THE SUBPRIME BUBBLE AND THE BUSH TAX CUTS

One of the goals of this campaign is to highlight the degree to which this administration has abandoned the traditional fiscal prudence and caution of the Republican Party, and the degree to which this is harming our country. The economic instability which is resulting from concerns about the subprime mortgage market is a perfect example - it is a direct result of policies of the Bush Administration, and it undermines a very important responsibility of government in a capitalist system. The Administration suggests that the Tax Cuts helped promote business investment and new business startups. But according to the Government's own numbers, that is not true. The Bush Tax cuts were used to fund speculation in the economy, including speculation on high risk subprime mortgages - the Bush Tax Cuts funded the speculation which is right now causing instability in the world financial markets. This President will go down as perhaps the worst economic steward our country has ever had. His administration has caused damage to our economy, did not focus on the real issues that need to be addressed, lessened the ability of our government o respond to the next economic downturn, and insured that the next recession will be more severe and last longer.

This Administration likes to suggest that the money from the Bush Tax Cuts went toward investment in new and existing businesses. That is not true. The U.S. Government tracks business investments, and tracks the number of new business startups. Neither shows any appreciable change after the tax cuts. The amount of money businesses were investing in new plants and equipment did not go up, and the number of new businesses being started did not go up. By the Federal Government's own numbers, the money from the tax cuts did not go into business investment.

Where did the Bush Tax Cuts go? The part of the tax cuts that actually went to middle class people would up as additional consumption - middle class families took their thousand or two thousand dollars in refunds and bought something they needed. However the bulk of the tax cuts went to the wealthy, or the very wealthy, people who already had everything they needed. So what did these people do with their money? Money not spent on consumption is saved or invested. But where to invest? People with money usually already have a pretty well defined investment strategy, with their money spread between safe, low risk investments and a small part put toward high risk, high return investments.

What does a wealthy person do when they have a sudden windfall - which is what the tax cuts were? Do they spend it on low risk investments? Do they buy U.S. government savings bonds? The answer, according to the U.S. Government, is No - the tax cuts were not used to buy U.S. savings bonds. The Bush Administration doesn't like to talk about this, but the U.S. saving bonds sold to subsidize our budget deficit are bought almost entirely by foreigners, with much of them bought by the Chinese government. Yes, its true - China is loaning money to the Bush Administration to pay for the tax cuts.

So what were the wealthy and very wealthy doing with their hundreds of millions in tax cuts? What do you do if you suddenly have money you didn't expect to have to invest? Not surprisingly, most people viewed it as Found Money. And with found money, you take chances - you gamble on higher risk, higher return outcomes. Why? Because you already have your safe investments in place. So why not try a higher risk investment? Why not speculate a little bit? Because if you lose the money, it doesn't affect your lifestyle or your long term financial prospects.

And that is exactly where the money went. A significant portion of the Bush Tax Cuts, hundreds of billions of dollars, went into hedge funds, to fund speculation on energy, housing and other sectors of our economy. This is the part of the subprime bubble that commentators haven't talked about that much. Why did the subprime market suddenly explode several years ago? There have always been subprime loans, and there have always been poor people or people with bad credits who wanted to buy houses, even at higher interest rates. So why now? Again, the answer is the Bush Tax Cuts. The limiting factor in the subprime market has always been on the lending side. The people that had money were always hesitant to fund subprime loans. This has been the limitation - there has always been a shortage of money for subprime loans, because most people with money did not want to take that much risk. Subprime loans were considered to be high risk, and most people do not want to put that much of their financial portfolio at risk.

What suddenly changed ? Why, several years ago, did people with money suddenly start making high risk loans by buying securities of high risk loans? Did the American pubic suddenly get a much larger appetite for high risk? The answer, of course, is No. People didn't suddenly develop a new appetite for risk. Because of the Bush Tax Cuts, people with lots of money suddenly had found money, unexpected money to find a place for. And since they weren't dependent on it - since it was just extra - they put it into high risk investments through hedge funds. The Bush Tax Cuts went to fund speculation in subprime mortgages.

The sudden availability of subprime loans had a ripple effect throughout our economy. If more people can suddenly get financed to buy houses, there are more buyers competing for houses. Subprime lending, along with low interest rates, had the effect of causing a general housing bubble. With a sudden influx of buyers, the value of existing homes went up. The demand for new home construction went up as well. Tens of thousand of jobs were created, in construction, building materials industries, mortgage and loan industries. The housing bubble essentially absorbed the jobs that our country was losing in the manufacturing sector. Those people who lost their jobs to Chinese manufacturing plants became carpenters and went to work for home builders. They bought new pickup trucks, and new tools. Without a doubt, the housing bubble was a primary driver of job growth in our economy over the last four years.

But here is the problem - most of those jobs are now going to disappear now that the bubble has burst. A topic of debate in economic policy is whether or not the Government can actually create demand, or does government just shift demand. So, for instance, did the government cause houses to be built that never otherwise have been built, create demand, or did government causes houses that would have been built in 2009 to instead be built in 2005 - a shift of demand from a future time to the current time. You can make a pretty good argument that government can't really create demand, that all it can do is shift it. So the jobs caused by government economic manipulation almost always go away. The jobs created in the real estate industry and housing industry are likely to go away. The guys that lost their manufacturing jobs but went right into home building are going to lose those jobs. The Ford factory workers that build the trucks that the contractors bought are going to see a reduction in demand, and layoffs.

And as our economy moves forward, there is going to be significantly less demand for new houses to be built over the next several years, because the houses that are needed have already been built. This is going to translate into less demand for a lot of different things - new pickup trucks, building supplies, mortgage brokers… And all of this together is going to cause the next recession to be more severe, and last longer. Normally home building is a relatively stable part of our economy, and a pickup in home building helps lead us out of periodic recessions. But during the next recession, there is going to be substantially less home building, making the recession worse than it otherwise would have been. And since we have built so many extra homes - since we have already built the new homes we will need in 2009, it is going to take longer for home building to pick back up, making the recession longer. Whether the Bush Administration or even any of the Republican candidates care to admit it, this Administration's economic policies are going to cause the Bush Recession to be a particularly harsh one.

Speculation - Speculation is an important part of our economy. We WANT people to speculate - we want people to take economic risks. Because that is a part of how new industries are discovered, new businesses are started. Its worth repeating - speculation is an important part of a healthy economy.

But speculation is also something that our government monitors and in most cases regulates, and in particular speculation using borrowed money. An economic truism is that people take greater risks when they are using other people's money. So our government, since the Depression, has been particularly cautious to monitor and in some ways curtail the use of borrowed money for speculation. We protect against speculation in the stock market using borrowed money, and further curtail speculation by limiting the number of shares of stock that can be bought or sold speculatively. The government oversees banks to make sure they are not taking too many credit risks. In many ways large and small, the government protects against the risk of too much speculation with borrowed money.

It does this not just to protect the speculator and the people that lend money to the speculators, but to protect the stability of the free market, the stability of our economy. Because speculators can make it seem like the value of assets is going up, even when it really isn't - speculation can create economic bubbles. Artificial increases in value don't last. And when the bubble bursts, it has consequences for our economy. If values are inflated, they eventually become deflated. If we have a boom, we pretty much always have a bust. And a key role of the federal government is to protect against exactly this kind of artificial swing in the economy - a key role of government in the free market is to protect again severe swings in economic activity. It is the role of government to insure that growth doesn't become hyper inflation, and that a recession doesn't become a depression. Again, it is a primary responsibility of a government in a free market economy to protect against instability in the economy.

It is worth noting that many hedge funds are doing exactly this kind of speculation with borrowed money. They are taking the money invested in their funds from the tax cuts, and borrowing many multiples of that amount to speculate on lots of different things - stocks, energy prices, subprime mortgages… And believe or not, currently the government has no kind of oversight or monitoring o hedge funds. The money that I said went into hedge funds - that's not from government figures, because the government doesn't monitor hedge fund activities - the numbers are from private industry groups. Why doesn't the government oversee hedge funds, with their trillion plus dollars of activity in our economy? Because decades ago, when hedge funds first started, they were very small and only invested the money of very wealthy people, without being reliant on borrowing money to fund their speculation. This is absolutely an issue that our country needs to deal with - it is irresponsible of our government NOT to oversee hedge funds. And it is well within the power of government to do so. But the Bush Administration has not taken any steps to do so - they have allowed the hedge funds to grow exponentially, have a greater and greater impact on our economy, and done nothing to bring underneath the regulatory and oversight umbrella of the federal government. Think about that - the Bush Administration was simultaneously helping to pump money into hedge funds for speculation, and at the same time not taking steps to protect against the impact of Hedge Fund's speculation on our economy.

Whether the administration cares to admit it or not, their economic policies have undercut a key role of our government. Instead of protecting against the swings that come from excessive speculation, the Bush Administration has promoted excessive speculation. Like it or not, the Bush Administration's policies have created economic instability, and, again, insured that the next recession will be a particularly bad one.

What Republicans Used to Think - Certainly, the Bush Administration didn't set out to fund speculation - this is just what happened. Instead the Administration was hoping that the extra capital from the tax cuts would go toward new business investments. By providing more available capital, the Administration hoped to foster more investment. But access to capital is only one of the factors that businesses evaluate when deciding whether or not to increase capacity. By far the most important factor is the market - businesses have to believe that they have a chance of selling the additional products they produce. And at the end of the day, businesses in the U.S. didn't think they had a chance to find markets for the new products, so they didn't make the investments to create new capacity. Because of this, the Bush Administration's efforts to promote investment didn't work.

There was a time when Republicans thought it would never work - they didn't think it was possible for the Government to really increase demand or investment. Republicans used to recognize that government was far more likely to shift demand than create demand, and that all that shifting demand did was to likely increase the swings in the economy and lead to greater economic instability. And Republicans also used to believe that government efforts to increase demand usually led to inefficiency - the government might be able to get people to spend money they wouldn't otherwise have spent, but that the people spending the money probably weren't going to get as much value in return. Republicans used to believe that Government encouraged demand led to poor economic decisions. So government should NOT try to artificially increase demand. And government deficit spending is a tool to pump up demand. The government already has mechanisms in place to keep demand from dropping, for instance unemployment insurance. But Republicans used to believe that trying to pump up demand was bad for our economy.

Republicans used to believe in something called the "Free Market". The Free market itself was best able to arrive at the correct level of investment and demand, and in doing so create the greatest value for our economy. This, surely, is one of the things that has been most baffling about this President Bush. He talks as if he believes in the free market, but at the policy level it is just the opposite - this administration is constantly proposing or implementing new ways to manipulate the economy. We judge politicians by their policies, not their platitudes. There has never been a Republican president with so little faith n the free market.

So there you have it. The Bush Tax Cuts didn't go to foster business investment, they went toward speculation, and are going to cause the next recession to be worse, and also limit the ability of our government to respond. Instead of promoting economic stability, the Administration promoted instability. Instead of trusting the free market, they have abandoned the free market, and over a century of Republican economic beliefs. The Bush Administration will go down in history as the worst Republican President ever, the worst economic steward we have ever had.