Reuters/Kevin Lamarque
Senator Elizabeth Warren has introduced what I would call a seismic proposition, one very likely to disturb the sleep of complacent politicians. Why, she asks, should the Federal Reserve lend money to banks at an interest rate of less than 1 percent when the government intends to charge students 6.8 percent interest on their college loans? The senator posted an amusing billboard on her official website: Want to borrow money from the government? Don’t be a student. Be a bank.
Warren has proposed legislation—her very first bill—to correct this anomaly. Instead of doubling the student loan rate from 3.4 to 6.8 percent, as the government did in July, she wants it reduced to the same rate that banks are charged at the Fed’s discount window: 0.75 percent. In addition, Warren wants the Fed to pay for this modest debt reduction, just as it did for the Wall Street bailouts. “Every time the US government makes a low-cost loan to someone, it’s investing in them,” the senator explained in an interview. “The US government does that every single day through the Federal Reserve. It invests in the largest financial institutions in this country. We should be willing to make that same kind of investment in our kids who are trying to get an education.”
This comparison should embarrass Washington: as Warren observed, the government actually makes money on its student loan business. It will collect $51 billion this year, according to the Congressional Budget Office. “In other words,” she said, “our kids have become a profit center, while the big banks walk away with the subsidy.” Try explaining that to the young people drowning in a trillion dollars of debt.
Conventional experts sputter that banks are different from students. “Yeah, I know that,” Warren countered wearily. That’s her point: Why should students be treated as less important than banks? “There’s a nice parallel here,” she said. “In fact, it gives us a chance to explore just what the values are that underlie whom the government helps.” The senator hopes her measure will inspire a national debate about values and public investment. “Of course we need a financial system,” Warren said. “But we also need young people to get educated. We also need infrastructure. We also need research. Those are all investments. I want us to have a bigger conversation. As a country, where should our investments be? Because right now, in my view, we are starving the wrong groups.”
Warren got off to a fast start as a reform-minded senator because, in a sense, she has been preparing for this role for more than twenty years. As a Harvard law professor, her specialty was bankruptcy law, but the real focus of her study has been the shifting social and economic forces that are tearing apart middle-class families and darkening the future for young people.
Warren eviscerates the frequent facile claims that the financial collapse was the result of citizens’ greedy overconsumption or irresponsible borrowing. In a series of books, she has documented the causes of growing household indebtedness and bankruptcy over the last generation, especially among women. Despite working longer hours at more jobs, families typically tipped into failure with one bad break: a serious illness or a laid-off earner. Warren tells their story persuasively in her book The Two-Income Trap (2003), written with her daughter, Amelia Tyagi.
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Warren was further educated by witnessing the dark intersection of banking and politics: how usurious lending flourished under deregulation, with compliant politicians ratifying predatory practices by labeling them “bankruptcy reform.” When she told the Democratic National Convention in 2012, “We just don’t want the game to be rigged,” she received a massive ovation.
After Wall Street’s collapse, Warren learned damning facts about the financial system as chair of the Congressional Oversight Panel investigating the bailouts. In its June 2010 report, the COP described the Federal Reserve’s incestuous relationship with Wall Street. “The AIG rescue,” the report concluded, “demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America’s largest financial institutions.” This freshman senator, in other words, already knew where the bodies were buried. Warren talks tough because she’s earned it. Up close, she sounds shockingly normal, with political sensibilities based in human sympathy and tempered by practicality. At one point, our interview wandered off the subject and we talked about our dogs. “We’re golden retriever people,” Warren said. When she taught her commercial law class at Harvard, she told her students they could understand the concept of “good faith purchaser” by thinking of a golden retriever. “An empty head and a good heart,” she explained.
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What rattles conservative central bankers and monetary economists is Warren’s assertion that the Federal Reserve should pay the costs of the student loan rate reduction out of the money it creates. The central bank’s unique advantage is that its dispersal of money does not count as government expenditure. The Fed’s new money is the nation’s “pure credit” because it belongs to everyone and no one in particular. “If Federal Reserve loans are subsidies, it doesn’t show up in the federal budget,” Warren explained. “They just do it. Every day and ‘off book.’ There’s no offset to make up for it. Nobody says, ‘Well, we need to find a tax loophole somewhere to make up for it.’ If we are willing to harness that [money creation power] for the big banks, we should be willing to put it into service for our students, because both are building the future.”
To lessen the controversy, Warren limited her proposal: the interest rate reduction would last only one year, forcing Congress to return to the problem and seek systemic solutions for the debt overhang and the rising cost of college. Her bill gives no relief to students and graduates who, she acknowledges, are already “being crushed” by debt. (Senator Sherrod Brown has introduced a parallel bill to reduce rates on existing loans.) “It’s a down payment on trying to give hardworking people a real chance,” Warren said. “Let’s get a foot in the door with this piece. We’ve got to win this thing in pieces.”
Others are urging more dramatic interventions: using Federal Reserve financing for directed lending and debt relief in the real economy. Though it’s not widely known, the question of such unorthodox Fed interventions has been a recurring subject among policy elites in a shadow debate on monetary policy.
This year the Levy Economics Institute, a center for progressive dissent on economic policy, published a provocative proposal by Walker Todd, former legal adviser at the Cleveland and New York Federal Reserve banks. Todd suggests the Fed could underwrite a significant reduction of the $1 trillion in student loan debt by drawing down the banking system’s swollen backlog of reserves, estimated at $1.8 trillion. Alternatively, Todd and others have said, the Fed could support large-scale debt reduction for households with failing mortgages, estimated by Todd at $2.2 trillion to $2.5 trillion. Others have proposed lending to help the small-business sector, now starved for credit by reluctant bankers. Still others envision the Fed as the backstop for a nationwide infrastructure investment program [see Greider, “The Fed and the Silence of the Left,” November 26, 2012].
The shadow debate among economists and policy thinkers is not secret, but it’s not exactly public either. Since Fed officials have been largely silent about unorthodox alternatives, the major media don’t bother to report the political implications. Public ignorance is a useful tool of the governing classes.
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Official Washington appears to have opted for an unspoken policy of complacency. The president talks up the limp economic recovery as good times, even if he’s careful to say they’re not good enough. The best you can say for Congress is that it stopped making things worse.
The only positive light—Federal Reserve chair Ben Bernanke’s deluge of easy money—is flickering, as conservative critics hector him to back off. The trouble with Bernanke’s policy is that it hasn’t worked, not if the goal is a vibrant economy with abundant jobs. And his recent hint that he might consider ending the Fed’s bond purchases provoked a mini-panic on Wall Street—a clear enough sign of the recovery’s weakness.
When orthodox policies fail, it’s time to try something different. In fact, Federal Reserve Governor Sarah Bloom Raskin has proposed a very different way of understanding why Fed policy hasn’t delivered a healthy recovery. Monetary policy was neutralized by inequality, she suggests. The stimulus that near-zero interest rates and trillions in easy money would usually provide has been blocked by the extreme inequalities of income and wealth stemming from decades of maldistribution upward. In an April speech, Raskin explained how the vicious combination of overindebtedness, declining wages and collapsing home prices has made it virtually impossible for most families to take advantage of the Fed’s low rates. People were tapped out, so they couldn’t get a loan on any terms.
“These effects likely clogged some of the channels in which monetary policy traditionally works,” Raskin explained. Typically, economic analysis focuses on the “general equilibrium behavior of ‘representative’ households and firms.” But the old “typical” no longer exists. Raskin’s insight suggests that economic policy has been following outmoded assumptions.
Maybe the economists should develop a new monthly indicator for downward mobility that would offset the news of growth in GDP. Growth for whom? Declining wherewithal is inescapable for many families in this new era. The indicator might also measure whether the country is gaining or losing the productive capacities needed to support general prosperity.
In those terms, not much seems to have changed. The winners now are the same folks who were winners before the crash, and likewise the losers. So far, the government’s reforms have only restarted the old engine of inequality. The trap that Professor Warren described a decade ago is still threatening millions.
The weak recovery is an argument not just for more concrete Fed intervention but also labor market strategies by Congress and the White House. But Republican obstruction is not likely to change unless Democrats propose and fight for a substantive program. In an earlier time, a Democratic administration would be hammering the Fed to stimulate more aggressively. In the Obama era, it’s the other way around, with the Fed begging Democrats to do something.
The continuing destruction is what Thorstein Veblen called “the slaughter of the innocents.” In US recessions, the principal victims are always the most vulnerable: racial minorities, the working poor and the less educated. This time, these innocents are joined by broader groups, especially young people. The unemployment rate for recent high school grads is 30 percent, with underemployment at 51.5 percent. Even recent college grads suffer from declining wages and lousy prospects, with some 40 percent holding jobs that don’t require a college degree.
“It’s not just the class of 2013,” said Heidi Shierholz, an economist at the Economic Policy Institute. “That class is joining the classes of 2009, ’10, ’11 and ’12. And they will be joining the classes of 2014 and ’15.” The economy has been falling short on jobs nearly every month. At the current pace, she said, the unemployment rate will not be back to pre-recession levels until 2019. “Research shows young people will catch up,” Shierholz said, “but it will take a long time—ten to fifteen years—and they will never make up for the earnings they lost along the way.” Shierholz knows what government can do to stimulate job growth—from infrastructure to direct job creation programs for hard-hit communities. “Those are the things we should be doing to give young people a fighting chance,” she said. She also knows government has no plans to do any of it.
Complacency is not a safe political bet in the long run, because people will eventually realize that politicians have left us with a permanently weakened economy and a large class of citizens left behind. This is not talked about much in political circles, but some leading economists fear it may already be too late to overcome.
Adam Posen, a former Federal Reserve economist and deputy director of the influential Peterson Institute of International Economics, described the potential consequences. “This isn’t like your old-fashioned recession, when the only people who were affected long-term were African-American males,” he said. “That doesn’t mean that was OK. It just means that pretty much everyone else, if they lost their jobs in a recession, would get their jobs back. In this cycle, vast shares of the workforce won’t get back in. Or they get back in at less good jobs and less good wages. That does permanent damage to the economy.”
The labor force has shrunk by nearly 4 million since the recession began—people so discouraged they’ve stopped looking for work. The conventional assumption is that they’ll come back once the economy picks up steam, but Posen and others doubt it. “We have destroyed some of our labor market capacity,” he said. “The real reason people like me were fighting so hard for more stimulus was that we didn’t want this to happen.”
When the Fed created trillions of dollars to rescue Wall Street, skeptical citizens began asking, “Where’s my bailout?” They correctly identified the fundamental contradiction facing the central bank, which refused to provide a similar kind of emergency aid to producers and consumers. Authorities claimed that was impossible, even illegal, and most of the media dismissed the question as uninformed. People were not told, however, that in the shadow debate on Fed policy, experts like Posen were asking the very same question. The advocates for more aggressive alternatives insist the country would have had a stronger, faster recovery if the Fed had responded to their pleas.
“That was essentially the battle I was fighting for two years when I was on the monetary policy committee of the Bank of England,” said Posen. At the British central bank, he argued publicly against austerity and for special measures that would get around the risk-averse banks by directed lending to distressed sectors like small business. Back home in America, Posen was simultaneously “lobbying my friends at the Fed” with roughly the same argument. He lost the battle on both shores. “Mainstream economists will tell you we would have had a faster recovery if the Fed had done more,” Posen told me. “There should have been more aggressive mortgage restructuring. There should have been more burden imposed on the banks, the shareholders, the bondholders and bank managements.”
Posen points out the political impediments to greater Fed action. “The Treasury was not encouraging,” he said. “That’s part of it. If the Treasury and White House had said, ‘We should do this’… but the Treasury wasn’t putting itself out there to do more mortgage restructuring.” Why didn’t Bernanke act? “It’s just a self-imposed political barrier,” Posen said of the Fed chair, with whom he wrote a book in the 1990s. “It’s not historical. It’s not economics. If anything, the economics tells you that the more you buy assets with cash, the bigger effect you are going to have on the real economy.” The Fed was afraid to act boldly, Posen surmised, for fear that Congress would take away some of its power. “The Fed would say to itself, ‘OK, we’re already under attack. We do need to stand up and fight for more quantitative easing, but there’s an argument that this is not our core mission. So let’s stick to our core mission.’” To put it bluntly, Bernanke choked.
Because there was no robust debate, the public never even learned of the Fed’s other options. Most politicians remained silent, perhaps ignorant themselves. Along comes Senator Warren, who wants to turn the shadow debate into a very public one. She hopes to educate voters and ask what they think—imagine that. It would be nice if other Democrats joined her. It would be especially good if Obama showed some interest. If Warren stirs up enough angry young people, maybe they’ll get the president’s attention.
In “Elizabeth Warren Heads to Washington, an Uncompromising Senator for the Left,” E.J. Graff described how Warren’s clear-as-a-bell progressive convictions mobilized a massive grassroots base (Nov. 7, 2012).
