield, no doubt to fill it with explosives and destroy the supply route. They also mounted periodic “human wave” attacks, going “over the top” of their own trenches in an attempt to overrun one section of the lines defending the base. The Americans also sent troops to probe for the enemy in the equivalent of the World War One No Man’s Land.

Terry Roach was one of the true heroes of Khe Sanh. On February 8, 1968, he commanded a unit that repelled a serious North Vietnamese assault that almost overran our lines. Here is what the Vietnam Veterans website says about what Lt. Roach did that day (the punctuation is theirs):

On February 8, 1968 an attack by North Vietnamese troops from the 101D Regiment of the 325C Division occurred around 4:45 am. The enemy was assaulting a Marine outpost on HILL 64 defended by a platoon from ALPHA COMPANY 1ST BATTALION 9TH MARINES ” THE WALKING DEAD. ”

This platoon was led by LIEUTENANT ROACH. The North Vietnamese troops quickly overran the northeast sector of the outpost. What followed is described in the book ” VALLEY OF DECISION ”

“Roach raced across the top of the hill and tried to organize his men, providing cover fire for surviving Marines who were wounded or trapped.”

By 9:00 am a relief platoon from Alpha Company mounted a counterattack and repelled the enemy within 15 minutes. 21 Marines were KILLED IN ACTION on HILL 64, including LIEUTENANT TERENCE RAYMOND ROACH JR who was posthumously awarded the BRONZE STAR MEDAL with ‘V’ device PURPLE HEART MEDAL.

Today while Bush sleeps, the rest of us toss and turn in a kind of national insomnia. In some quarters an argument rages over the Iraq War between those who say they support the troops but not the cause and those who maintain that if you cannot support the cause you do not support the troops. Yet reading what the troops wrote and are still writing about Khe Sanh, it seems abundantly clear that most soldiers fought to preserve the SYSTEM that put them there–American democracy.

More than anyone else, these people in uniform recognize democracy can be imperfect, just as the person fighting beside you may not be someone you would choose to have there. Like democracy, wars do not often meet our ideals. America tolerated racism, lynchings, the Klan. World War II was not a John Wayne movie. Yet American soldiers will give their lives for that democracy and for that person next to them.

The sacrifices of the troops at Khe Sanh were not made with the hope that America would remain as static as William Westmoreland–for no one at Khe Sanh would ever want to put an army under a Westmoreland again-but that we would continue to perfect what has been termed the American experiment. Their deaths might make it possible for another Lincoln or another FDR to remake our country; they might spawn more ideas like the eight-hour day, Social Security, women’s suffrage, and the Voting Rights Act.

That is why we owe them our thanks and honor them on this day.

After eight years of infrequent press conferences from a President who had trouble stringing two coherent sentences together and constantly had me worried he might start World War III (well he did start one war) with some off-the-wall remark, it is a pleasure to listen to a President-elect who can speak intelligently about the issues, inject a sense of humor when called for and maneuver adroitly when the press tries to back him into a corner.

Analogies with FDR

As you may remember from a previous essay, after Franklin Roosevelt’s election in 1932 in the midst of the worsening economic crisis, talks took place between representatives of the incoming and outgoing administrations. In the beginning Roosevelt and his staff were open to dealing with the crisis immediately, for they knew that even the months between the election and when FDR officially would take power were uncertain and that if something was not done, people would suffer.

Yet, unbelievably Hoover insisted that the negotiations must be on his terms. According to Arthur Schlesinger, jr.’s account of the incident, Roosevelt felt that agreeing to Hoover’s terms would mean accepting “the whole major program of the Republican Administration” [are you listening Nancy "AIG" Pelosi?] and “the abandonment of the so-called New Deal.” FDR was so angry at Hoover he broke off negotiations even though others tried to bring the two men together to deal with the crisis.

Barack Obama finds himself in a similar situation, but also one with a Democratic Congress and a House Speaker who seems to think she can set policy without consulting with the President. Several times the press tried to trap Obama into a conflict with Bush, but with the skill of a seasoned President he side-stepped the mines they tried to plant in front of him.

Obama would neither endorse nor criticize what Bush was doing. In the second paragraph of his prepared remarks he made this quite clear:

The United States has only one government and one President, and until January 20th of next year, that government is the current Administration.

As for Pelosi, her off-the-wall and frankly insulting press conference may have been one of the reasons Obama felt obligated to hold his meeting with the press the day after Pelosi. Pelosi had attempted to outline some economic proposals which Obama in effect slapped down by issuing the specifics of his plan to deal with the crisis.

A Plan

By now everyone is well aware of Obama’s plans, but with my emphasis on principles I was as much interested in hearing about the values that would lie behind his plan as I was in the specific proposals, which no doubt will receive further changes between now and Inauguration Day and also will probably be modified by Congress. In addition, as with FDR, no one can predict what the nation will look like the day Barack Obama puts his hand on the Bible and swears to uphold the Constitution.

In his prepared remarks he stated:

We need a rescue plan for the middle class that invests in immediate efforts to create jobs and provides relief to families that are watching their paychecks shrink and their life savings disappear.

We must also remember that the financial crisis is increasingly global and requires a global response.

In a backhanded comment on the bailout bill’s problems alluded to in the previous essay, he added:

We will review the implementation of this Administration’s financial program to ensure that our government’s efforts are achieving their central goal of stabilizing financial markets while protecting taxpayers, helping homeowners and not unduly rewarding the management of financial firms that are receiving government assistance.

Leading from Principles

But it was in his answers to reporter’s questions that his principles really became central. As one who has written for several years now about the need for leaders who lead from principles, I was gratified to hear Obama evoke his values several times. As I listened to the press conference it became clearer to me that Barack Obama is not a triangulator, but instead is someone who is guided by values.

I must admit I have come slowly to this point. This press conference was extremely important because now Barack Obama did not need to hold back on certain things or walk a certain path to insure his election. During the campaign many, including me, worried if he would be another triangulator in the Clinton mold. This press conference would be America’s first chance to really see the character of their new leader.

The key phrase came for me at the very end of the press conference in answer to the last question in which a reporter asked if he was going to seek a tax increase for upper income Americans. This was Obama at his best and a moment that gives me some hope he may be not just a good but a great President.

Rather than launch into discussing raises taxes for the rich, Obama used his answer to again highlight his tax-cut plan for ordinary Americans. Then at the end of his remarks came a phrase that literally sent shivers up my spine:

But, understand, the goal of my plan is to provide tax relief to families that are struggling, but also to boost the capacity of the economy to grow from the bottom up.

Those words, “to boost the capacity of the economy to grow from the bottom up” are virtually a direct quote from Franklin Roosevelt’s famous “Forgotten Man” speech and echo similar words made by Harry Truman and Woodrow Wilson.

From the Bottom Up

I cannot stress enough how important it was that Obama evoked that principle and especially that he made it the final remark of his press conference. All he had outlined before about plans to help the auto industry and people struggling with mortgage foreclosures were important policy statements, but this final sentence was the most important of his press conference.

It showed that no matter what might happen with specific initiatives; Barack Obama will lead from the bottom up not the top down. Here are Franklin Roosevelt’s words:

These unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power, for plans like those of 1917 that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid. [My emphasis.]

The Importance of Obama’s Words

By directly evoking Roosevelt’s words, Barack Obama signaled several things. First, the days of top-down economics are over. For two decades this country has proceeded under the assumption that if we give tax breaks to the rich, the money will trickle down to the rest of us. Well it has trickled, one tiny drop at a time, until that trickle has all but come to a stop.

Call it “trickle-down economics,” “Reaganomics” or whatever epithet you can think of, it has lead this nation into the worst economic crisis since the Great Depression, just as similar policies caused the depressions of 1893 and 1932. Obama was telling us that if he has anything to say about it, America is about to undergo a huge shift in the principles that guide our economy.

The second thing Obama’s remark signaled was that by evoking Franklin Roosevelt’s language, he was tying himself and his administration to Roosevelt. There was one other remark, which people also may have missed, that showed this new administration intends to model its efforts on the New Deal.

At the beginning of the question session, he was asked about meeting with George W. Bush. In the very last paragraph of his answer (you know it’s nice to be able to refer to press conference remarks as if they were spoken in real English), Obama stated:

Now is a good time for us to set politics aside for a while and think practically about what will actually work to move the economy forward.

As any high-school history student knows, this emphasis on what will work was one of the prime features of the New Deal.

But it was the third and most important dimension of Obama’s remarks that should make everyday Americans feel optimistic about our new President, for by talking about the “bottom up” he was talking about us. For once decisions would be made on the basis of principles that favored what has become the contemporary version of FDR’s forgotten American.

That Obama would insert these remarks at the very close of his press conference in way that suggests they come from the deepest part of his soul should have us all breathing a little easier.

The People behind the Remarks

Behind Barack Obama stood a team of his economic advisors. Some of them had to make you wonder. There was one of the architects of the repeal of Glass-Steagall, former Clinton Treasury Secretary Robert Rubin and Paul Volcker, who helped to weaken Glass-Steagall. Yet there was also Robert Reich, who has been a voice against top-down economics for decades and former Democratic Congressman David Bonior, who served as John Edwards’ campaign manager.

There was former Securities and Exchange Commission member Roel Campos, who pushed the Republican-dominated board to penalize companies for securities violations, and former SEC chair William Donaldson, whose stormy tenure was marked by his championing hedge fund regulation, mutual fund governance and stiffer corporate penalties. And, of course, there is America’s favorite billionaire Warren Buffett, the one financial wizard who seems to have weathered the financial crisis in reasonably good shape and who once spoke out against the Bush tax cuts.

What this group suggests is that Barack Obama will seek out ideas from a variety of sources. Yes, I would have liked to see more mavericks and fewer Wall Street types, but we must also remember that at this point Wall Street also needs to feel some confidence in the new President.

The Implications

Even if one does not rejoice over Obama’s committee, that one statement goes a long way towards lessening fears that this President will govern from expediency rather than from values. So this observer would give him an “A” for his first press conference and looks forward to more of them.

With the election over, it is time to get back to the economic mess. Many of you have been following my many essays on the repeal of Glass-Steagall and it consequences for the current financial crisis as well as the weakness of one of the worst pieces of legislation ever passed by Congress, the bailout bill.

One nice result of this election will be that Phil Gramm is out of the picture as an economic advisor, which should make us all feel a little safer about our money. But Gramm still left behind the mess we have. One of the pieces that has been little noticed but suddenly has come to the fore is a huge loophole in Gramm-Leach-Bliley which also has become an even bigger loophole in the current bailout attempt. That loophole is a little-noticed provision relating to ILCs, or Industrial Loan Corporations.

What Are ILCs

ILCs have actually been around for a long time. ILC’s are strange financial creatures in that they may be owned by nonfinancial institutions such as General Motors, but their biggest difference with regular banks is that they are state-chartered and not subject to federal regulation. The Federal Deposit Insurance Corporation fact sheet on ILCs gives a succinct definition:

Industrial loan companies and industrial banks (collectively, ILCs) are FDIC-supervised financial institutions whose distinct features include the fact that they can be owned by commercial firms that are not regulated by a federal banking agency.

This sentence describes the two unique features of ILC’s, features that currently have financial experts questioning the bailout legislation. These are that ILC’s can be owned by commercial firms (the GMAC loan company is an ILC) and that last kicker “not regulated by a federal banking agency.”

The FDIC fact sheet goes on to explain the consequences of the latter:

The ILC is subject to oversight by federal and state bank regulators; however, the controlling company in many cases is not.

A useful chart in the fact sheet points out the consequences of not being able to regulate the controlling company by outlining the differences between banks and ILCs. Among them is the fact that the “parent” of an ILC is not subject to the following:

Parent** subject to umbrella federal oversight; Parent** activities generally limited to banking and financial activities; Parent** could be prohibited from commencing new activities if a subsidiary depository institution has a CRA rating that falls below satisfactory; Parent** could be ordered by a federal banking agency to divest of a depository institution subsidiary if the subsidiary becomes less than well capitalized.

A Brief ILC History

ILCs were the brainchild of one Arthur Morris, a visionary who was concerned that middle income and poor people had trouble getting loans. The way Morris got around the banking laws at the time was to issue certificates in the value of the loan which the borrower then “purchased” in the amount needed. Morris’ other revolution was that the purchase of these certificates required no collateral, but only two cosigners who could vouch for the person purchasing the certificates.

Ever since, ILCs have also been known as Morris Plan banks. Under the well-meaning supervision of someone like Morris, ILCs performed a valuable function, but as the FDIC points out, they were totally unregulated since no one knew quite what to do about Morris’ unique approach to loans.

In the beginning, these entities were not subject to supervision by any federal banking regulator but rather were state-chartered and supervised by the states. These early industrials operated more or less like finance companies, providing loans (at a high interest rate) to wage earners who could not otherwise obtain credit. The loans were not collateralized but were based on endorsements from two creditworthy individuals who knew the borrower.

This state chartering of ILCs persists today.

In 1982, the federal government extended FDIC protection to Morris’ certificates.

Provisions of this legislation allowed ILCs that were regulated in a manner similar to commercial banks to apply for federal deposit insurance. Reinforcing this development, some states changed their laws to require their ILCs to obtain FDIC insurance as a condition of keeping their charters.

The entry of the FDIC into ILC’s allowed them to dictate the terms of the insurance, which included:

The financial history and condition of the applicant; the adequacy of the applicant’s capital structure, future earnings prospects, and character of management; the convenience and needs of the community.

The ILC Exception

The special status of an ILC was further defined in the repeal of Glass-Steagall. When Congress abolished Glass-Steagall in 1999, it left a huge loophole for ILCs by not making them subject to the Bank Holding Company Act, which regulates the activities of what we today term “full-service banks.” In 2007 testimony before the House Committee on Financial Services, Federal Reserve Vice Chairman Donald Kohn outlined the consequences of the loophole:

The ILC exception also creates an unlevel competitive playing field by allowing both financial and commercial firms to own an insured bank but avoid the prudential limitations, supervisory framework and restrictions on affiliations that apply to corporate owners of other insured banks.

Through the ILC loophole have poured a veritable cascade of new financial institutions. Kohn described what has occurred because of the loophole:

What was once an exception with limited and local reach has now become the avenue through which large national and international financial and commercial firms have acquired a federally insured bank and gained access to the federal safety net. Indeed, dramatic changes have occurred with ILCs in recent years that have made ILCs virtually indistinguishable from other commercial banks.

Kohn went on the cite statistics illustrating the growth of ILCs:

As a result of these and other changes, the aggregate amount of assets and deposits held by all ILCs operating under this exception increased substantially just in the nine years between 1997 and 2006, with assets increasing by more than 750 percent (from $25.1 billion to $212.8 billion) and deposits increasing by more than 1000 percent (from $11.7 billion to $146.7 billion). In fact, in 2006 alone, the assets and deposits of ILCs increased by $62.7 billion and $38.8 billion, respectively. The number of Utah-chartered ILCs also has doubled since 1997, while declining in the few other states permitted to charter exempt ILCs.

The nature and size of individual ILCs and their parent companies also has changed dramatically in recent years. While the largest ILC in 1987 had assets of approximately $410 million, the largest ILC today has more than $67 billion in assets and more than $54 billion in deposits, making it among the twenty largest insured banks in the United States in terms of deposits.

The Wal-Mart Fiasco

ILCs first came to the attention of the general public when Wal-Mart proposed to create its own ILC. In essence, the nation’s largest retailer would now become one of the nation’s largest banks. This is probably the place to point out that ILCs are not inherently evil. For many companies they perform a useful role. For example, when you buy a new car, GMAC will oversee your car loan if you don’t want to go to a bank.

Unfortunately, Wal-Mart proposed a far-reaching, fukk-service ILC that had organizations such as the American Bankers Association crying “foul,” for they charged that it would breach the long-sacred separation of banking and commerce. The ABA and others also feared Wal-Mart’s application would drive small town banks out of existence just as they have impacted other small town businesses. These reasons plus Wal-Mart’s economic clout aroused enough opposition that Wal-Mart withdrew its application in 2007.

Others Play the ILC Game

While a great deal of publicity has been generated by corporations such as Wal-Mart creating ILCs, less recognized has been the use of ILCs by banks themselves. The largest ILC is owned by Merrill Lynch, whose assets of $67 million make it among the top twenty financial institutions in the country. Goldman Sachs and Morgan Stanley also own ILCs, although both of them are in the process of converting them to bank holding companies.

But given the involvement of financial institutions in ILCs and the ILC loophole one has to ask whether any of the funds Paulson plans to invest could end up in ILCs, where they would be subject to less scrutiny.

The ILC Bailout Scandal

Well, it turns out banks began to use their bailout money for exactly what many feared, mergers and acquisitions, especially of ILCs. The biggest and most controversial of these deals was the acquisition of National City Corp. by PNC Financial Services Group. National City is an ILC. The PNC purchase caused Rep. Steve LaTourette to charge Comptroller of the Currency John C. Dugan steered bailout money to PNC because he was a former PNC attorney.  LaTourette wrote Treasury Secretary Paulson question whether Dugan:

Steered $7.7 billion of taxpayer bailout money to his former client, PNC, so it could buy National City Bank

Dugan angrily denied the charge:

The suggestion is absolutely baseless, and I am astonished that you would make such sweeping allegations without checking the facts.

But the damage was done. A bank had used bailout money to buy an ILC.

In another blatant in-your-face move Cleveland’s KeyCorp, went so far as to say it plans to buy other banks. Key Chairman and Chief Executive Henry Meyer told the Cleveland Plain Dealer:

Meyer said he has three things in mind for the $2.5 billion his company is getting from TARP, the Troubled Asset Recovery Program: Strengthening Key’s finances, lending more and buying other banks.

Huntington Bancshares of Columbus also plans to use its bailout money to buy banks. Chairman and Chief Executive Thomas Hoaglin said in a written statement.

The capital allows us to give consideration to any strategic opportunities that may arise to expand our franchise through the purchase of weaker banks.

Those purchases will most likely involve ILCs. Banking analyst Jeff Davis of Wolf River Capital in Nashville said:

We’re going to see a lot of this TARP money used in the way PNC did with National City.

Why Would a Bank Want an ILC?

Now we get to the heart of the matter, why would a regular bank want to own an ILC? The answer lies in the loophole. By setting up a separate ILC, the bank can avoid Federal Reserve regulation. They can engage in whatever questionable practices they want without having the Fed looking over their shoulders. Laura Mandaro puts it well:

An industrial loan charter grants companies most of the powers bestowed by a commercial bank charter, including the ability to accept federally insured deposits and make consumer loans. Its main restriction is a prohibition on accepting demand deposits if the corporation has assets of more than $100 million. But with the restriction comes a big benefit: The charter holder does not need to follow the Bank Holding Company Act and thus avoids supervision by the Federal Reserve Banks.

So what we have are two loopholes coming together. The Gramm-Leach-Bliley loophole exempting ILCs from Federal Reserve supervision and the second worst financial bill is recent history, the so-called bailout bill, which did not even have the intelligence and foresight to forbid banks receiving bailout money from buying up ILCs.

Your Tax Dollars at Work

So while all of us sweat out the current financial crisis, our brilliant Congress left a loophole in the bailout bill wide enough to drive a truck through–a truck full of money on its way to purchasing an ILC.  And what are they doing this with–your tax dollars. So the bottom line is that your taxes are being spent on two loopholes that never should have been there in the first place.

The fear is that if banks like PNC start squirreling away their bailout money in ILCs, it will be difficult to regulate it. In short, the bailout is a sham for it allows banks to get involved once again in the very activities that caused this crisis.

Let us hope that one item at the top of the new administration’s list is closing those loopholes as a first step to solving the financial mess we are in. It’s time to level the playing field and get ILCs under federal supervision.