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The existing solutions to the financial crisis promoted by both Congress and what’s left of the Bush Administration reward the wrong people, the wrong behavior and from a systemic perspective make things worse rather than better.  Three institutions that are breaking the law have received public funds that actually expand their illegal activities. Bank of America, JPMorgan Chase and Wells Fargo currently are in violation of a provision that requires that no financial institution control more than 10% of the market.

The bailout funds will enable them to expand market share, which they have eagerly sought to increase by using their bailout dollars to buy more banks. So rather than prosecute these financial criminals, the Dictator of the Treasury is actually making a contribution to their illegal activity. It’s rather like investing your funds in a burglar. For this there will probably be a seat waiting on one of their boards when the Bush Administration slinks out of town–that is after a suitable length of time has passed so it does not appear too unseemly.

This revolving door activity among financial regulators and the companies they regulate is reminiscent of the scandals about admirals and generals retiring to jobs with defense contractors who built $400 toilet seats. Of the people supposedly on Barack Obama’s short list for Treasury Dictator, a number of them have played this game, with some of them even participating in the repeal of Glass-Steagall that helped to create this mess. So Robert Rubin has gone from Goldman Sachs to Treasury Secretary and back to Citigroup.

Dollars for Democracy

Contrary to the wrong-headed and halfway measures now on the table I would like to push for more radical medicine to solve the country’s financial ills. I term it “Dollars for Democracy” because it proposes we cure this crisis the same way we cured the last one–from the bottom up rather than the top down.

Our new President-elect has already used that phrase in his first press conference in answer to a question about how he plans to deal with the crisis–which is a good sign.  In the same press conference he stated that if the current Administration and Congress do not take meaningful action to stem the crisis, he will make dealing with it his first priority, thereby contradicting the Speaker of the House who wants to make children’s health insurance HR 1.

By proposing a bottom-up approach Obama ended two decades of top-down economics–the kind that comes from that revolving door traffic. This crisis has shown that top-down economics not only does not work but in fact contributed to the crisis by eliminating feedbacks in the system that enable it to function more efficiently and more equitably. To paraphrase economist Joseph Stiglitz, this crisis is for top-down economics what the fall of the Berlin Wall was for communism.

In addition to the bottom-up principle, I would add two additional ones that offer a radically different set of values for resolving this crisis. The first is that the solution must be systemic rather than piecemeal. Current approaches do not view the crisis as a system failure, but instead see it as a failure of particular banks or consumers who used bad judgment or worse. So Dictator Paulson bails out financial institutions that are part of the problem while Congress proposes to aid those whose mortgages have been foreclosed. Neither deals with the systemic failures that caused this mess.

Many years ago, when I attended a program on system dynamics at MIT, one of the exercises we participated in was a simulation of the fall of People Express Airlines. The simulation used a system dynamics “flight simulator” that allowed us to pilot People Express to see if we could make it profitable. Another prominent business school had used a case study of People Express to show how management had been too liberal with its employees, paying them too much and allowing them too large a role in decision-making. To this school, the problem boiled down to bad management.

Playing the simulator we found that the real problem was People Express had charged too little for its flights. Essentially the way to keep the airline profitable was to slowly stair step up price increases such that they stayed enough below those of the other carriers to continue attracting passengers, but not so low that they jeopardized profitability. It was a dramatic lesson in focusing on systemic solutions rather than management policies.

The third principle is my long-standing advocacy of the level playing field. A major role of government is to ensure that any solution contribute to equity rather than increase inequity. By this I mean that the economic playing field should not tilt towards the rich and powerful thereby further exacerbating what has already become a national scandal and a powder keg waiting to explode.

Currently inequality is the worst it has been in a century. Economists Emmanuel Saez and Thomas Picketty have shown that the share of income held by top .01% is the worst it has been since 1926 and is approaching that of the what historian Vernon Louis Parrington termed “the Great Barbecue.” Parrington’s description is worth quoting because it sounds so contemporary even though he describes a period over a century ago that we also term the Gilded Age:

Congress had rich gifts to bestow — in lands, tariffs, subsidies, favors of all sorts; and when influential citizens made their wishes known to the reigning statesmen, the sympathetic politicians were quick to turn the government into the fairy godmother the voters wanted it to be. A huge barbecue was spread to which all presumably were invited. Not quite all, to be sure; inconspicuous persons, those who were at home on the farm or at work in the mills and offices, were overlooked; a good many indeed out of the total number of the American people. But all the important persons, leading bankers and promoters and business men, received invitations. There wasn’t room for everybody and these were presumed to represent the whole. It was a splendid feast. If the waiters saw to it that the choicest portions were served to favored guests, they were not unmindful of their numerous homespun constituency and they loudly proclaimed the fine democratic principle that what belongs to the people should be enjoyed by the people.

Together these three principles–bottom up not top down, systemic reform and the level playing field–form a three-legged stool to prop up the economy, a solution that America can rest on without risking a painful and potentially injurious fall that could be as hard as the one we experienced during the Great Depression.

Principle One: Bottom Up Not Top Down

This principle guided William Jennings Bryan’s response to the 1893 depression and the abuses of the Great Barbecue resulting in his famous 1896 Presidential nomination.  This principle guided the reforms Woodrow Wilson instituted after winning the 1912 election and it guided the efforts of Franklin Roosevelt to resolve the Great Depression of the 1930s. The successes of Wilson and Roosevelt earned them the distinction of being ranked among our greatest Presidents. If Barack Obama wishes to join them he would do well to follow their lead.

Building from the bottom up means getting aid directly to the people who need it rather than, for example, giving it to some corporation in the hopes they will create more jobs. In this crisis there are two groups who are most profoundly impacted: mortgage holders, the unemployed and about-to-be-displaced workers.

Mortgage Holders

Mortgage holders who have been or are about to be foreclosed represent the first priority. Quite simply banks and communities are finding out it is much cheaper to keep people in their homes than to drive them out. Empty houses lower adjacent property values, attract crime and many times are vandalized for anything that can be sold leaving them gutted and worth only a percentage of their original value. In addition the FDIC estimates the costs of a typical foreclosure action can total between 20 and 40% of the market value of the home. So, quite simply we need to bailout the foreclosed.

There is a red herring argument that such a bailout would reward those who either made stupid decisions or frankly were speculating (the notorious flop problem). Making such an argument is like being against unemployment because some of the unemployed may have been laid off because they were lazy or incompetent. Unemployment payment policymakers long ago decided that trying to sort out all the different reasons why someone may have been laid off was counterproductive and quite frankly not cost effective because it required a larger bureaucracy to sort through all the claims.

This same principle should apply to mortgage foreclosures. Those needing help should merely have to apply and verify a few facts before receiving aid. That verification process would sort out the floppers from those who really need the aid. A simple way to do that is time–anyone who has lived in their current residence for less than six months (about the time the crisis began) should be disqualified unless they can prove some extenuating circumstance such as a layoff or sudden health care crisis.  People will slip through this net, but it should catch the worst abusers.

The second step for those facing or in foreclosure is to adopt the plan proposed by FDIC Chair Sheila Bair. In October Bair testified about her plan to the Senate Committee on Banking, Housing and Urban Affairs. Bair proposed that banks modify loan terms to make it easier for borrowers to pay.  Currently the FDIC is applying this program to its role as conservator for the IndyMac Bank which was closed this past summer. Bair told the committee:

We hope to convert as many of these distressed loans as possible into performing loans that are affordable and sustainable over the long term.

Of the more than 60,000 mortgages serviced by IndyMac Federal that are more than 60 days past due, in bankruptcy, in foreclosure, and otherwise not currently paying, approximately 40,000 are potentially eligible for our loan modification program.

On average, the modifications have cut each borrower’s monthly payment by more than $380.

By achieving mortgage payments for borrowers that will be both affordable and sustainable, these distressed mortgages will be rehabilitated into performing loans and avoid unnecessary and costly foreclosures.

Bair then told the Committee that the FDIC program would like to promote similar programs across the country.  Given Bair’s figures for IndyMac this means that potentially two thirds of existing foreclosures could be resolved this way.

The third step has not been proposed by anyone, but is necessary if there is to be a long-term solution to the problem. Currently some states have a loan policy called a usury law which forbids interest rates above a certain limit, but like many state efforts usury laws are a patchwork of inconsistent legislation where you are better off in State A than State B. The time has come for a federal usury law that would apply to all financial institutions dealing with the FDIC and the Federal Reserve.

The common systemic vector running through all this is time. Most mortgage holders currently facing foreclosure are holders of variable rate mortgages with balloon payments or increases that kick after a certain amount of time has passed. Bair’s IndyMac plan to a large extent involves changing that time envelope.  Usually if people have more time they can work things out.  Even a usury law is as much a time factor as it is a rate factor, for most predatory lending dangles low payments for a certain amount of time as bait then once the customer is on the hook they face a sudden rise in payments.

The Unemployed

We are now beginning to see the first ripples of a broadening crisis as employment continues to rise, reaching the highest level since 1992. The Bureau of Labor Statistics October unemployment report noted:

Employment has fallen by 1.2 million in the first 10 months of 2008; over half of the decrease has occurred in the past 3 months.

The Bureau reported a disturbing rise of 127,000 in August, 284,000 in September and 240,000 in October. More ominously on the horizon lurks the deteriorating situation of the U.S. auto industry which could trigger massive layoffs.

For the unemployed, the most immediate solution is an extension of unemployment benefits.  While both political parties agree that this is necessary the devil is in the details. The House has passed a bill extending benefits by up to 13 weeks, but thus far the Senate has yet to act. Republicans succeeded in blocking the bill last month, but President Bush signaled yesterday that he would sign the bill if the Senate approves it, but only if the $25 million bailout for the auto industry is removed.

While Congress, the Administration and the GOP right wing engage in what has become their usual battle, the unemployed continue to wait for relief. The time spent on debating unemployment extension is fast approaching the famous 100 days it took to enact what became the core of the New Deal.

Unemployment: Long Term Proposals

Even if the politicians can get their act together on extending unemployment, we need a longer term solution to the unemployment problem, particularly among people of color in the inner cities and in rural America where there has been a depression going on for quite some time that has largely been ignored or dealt with on a piecemeal basis through grants or other programs that last for a period of time and then fade away.

This unemployment largely has three dimensions: it is an education problem, a skills problem and a job opportunity problem. Past efforts have failed to link these three. We put money into education, but not skills training, skills training but not education and fail to link the first two to real employment possibilities. It does no good to train skilled people in the inner city or a small town if there are no jobs for them.

If the common systemic vector in the mortgage crisis is time, the common systemic vector in both inner city and rural unemployment is space. That is, there either are no jobs or people cannot get to them. For rural America it means the old scenario of picking up roots and moving to the big city. For inner city people it is often a transportation problem since many rely on public transportation.

In most of America’s inner cities there is a daily scene in which people looking for work gather early in the morning, hands in their pockets or anxiously smoking and pacing as they stand in front of temporary employment agencies waiting to see if there will be any work. Many times these temp agencies provide transportation, so why couldn’t large corporations looking for permanent employees do the same?

In short you can either bring the job to the worker or the worker to the job. We have tried the former for half a century and it has not worked, but there have been few systematic attempts to implement the second. If coupled into a systemic program that combined education and skills training it could prove a viable solution.

As for rural America, unfortunately getting the worker to the job requires moving. As for getting the job to the worker, one problem with small towns has been the gradual erosion of locally-based businesses and their replacement by national chains. A great deal has been written about the Wal-Mart factor, but it is not just Wal-Mart but McDonald’s. Home Depot, Walgreens, Pizza Hut and all the other chains also have driven out local hardware stores, restaurants, pharmacies and clothing stores. This has not only brought a dreary monotony to the American landscape with the discount architecture of the chains, but killed local employment.

An entire generation of Americans has been conditioned to buy at chains, including those who live in rural America. Yet like a monoculture this chain-oriented economy puts rural communities at the mercy of national decisions, so that chains contract or even go out of business leaving behind empty stores. Curiously this is not unlike the problem rural America faced a century ago when the railroads first disrupted small town life.

America’s small towns have little leverage by themselves, but if they allied on a regional basis they might have some bargaining power. This runs counter to s strong tradition of local independence, but if the towns cannot work together they will fail together.

The Systemic Vector

You will notice that each of these issues–mortgage and unemployment–has a systemic vector that lies at the root of the problem. For the mortgage crisis it is time, for chronic unemployment it is space/distance. Identifying these systemic vectors is the key to solving many social problems, but it takes an understanding of systems thinking and even modeling of the problem before you can see which vector is really at the heart of it.

Systemic solutions to the financial crisis is the second part of Dollars for Democracy plan and the next essay in this series is devoted to it.

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