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The Pain of Paper Millionaires

Dissent, the Housing Crash and the Next President

by ALAN FARAGO

"Everybody just standing round ‘neath the tree shooting pigeons on the limb,
But when Quinn the Eskimo gets here, them pigeons will go to him."

The Mighty Quinn, by Bob Dylan 1967

A thousand and one bearish pundits have been leaping on the staggering bull of the housing market. Even the presidential candidates are on the sidelines, wondering how to place their bets.

The bull rises to shake them off, nostrils flaring. The infusion of hundreds of billions by the world’s central banks lubricates its joints.

This is what taxpayers must want, for the world central banks to be commanding liquidity and the printing presses forward, faster, harder. It is a great bull that can summon such resources.

But is there a plan? Is there an end in sight? Is there a candidate to be president who can seize the moment?

Losses in hedge funds and investment banks around the world dwarf the last great financial debacle, nearly a decade ago, when Wall Street and the Federal Reserve came to the multi-billion dollar rescue of one of their own, Long Term Capital Management.

The news is filled with investment banks and mortgage firms announcing big layoffs. Still it will take months even quarters for the extent of damage to world debt markets to reveal, with so much investment tied up in hedge funds and private equity opaque even to investors.

It is a seeming paradox: how federal regulators are fanning across Wall Street like NIH teams sniffing for bird flu, while financial executives egg on the bull: "confidence is returning to credit markets".

What else could they say and who would listen, given that fellow citizens never cared much about tomorrow so long as their gas tanks can be filled at a reasonable cost today. That is what the presidential candidates know to be true.

But this is what I know to be even more true.

For a decade, the state of Florida has been sniffing glue from the paper bag of the multi-billion dollar construction and development industry. This is not hyperbole.

From the governor’s mansion to the state legislature, straight down to the scurrying and scratching of local city and county commissions, the thrall of the bubble in Florida has most people and media casting a wistful glance backwards in time.

Meanwhile, the Everglades and tens of thousands of acres of wetlands and billions of dollars in coastal real estate have turned forever pale. Aquifers are so depleted in sandy parts of the state that the local growth industry is sinkhole insurance.

This is how the confused dream of compassionate conservatism-exemplified by former Governor Jeb Bush-played out: that the best way to "protect" the environment is through economic growth and stifling dissent by the way.

So it is no surprise that Florida is hip-deep in red algae washed ashore, furious environmentalists, and the dominant concern of the Chamber of Commerce is; can’t we just get the machines, and the graders, and the nail guns going again?

No, we can’t. Not until there is a discussion about what forms of economic growth can sustain and nurture a democracy that is wobbling on its knees.

Of course Americans are so conditioned to passivity bred by the triumph of the inconsequential that accountability has more or less disappeared as an anchor for democracy.

But nothing hurts like a recession or worse. Now is the time for dissent.

Incipient anger is rising in the United States, but the deep stresses underlying the world’s largest economy, transformed by the force of globalization, remain poorly observed.

Here is the simple version: as jobs and manufacturing poured from the American heartland to low-labor cost nations like the tide ebbing at the Bay of Fundy. (click here, for a visual representation.) The US economy became increasingly reliant on growth generated by housing and construction: a stool built on two legs.

This was the genius of the Republican gains in Congress and control of the White House: the growth machine provided political contributions through the funnel of construction and development, primed by historic low interest rates of the Federal Reserve and marginal, ineffective supervision of lending practices and financial derivatives.

Critics of this point of view argue that the dispersion of risk, through derivatives, is a net good to society, making global economies safer: that is only true if risk is clearly priced. But there are so many external costs of growth-like carbon emissions-that are not included in pricing risk, that even if financial derivatives were clearly packaged, the underlying models still won’t work.

Others argue that technology and productivity gains represent important fuel for economic growth: the third leg of the US economic stool.

But technology gains serve the American consumer whose purchases are determined, mostly, by preferences in housing and construction.

The epitome of these preferences, suburban sprawl, is described by advocates as "what the market wants". Clearly, humans were not created to live in zero lot line subdivisions: suburban sprawl is what the market can easily finance, not what the market wants.

Patterns of construction and development in the US act in the same way as chutes for cattle: steering, herding, moving Americans into strip malls, platted cul de sacs, and cities serving the purposes of automobile executives and not ordinary people who haven’t been blessed by sales training programs, seminars, and other techniques to market features as benefits and wants as needs.

In this sense, the gains to the economy from technology and productivity represent a better-designed chute.

That the two-legged stool has been sold as a three-legged stool is no less remarkable than the conversion of an ordinary mortgage by Wall Street bankers and fresh-faced MBA graduates into structured financial derivatives worth ten or a hundred times the original value.

Democratic and Republican candidates to be president might be vaguely or even acutely aware that the crisis in the nation’s housing markets has something to do with billion dollar bonuses garnered by Wall Street executives goading armies of lawyers, consultants, and engineers; teams that conjured an ocean of debt from the hard labor of American homeowners and workers, not to mention unions largely oblivious, as unions are to any other way of doing business.

"An unstoppable force!" is what Jeb’s former campaign finance chief, Al Hoffman, called the growth machine to the Washington Post in 2003.

And even though the engine of growth in Florida is sputtering as elsewhere, even though Al Hoffman is ensconced in a sinecure ambassadorship in Portugal, even though Hoffman’s company, WCI Communities, staggered into an agreement earlier this week with corporate raider, Carl Icahn, even though another sinecure ambassador, from the era of George HW Bush, Charles E Cobb Jr., is vice-chairman at WCI; no one became king, recently, by arguing as prince that something is rotten in the heart of Denmark.

And so, let dissent help interpret what is happening in world financial markets.

Firstly, understand that attributing the world-wide credit debacle to lowest quality home mortgagees, represented as "subprime", is a red herring.

If the credit derivative problems are contained to homeownership-and that’s emerging to be a big ‘if’-who is really of consequence are America’s paper millionaires, numbering according to Marketwatch in 2005, 8.9 million people. Many of these paper millionaires are readers, wondering if they have bitten off in housing expense more than they can chew.

Since so much of the American economy is wrapped up in housing and construction, whether these paper millionaires are valuing their holdings as real estate wealth or stocks of companies like Home Depot or Countrywide Financial or Thornburgh Mortgage: the pain of the paper millionaires has yet to be accounted for in the presidential campaign.

Secondly, be sure in the knowledge that the reading public is only getting half the story as world-wide financial markets pulse with uncertainty.

We know as much about what is going on today in consideration of the risk to the global financial system as the public knew about Jekyll Island in 1910 or Quinn the Eskimo in 1967.

The problem of financial derivatives is a lot like taking several origami models made of paper, unfolding them, laying them on a single plane, cutting them into four squares, shuffling them, and asking teams of lawyers to put them back in their original shapes as cranes or butterflies.

Wall Street appears to believe that lowering the key interest rate of the Federal Reserve is a better task. It certainly is an easier one.

What’s wrong is that the federal government allowed financial institutions to spin without friction solid assets into a confection of liabilities so complicated, so vast, so difficult to unwind, that world credit markets are in a "coalition of the willing" whether they want to be, or, not.

The world’s biggest sumps for excess liquidity-China and oil producing nations-are struggling to keep their own demons in check.

That a Fed interest rate cut, or even a series of cuts, could lure the American consumer from his or her home into more debt–or help to elect the next president of the United States–makes very little sense.