Service-Based Economy Is Progress? Show Me the Money 22 comments
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Despite all the hype surrounding the growth of the “knowledge-based” economy and the touting of America as a service super-power, the failure to develop and maintain a high-end manufacturing sector, such as Japan’s, is proving to be a serious economic liability to the country. While some might argue that comparing the US economy to Asia’s newly industrialized economies is inappropriate, this is not true for that of Japan’s. Despite setbacks following World War II, Japan is by no means newly industrialized, and if one claims comparisons between the US and Japan are prima facie invalid, than one is effectively claiming that the US economy cannot be compared to anything.
While empirically we do know that the service sector in the United States occupies a greater portion of the economy than in Japan, and that the US is also a leader in very advanced information, software, bio and other “knowledge-based” technologies, this does not necessarily imply the conclusion that the growth of the service sector in the US is a sign of economic progress. It is possible for the majority of growth in the service sector to be attributable to non-high technology industries such as food service, day-care, hospice care, prisons, litigation, manicures and the proverbial hair cut, things that are not easily trade-able, and in some cases not even necessarily in the long-term interests of society.
What growth there is in the high-value-added “knowledge” sectors, such as biotech, software, and information and communications technology goods (ICT), simply can't replace the huge number of manufacturing jobs that have been lost to outsourcing. Furthermore many of these industries are themselves at risk to off shoring (China is now a larger ICT exporter than the US, India is making inroads into programming and pharmaceuticals, and the developmental arm of the Japanese government is well aware of the need to strengthen Japan’s own “knowledge” sectors).
As for the oft-touted financial sector, the events of 2008 should force even its strongest proponents to seriously rethink their definition of meaningful economic “restructuring” when the country is asking for fiscal bailouts from authoritarian regimes like the Chinese Communist Party who have grown wealthy selling us things we no longer make for ourselves.
As a result, even as the country grows more “high-tech” the current account deficit continues to increase. In the end many of those who are losing out in this game discover that their best hope is to find work at what is now the nation’s largest private employer: Wal-Mart (WMT). That approximately 70% of Wal-Mart’s merchandise is made in China exacerbates the deficit and perpetuates the problem.
And this is exactly where the problem lies: the consistently large US trade deficit means precisely that as a whole, Americans consume more than they produce; this excess consumption is funded primarily by the governments of China, Japan and various Persian Gulf States. To claim that a consistent trade deficit is not economically harmful is disingenuous unless that trade deficit is the specific result of that excess “consumption” being used for investment in infrastructure, plants, technological research or education. This is not the case in the United States, unless one is to consider consumer debt and military expenditures as “investment”.
Some economists argue that free-markets, such as those the US economic system is built around, are always efficient and therefore always “right”. Thus, the economic conditions of such countries must also be “right” or at the very least, nothing to worry about. However, unless one claims that the current financial crisis, or the great depression occurred because markets were not free enough (a claim that absolutely must be backed up with direct empirical evidence) then this crisis is an example of free-markets failing, if not in efficiency then at least in effectiveness.
To be clear, I am not claiming that the basic tenets of neoclassical economics are wrong, but rather the assumption that whatever occurs in the economy must be progress because “the market always knows best” is flawed. There are numerous examples throughout neoclassical economics and game theory that demonstrate the usefulness of regulation and policy.
It is a fact that real median household incomes in the US have been stagnant or in decline for the past 10 years and are only about 3% higher than they were in the late 1980s. The claim that a shift to a service-based economy is economic progress is highly questionable. In the free-market world this may be economic evolution, but evolution is not synonymous with advancement.
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This article has 22 comments:
> jack
If your economy is outsourcing more and more labor....and not developing new ideas...then you outsource more and more wealth.
Our economy hasn't been a free economy for years upon years. We have a federal reserve system. This is a system run by international bankers.....all money created has to be paid back + interest. We then get into a circle of more money created...which is more debt...and more debt which means we need to create more money.....hence we live with neverending inflation. If all debts were paid...we would have no money in the system.
So first we need to abolish the federal reserve....and create real money backed by gold. This means we will have NO inflation.
We need to revert to a sustainable economy.....which may or may not mean producing goods/services.....and relying less on a credit card.
If we do this.....these high and lows in the economy will be eliminated. The federal reserve and the government has created all these problems....either by policy....or by how they control the money supply...and/or both.
If money has a set value.....and they cannot increase/decrease the money supply.....and policies removed to require an all out equaility...people are held responsible for their actions.....we would have a sustainable economy IMO.
The people who own the money supply are the people who control the country.....and in all honesty....most of these bubbles and busts could all be part of a bankers whim.....and to control the country into doing whatever it may wish.....or buy other companies for pennies on the dollar...etc
Free trade deals permit the free movement across borders of goods and money but not labor. Even if they wanted to, workers cannot follow their jobs to the countries these jobs have been exported to. So if you offshore their productive and decent-paying jobs a lot of people with non-virtual aptitude sets will become structurally underemployed. Valuable skill sets become unemployable, like a laid off automotive sector machinist whose next best option is Walmart greeter.
At least part of a nation's economic efficiency must be the efficient employment of its people's talents. The optimal industrial mix of a nation's economy must accomodate the actual mix of its people's skill sets. This is why a broad based manufacturing sector is crucial to national economic health in a developed economy like the US. Does the economy serve the interests of the people or do the people serve the interests of the economy?
Economic activity used to be divided into three categories: primary, secondary and tertiary. Primary is mining, agriculture and other directly resource based industry. Secondary is manufacturing, construction and other physical transformation of resources into goods useful to humans. Tertiary is services like banking, legal, information technology, retail, etc.
You need all three to most fully employ your people's talents in a structurally stable economy. Trying to force people into types of work they don't want to do and are not suited for will be a costly mistake. Sacrificing your primary and secondary industry is contrary to your national interest.
You are correct about the Federal Reserve... but how do we create money backed by gold, when the Federal Reserve owns it, and we are holding pieces of paper that has nothing but a "legal currency"
Heres the interesting move that discusses these.
www.zeitgeistmovie.com/
and the addendum
video.google.com/video...
On Nov 26 09:06 AM derryl wrote:
> My main objection to the whole idea of wholesale conversion to a
> "knowledge" economy is that most people lack the aptitude, skill
> set, call it what you will, to successfully participate in such an
> economy. Maybe 10-20% of the population is suited to "knowledge"
> work. The other 80-90% of the population can succeed at trades, manufacturing
> and other less virtual, more physical kinds of work.
>
> Free trade deals permit the free movement across borders of goods
> and money but not labor. Even if they wanted to, workers cannot follow
> their jobs to the countries these jobs have been exported to. So
> if you offshore their productive and decent-paying jobs a lot of
> people with non-virtual aptitude sets will become structurally underemployed.
> Valuable skill sets become unemployable, like a laid off automotive
> sector machinist whose next best option is Walmart greeter.
>
> At least part of a nation's economic efficiency must be the efficient
> employment of its people's talents. The optimal industrial mix of
> a nation's economy must accomodate the actual mix of its people's
> skill sets. This is why a broad based manufacturing sector is crucial
> to national economic health in a developed economy like the US. Does
> the economy serve the interests of the people or do the people serve
> the interests of the economy?
>
> Economic activity used to be divided into three categories: primary,
> secondary and tertiary. Primary is mining, agriculture and other
> directly resource based industry. Secondary is manufacturing, construction
> and other physical transformation of resources into goods useful
> to humans. Tertiary is services like banking, legal, information
> technology, retail, etc.
>
> You need all three to most fully employ your people's talents in
> a structurally stable economy. Trying to force people into types
> of work they don't want to do and are not suited for will be a costly
> mistake. Sacrificing your primary and secondary industry is contrary
> to your national interest.
In 70's, it was decided by the industries that the wage structure in the US is not competitive with the third world countries. If we want free trade, then there is no way you can keep those industries in the United States, unless we are willing to lower our own living standard. I am sure you heard of "post-industrial America". Surprise! We are there!
We are witnessing the same thing in the auto industries. Anyone want to bet what is going to happen to auto big 3? It's only a matter of time. Don't pretend that you don't know. We are ahead in wages and benefit, and behind in technology. Auto industries are striving the the South, but not in Detroit. Can we do something about people and industries who are digging their own grave?
thanks
I think we need this calamity, so that to remember Milton Friedman, and oust the Keynesian's. The strength of Keynesianism was it attempt to explain the success of the Soviet Unions command economy. Now we follow in their footsteps.
> jack
We may have lost large-scale productive capacity, but gained in small-scale production. Who among us does not have enough stuff? Do we really need more poisonous plastic toys from China that the Europeans won't let anywhere near their kids? Do we need new gas-hogs every year? Can we get by with wooden toys made by a neighbor that may even cost less or better-made old stuff at the thrift shop?
A garage-sale economy is difficult for the taxing authorities to tap into, not only here, but elsewhere. The garage-sale phenomenon has been exported to Japan, for example, according to exchange students I hosted. This makes true cross-boundary comparison challenging. Governments don't get their cuts from this, and it is hard for economists to measure.
The neighborhood market was forced on Castro when the Soviet Union stopped sending oil. The most centralized, mechanized, fertilized, pesticided agriculture in South America had to go back-yard.
Neighborhood markets sprang up quickly, ideology notwithstanding. Tough luck for the state store.
It is my observation that this has happened in China as well, from eyeballing things during a trip there in 2001. State stores generate foreign exchange, when excursion buses stop there. Locals shop local.
The back-yard phenomenon may account for the better health statistics in Cuba, by some measures, than here. The average Cuban lost weight.
During times when fossil-fuel use drops precipitously, this could happen for us as well.
Vigorous exercise is addictive because of its biochemistry and so is fasting. The best coaches now understand they have to tell side-lined, injured athletes that they are going to withdraw from feel-good biochemicals if they stop cardio. They have to compensate for this somehow.
Fasting can trigger endogenous endorphins, which is why anorexia is so hard to treat, and which may be the true reason fasting is part of so many spiritual practices.
Some of the people who started biking will not go back to driving.
People in Cuba had to do their own gardening. A certain percentage of our population is already embarking on Victory Gardening here, for various reasons. It is Americans and Australians who showed up in Cuba to help with that transition where they could. If an embargo doesn't kill you, it might make you stronger.
The USA is a very resilient, curious, smart conglomeration of peoples, as much as we put ourselves down. Many neighborhoods that used to have pubs on every corner now have coffee shops and gyms.
Where in the statistics do we put former Type II diabetic bond traders who career-change to become personal trainers at the local gym? Do we smirk and call this a transition to service work, even if they keep their limbs intact, without costly amputations after going on disability?
If goverporations hoard and defame the currency, as they seem intent on doing, many Americans are just going to start getting along with their neighbors, out of necessity.
If we could keep the politicians and tycoons on a strict diet of corn syrup and saturated fat, using the paper they print to buy it all, we could probably make faster headway on our challenges. Paying tribute is a drag.
Obama apparently isn't going to appoint a chemical salesman to agriculture. There was an uproar when someone at the New York Times proposed it. We'll see who gets to be chef-in-chief.
Narcissistic governments ignore can-do American spirit at their peril. Obama used can-do rhetoric to get where he is. My hunch is he will want to get on the trickle-up train at some point.
That might be dangerous for his personal safety unless he uses every single one of his famous brain cells and has good parties to which he invites those who are not fans of trickle-up. I hope he gets them to prepay their tickets.
Hardly. Ask Ben Graham (well, okay, he's dead) or Warren Buffett (well, okay, you couldn't possibly). At any time, the markets are full of inefficiencies, improper valuations, and opportunities. When was the market right: when it valued Berkshire Hathaway shares at $95,000 on 11/18 and 11/25, or when it valued it at $75,000 on 11/20?
"Capital and investment flow to where the market is the most free. Oddly, that is China and India(at least more than us). "
Nonsense. You clearly have no idea of the conditions the Chinese typically place on non-Chinese companies. Capital flows not to where the market is "most free," but to where the risk-adjusted return is highest. Basic, basic capitalism.
"We have government encouraged labor cartels(UAW, AFL-CIO etc.),"
Which have created work conditions which are not as favorable to labor as exist in much of Europe. By the way, I think you need to look up the word "cartel."
"We tax consumption and labor and savings and investment."
And yet our taxes are lower than Germany, France, Canada, Austria, Belgium, Denmark, Finland, Greece, Hungary, Switzerland, Turkey, the UK, Portugal, the Czech Republic, Norway, Spain, Italy, Australia, New Zealand, Korea, Luxembourg, Poland, and of course Sweden. Of the OECD countries, only Ireland and Iceland have a lower tax burden.
"We should be taxing what we don't want."
We do. But this could quite obviously not be the source of a meaningful amount of revenue.
"Our nations economist have not spoken with a unified voice to say 'taxes bad' ,'government spending bad', 'market intervention bad'."
Funny that you didn't say "deficit spending bad"; how very Reaganesque of you. By the way, there's been no unified statement like you want because NOBODY BELIEVES IT. Economists tend to agree with Holmes' statement that taxes are the price we pay for civilization. And clearly, not all government spending is bad, and not all market interventions are bad.
"I think we need this calamity, so that to remember Milton Friedman, and oust the Keynesian's. The strength of Keynesianism was it attempt to explain the success of the Soviet Unions command economy."
You demonstrate once again that you don't know anything about Keynes' theories. Please, go ahead and make some connection between Keynesianism and the failure of the credit markets. I need something more to discredit.
On Nov 26 03:44 PM BS Detector wrote:
> "The free market is always right."
>
> Hardly. Ask Ben Graham (well, okay, he's dead) or Warren Buffett
> (well, okay, you couldn't possibly). At any time, the markets are
> full of inefficiencies, improper valuations, and opportunities.
> When was the market right: when it valued Berkshire Hathaway shares
> at $95,000 on 11/18 and 11/25, or when it valued it at $75,000 on
> 11/20?
>
Yes it was! Continually evaluating and correcting.
> "Capital and investment flow to where the market is the most free.
> Oddly, that is China and India(at least more than us). "
>
> Nonsense. You clearly have no idea of the conditions the Chinese
> typically place on non-Chinese companies. Capital flows not to where
> the market is "most free," but to where the risk-adjusted return
> is highest. Basic, basic capitalism.
>
The risk-adjusted return is highest because their markets have suddenly been allowed the freedom to self adjust and correct.
> "We have government encouraged labor cartels(UAW, AFL-CIO etc.),"
>
>
> Which have created work conditions which are not as favorable to
> labor as exist in much of Europe. By the way, I think you need to
> look up the word "cartel."
>
Unemployment is very safe.
From Wikipedia
"A cartel is a formal (explicit) agreement among firms." (<---firms here being Labor Unions)
"Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products." (<-- here the product is labor. They especially are Labor cartels.)
> "We tax consumption and labor and savings and investment."
>
> And yet our taxes are lower than Germany, France, Canada, Austria,
> Belgium, Denmark, Finland, Greece, Hungary, Switzerland, Turkey,
> the UK, Portugal, the Czech Republic, Norway, Spain, Italy, Australia,
> New Zealand, Korea, Luxembourg, Poland, and of course Sweden. Of
> the OECD countries, only Ireland and Iceland have a lower tax burden.
>
In the 80's maybe. During the campaign it was stated that corporate taxes are the 3rd highest in the world. We constantly tell ourselves how low are taxes are. That so you won't mind paying. When everybody pays for every tax.
>
> "We should be taxing what we don't want."
>
> We do. But this could quite obviously not be the source of a meaningful
> amount of revenue.
>
Meaningful to who, bureaucrats.
> "Our nations economist have not spoken with a unified voice to say
> 'taxes bad' ,'government spending bad', 'market intervention bad'."
>
>
> Funny that you didn't say "deficit spending bad"; how very Reaganesque
> of you. By the way, there's been no unified statement like you want
> because NOBODY BELIEVES IT. Economists tend to agree with Holmes'
> statement that taxes are the price we pay for civilization. And
> clearly, not all government spending is bad, and not all market interventions
> are bad.
>
Tax revenue double under Reagan. During his term Democrats complained loudly about cuts to future spending. Those deficits clearly belonged to Democrats.
Are you say the more one pays in taxes the more civilized one is? Socialism is not Civilization and thats what our liberal friends arguing for when the quote Holmes, socialism.
The burden of proof is on Market intervention as a being even marginally productive in the long term.
> "I think we need this calamity, so that to remember Milton Friedman,
> and oust the Keynesian's. The strength of Keynesianism was it attempt
> to explain the success of the Soviet Unions command economy."
>
> You demonstrate once again that you don't know anything about Keynes'
> theories. Please, go ahead and make some connection between Keynesianism
> and the failure of the credit markets. I need something more to
> discredit.
The Failure of credit market is a failure of government. Government intervention to put poor people in their own homes "the American Dream". The predominant economic theory in practice today is Keynesianism. Through Keynes the argument is made for government to grow and spend us out of trouble. Isn't that exactly what Obama is planning now? We need to tax cut our way out of this. And not by cutting taxes of those who don't pay them now, but those who pay the bulk of them.
too bad that 90% of the participants dont even know how to
spell "service" much less provide it !
"The free market is always right. Capital and investment flow to where the market is the most free. Oddly, that is China and India... "
I urge readers to reread this guys comment because his conclusions are spot on. The article starts off fine but the author's conclusions are off base. Today's glaring failures of the U.S. are the tipping point from getting off the "free-markets" path decades ago. We have been gradually adopting socialist principles as we keep moving closer to the French economic model at an accelerating rate. At this critical time we should go back to adopting a Hong Kong economic model but that is as likely as snow in South Africa.
And you can be damn sure that future history books will teach us the wrong lessons (that this is a failure due to greed, capitalism run amok and lack of regulatory oversight).
Ludwig Von Mises... we need you more than ever!
hitler had an unemployment problem in germany. he put able-bodied men to work building autobahnen.
deficit spending on infrastructure in july-august 2008 @ the height of the steel/cement speculative commodities bubble would have been unwise. 4 months later it seems very wise to put americans back to work any which way you can.
unions exist to correct management abuses. united parcel service has a union (teamsters) but they still have management abuses (when the shop steward doesn't do his job & lets them get away w/it).
> jack
Your belief that BRK was appropriately valued at all times during a 5-day period that saw it dip and regain 20% pretty much says it all. The fact is that the free market is constantly making valuation errors; the difficulty (some say impossibility) lies in understanding and capitalizing on them.
"The risk-adjusted return is highest [in China and India] because their markets have suddenly been allowed the freedom to self adjust and correct."
Um, no. Returns are higher there because those economies are growing at a faster rate. You have demonstrated no knowledge of the burdens and limits placed on foreign capital; you simply assume that the growth is due to new-found freedom.
"Unemployment is very safe."
Thank you for destroying your own argument. If we had "government encouraged labor cartels(UAW, AFL-CIO etc.)" we would inevitably have higher unemployment, like Europe, right?
"From Wikipedia - 'A cartel...'"
Try Random House: "1. an international syndicate, combine, or trust formed esp. to regulate prices and output in some field of business."
Try American Heritage: "1. A combination of independent business organizations formed to regulate production, pricing, and marketing of goods by the members."
"(firms here being Labor Unions)"
Stretch.
"(here the product is labor. They especially are Labor cartels.)
Streeeeeeeetch.
Unions are by definition not cartels.
"'> And yet our taxes are lower than...'
"In the 80's maybe.
No, as I said, the tax burden of the United States is NOW lower than every OECD nation except Iceland and Ireland.
"During the campaign it was stated that corporate taxes are the 3rd highest in the world."
First off, is that your best effort at substance? "During the campaign it was stated that..."? Secondly, you were broadly talking about taxation, not specifically about corporate taxes. Thirdly, the marginal tax rate is not the same as the effective tax rate. The effective tax rate is 27%, and the corporate tax burden as a percentage of GDP, compared to the OECD states, is lower. (www.smartmoney.com/inv.../)
"We constantly tell ourselves how low are taxes are."
Compared to most of the world, our taxes are low. Please do some research if you'd like to refute the statement.
"'> We do [tax what we don't want]. But this could quite obviously not be the source of a meaningful amount of revenue.
"Meaningful to who, bureaucrats."
Sigh. Please state specifically what you think should be taxed, at what level, to produce what revenue. Oh, I'm sorry, I forgot that you anti-tax types can't produce any real numbers.
"Tax revenue double (sic) under Reagan."
This isn't any more true than the last time you wrote it. Even without adjusting for high inflation, even with the economy recovering from a deep recession, this doesn't hold true. Individual and corporate income tax revenue: 1981 - $347M; 1989 - $549M. [It's almost true for Social Security taxes, which Reagan RAISED enormously: 1981: $183M; 1989 - $359M.] Factor in inflation, and the increase in revenue diminishes substantially: nominally during Reagan's two terms, income tax revenue increased 58%; in real terms it was 16%. (source: EROP tables B-80 and B-60)
"During his term Democrats complained loudly about cuts to future spending."
Really? Examples, please.
"Those deficits clearly belonged to Democrats."
Don't know why you think Reagan should get credit for tax cuts, but not take blame for deficits. They're all part of the same budgeting process. And, by the way, Reagan's original budgets were LARGER than those passed by Congress.
"Are you say (sic) the more one pays in taxes the more civilized one is?"
I guess you'll need to look up "civilized" and "civilization."
"Socialism is not Civilization and thats what our liberal friends arguing for when the quote Holmes, socialism."
Here, let me help you, since you clearly don't know what socialism is, either: "a theory or system of social organization that advocates the vesting of the ownership and control of the means of production and distribution, of capital, land, etc., in the community as a whole." (Random House)
There are two American policies that have been the closest to socialism: semi-nationalization of banks under George W. Bush, and wage and price controls under Nixon. No Democrat's policies or positions even comes close to these.
"The Failure of credit market is a failure of government. Government intervention to put poor people in their own homes 'the American Dream.'"
Again, such a weak understanding. Without the completely unregulated credit default swap market and the terrible handling of mortgage backed securities, the damage from sub-prime and other failed mortgages would not have spread into the financial system as a whole. There is plenty of blame to go around on this one.
"The predominant economic theory in practice today is Keynesianism."
Really? What does that mean, "in practice"? Do you think the Bush White House is full of Keynesians?
"Through Keynes the argument is made for government to grow and spend us out of trouble."
You're missing half the story. Keynes argued that government action should be counter-cyclical, using deficit spending to boost a sagging economy but doing the opposite during expansions. We lost the discipline the second half of the equation requires during the 1980s, appeared to get it back in the 1990s, and blew it out of the water in the 2000s.
"Isn't that exactly what Obama is planning now?"
If you mean massive deficit spending, yes. The real question is how.
"We need to tax cut our way out of this. And not by cutting taxes of those who don't pay them now, but those who pay the bulk of them."
Keynes would argue that lowering taxes on those who create jobs won't help end this crisis quickly, as these economic actors are not likely to increase investment until they see consumer markets improving. If the economy is in as bad shape as it appears, Keynes would argue that government spending to boost aggregate demand would be better, as it would improve market conditions more quickly, which would lead to the supply side of the economy ramping up again more quickly.
Another argument made by Keynes is that government spending is not necessarily wasteful. For example, the vast majority of infrastructure projects are necessary and proper, and running deficits to fund them during this downturn would fit well with Keynesianism. I believe this is the kind of spending Obama's been talking about.
Hmmm...
"The Bush administration backed off proposed crackdowns on no-money-down, interest-only mortgages years before the economy collapsed, buckling to pressure from some of the same banks that have now failed.
"It ignored remarkably prescient warnings that foretold the financial meltdown, according to an Associated Press review of regulatory documents.
"'Expect fallout, expect foreclosures, expect horror stories,'" California mortgage lender Paris Welch wrote to U.S. regulators in January 2006, about one year before the housing implosion cost her a job.
"Bowing to aggressive lobbying—along with assurances from banks that the troubled mortgages were OK—regulators delayed action for nearly one year.
"By the time new rules were released late in 2006, the toughest of the proposed provisions were gone and the meltdown was under way.
"'These mortgages have been considered more safe and sound for portfolio lenders than many fixed rate mortgages,'" David Schneider, home loan president of Washington Mutual, told federal regulators in early 2006.
"Two years later, WaMu became the largest bank failure in U.S. history.
"The administration's blind eye to the impending crisis is emblematic of a philosophy that trusted market forces and discounted the need for government intervention in the economy.
"Its belief ironically has ushered in the most massive government intervention since the 1930s.
"'We're going to be feeling the effects of the regulators' failure to address these mortgages for the next several years,'" said Kevin Stein of the California Reinvestment Coalition, who warned regulators to tighten lending rules before it was too late.
"Many of the banks that fought to undermine the proposals by some regulators are now either out of business or accepting billions in federal aid to recover from a mortgage crisis they insisted would never come.
"Many executives remain in high-paying jobs, even after their assurances were proved false.
"In 2005, faced with ominous signs the housing market was in jeopardy, bank regulators proposed new guidelines for banks writing risky loans.
"Today, in the midst of the worst housing recession in a generation, the proposal reads like a list of what-ifs:
"* Regulators told bankers exotic mortgages were often inappropriate for buyers with bad credit.
"* Banks would have been required to increase efforts to verify that buyers actually had jobs and could afford houses.
"* Regulators proposed a cap on risky mortgages so a string of defaults wouldn't be crippling.
"* Banks that bundled and sold mortgages were told to be sure investors knew exactly what they were buying.
"* Regulators urged banks to help buyers make responsible decisions and clearly advise them that interest rates might skyrocket and huge payments might be due sooner than expected.
"Those proposals all were stripped from the final rules. None required congressional approval or the president's signature.
"'In hindsight, it was spot on,'" said Jeffrey Brown, a former top official at the Office of Comptroller of the Currency, one of the first agencies to raise concerns about risky lending.
"Federal regulators were especially concerned about mortgages known as 'option ARMs,' which allow borrowers to make payments so low that mortgage debt actually increases every month.
"But banking executives accused the government of overreacting.
"Bankers said such loans might be risky when approved with no money down or without ensuring buyers have jobs but such risk could be managed without government intervention.
"'An open market will mean that different institutions will develop different methodologies for achieving this goal,'" Joseph Polizzotto, counsel to now-bankrupt Lehman Brothers, told U.S. regulators in a March 2006.
"Countrywide Financial , at the time the nation's largest mortgage lender, agreed.
"The proposal 'appears excessive and will inhibit future innovation in the marketplace,' said Mary Jane Seebach, managing director of public affairs.
"One of the most contested rules said that before banks purchase mortgages from brokers, they should verify the process to ensure buyers could afford their homes.
"Some bankers now blame much of the housing crisis on brokers who wrote fraudulent, predatory loans.
"But in 2006, banks said they shouldn't have to double-check the brokers.
"'It is not our role to be the regulator for the third-party lenders,'" wrote Ruthann Melbourne, chief risk officer of IndyMac Bank.
"California-based IndyMac also criticized regulators for not recognizing the track record of interest-only loans and option ARMs, which accounted for 70 percent of IndyMac's 2005 mortgage portfolio.
"This summer, the government seized IndyMac and will pay an estimated $9 billion to ensure customers don't lose their deposits.
"Last week, Downey Savings joined the growing list of failed banks.
"The problem: About 52 percent of its mortgage portfolio was tied up in risky option ARMs, which in 2006 Downey insisted were safe—maybe even safer than traditional 30-year mortgages.
"'To conclude that 'nontraditional' equates to higher risk does not appropriately balance risk and compensating factors of these products,'" said Lillian Gavin, the bank's chief credit officer.
"At least some regulators didn't buy it. The comptroller of the currency, John C. Dugan, was among the first to sound the alarm in mid-2005.
"Speaking to a consumer advocacy group, Dugan painted a troublesome picture of option-ARM lending.
"Many buyers, particularly those with bad credit, would soon be unable to afford their payments, he said. And if housing prices declined, homeowners wouldn't even be able to sell their way out of the mess.
"It sounded simple, but 'people kind of looked at us regulators as old-fashioned,' said Brown, the agency's former deputy comptroller.
"Diane Casey-Landry, of the American Bankers Association, said the industry feared a two-tiered system in which banks had to follow rules that mortgage brokers did not. She said opposition was based on the banks' best information.
"'You're looking at a decline in real estate values that was never contemplated,'" she said.
"Some saw problems coming.
"Community groups and even some in the mortgage business, like Welch, warned regulators not to ease their rules.
"'We expect to see a huge increase in defaults, delinquencies and foreclosures as a result of the over selling of these products,'" Stein, the associate director of the California Reinvestment Coalition, wrote to regulators in 2006.
"The group advocates on housing and banking issues for low-income and minority residents.
"The government's banking agencies spent nearly a year debating the rules, which required unanimous agreement among the OCC, Federal Deposit Insurance Corp., Federal Reserve, and the Office of Thrift Supervision—agencies that sometimes don't agree.
"The Fed, for instance, was reluctant under Alan Greenspan to heavily regulate lending.
"Similarly, the Office of Thrift Supervision, an arm of the Treasury Department that regulated many in the subprime mortgage market, worried that restricting certain mortgages would hurt banks and consumers.
"Grovetta Gardineer, OTS managing director for corporate and international activities, said the 2005 proposal 'attempted to send an alarm bell that these products are bad.' After hearing from banks, she said, regulators were persuaded that the loans themselves were not problematic as long as banks managed the risk.
"She disputes the notion that the rules were weakened.
"In the past year, with Congress scrambling to stanch the bleeding in the financial industry, regulators have tightened rules on risky mortgages.
"Congress is considering further tightening, including some of the same proposals abandoned years ago."
www.cnbc.com/id/279980...
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