Neoliberalism’s Fatal Faith in Debt Fiction

“When Smith and Mill and the classical economists talked about ‘free’ markets, they meant an economy free of rent, free of interest, free of parasitism. Today in the United States, the whole idea is that a free market is free for the parasites.”

Transcribed from the 12 September 2015 episode of This is Hell! Radio (Chicago) and printed with permission. Edited for space and readability. Listen to the full interview:

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“Basically, criminals took over the Obama Administration, using him as a front man. He was quite open about this, essentially saying to them, ‘I’m the only guy standing between you and the mob with pitchforks.’ Obama has always been a genius in keeping the mob at bay while actually doing what his Wall Street campaign contributors want, and basically screwing his constituency.”

Chuck Mertz: The world’s economy is slowly having its lifeblood sucked out of its collapsing veins by predators who have power over policy and democracy. Here to tell us how we got here and how we can pour salt on those parasitic leeches of Wall Street, Michael Hudson is the author of Killing the Host: How Financial Parasites and Debt Bondage Destroy the Global Economy.

Good morning, Michael.

Michael Hudson: Good to be here.

CM: You want us to question the sanctity of debt. But if we allowed debt forgiveness, wouldn’t that destroy the entire capitalist system? Borrowers would see loans as free money, and creditors wouldn’t lend because they would know that they would never be repaid, because people don’t believe in the sanctity of debt.

So isn’t the sanctity of debt what keeps our economy going?

MH: No. That’s what’s destroying the economy. The American economy has now slowed down, and the Eurozone has turned into a dead zone, largely because of debt deflation. If the American public have to pay their debt, and the Europeans and other countries have to pay their debts, there’s no way that their economies can grow further. Because all of the money is basically going to be spent paying the financial sector, not for goods and services.

You can see this by looking at the average paychecks of Americans. The government now guarantees mortgages by banks that absorb up to 43% of the loan applicant’s income for home mortgage payments. Rent is also about 40%. So there goes the first slice. Also, when you get your paycheck, there’s a 15% FICA wage withholding for Social Security and Medicare. This is a shift of the tax burden off of the higher brackets and onto people who earn less than $100,000 a year.

There’s another 10% of income that goes to interest people pay to banks for student loans, credit card loans, auto loans to get to work, and penalties. And the penalties are even higher than the interest payments, for leading credit card companies.

And finally, there are the regular local taxes. Sales taxes and income taxes that have, again, been shifted off of the top wealthy layer—off the finance, insurance, and real estate sectors—onto industry, consumers, and agriculture.

If you add it all up, only about one quarter of the average family’s paycheck actually goes for goods and services—for clothes, food, transportation, other basic needs that they have. What that means is that even if you give American workers all of their clothes and all of their food for nothing, they still couldn’t compete with foreign workers, because they have to pay such a big nut out of their paycheck every month for housing costs that are vastly inflated by the banks.

A house is worth whatever a bank will lend. And as the banks lend more and more relative to the value of the house, on easier and easier credit—on junk mortgages—the access price to housing gets built up.

Beyond that, there’s a deeper phenomenon: the generalized financialization of the economy. We’ve moved into a central planning economy—exactly what the free market people warned about in fighting socialism. Our economy is being planned. Not by government, and not by elected representatives, but by Wall Street, by the financial firms.

They are now in charge of allocating where the economy’s resources go. Wall Street and the banks don’t lend money for the same things that governments spend on. Governments spend money on building infrastructure and social programs and doing the things that governments do. When banks lend money, they don’t spend it into the economy for goods and services. They lend money to buy assets. And that means to inflate the price of housing.

The more banks lend against real estate, the higher real estate prices go. The more they lend students to pay for their education, the higher universities are able to raise their tuition rates, because students can now get the money. And then when they graduate, they have a lifetime of debt peonage.

So more and more, the economy is having to pay off the debts that have run up, and the problem isn’t that the people wouldn’t lend more if debts were canceled. Keynes showed long ago that lenders will lend wherever they can. When Argentina wiped out the debt, that made them one of the most credit-worthy countries in the world. Russia and China were the most credit-worthy countries after their revolutions, because they didn’t have any debt at all.

The way to recover is indeed to wipe out the debt.

CM: You write that people who invest in real estate feel that they are saving and getting richer by paying for an investment that will grow. They feel like they are saving, but are they? How much of investing in real estate as a savings for retirement is based on myth and illusion?

MH: Most of it. There are two ways of saving for retirement. One is to buy your house, and the other is to buy stocks. I’ll deal with them in order.

We think that if you borrow to buy a house, the price is going to go up and you’ll get a free ride. That’s how most of the American middle class after World War II became affluent. They bought a house at low prices in the 1940s or even the 1950s or 60s, and watched the price of the house go up and up and up.

But what was forcing the price up was other people borrowing—other people going into debt. And as the prices went up, the homeowners of the post-World War II generation benefited, but the new people just entering the labor force had to pay higher and higher prices by taking on higher and higher debts.

A point has been reached today where, here in New York City, the average rent is $4500 a month. You can imagine, there’s almost no way that a city whose population has to pay $4500 a month for rent (and even more for homeownership) can compete with other cities or other housing markets except by being in the financial sector that basically makes its money by ripping off the rest of the economy.

But the stock market is another problem. About half a century ago, when pension funds began to be developed by General Motors and others, people called this “labor capitalism.” Financiers thought it was wonderful. As part of the wage agreements, if you will earn less now, we will put the money in the stock market, and the stocks are going to go up and up. And as more and more workers contributed to the pension funds, there was a flood of money into the stock market, pushing up stock prices. And that’s been happening since the 1940s.

The problem is that now that the economy is aging, all these pension funds have reached payout time. It’s now time to begin paying the retirees, and they’re paid by the pension funds selling off stocks. That led George Bush, about a decade ago, to urge privatization of Social Security. The idea was that the workers would turn over their savings into pension funds that would be withdrawn from their paychecks and pushed into the stock market.

This would have created a bonanza for Wall Street, because the speculators could see all this money that was now going into the stock market, and it would push up the stock price—until workers begin to retire, and then all of a sudden everything that came up would go down. And when the stock market goes down, it goes down very rapidly. Because analysts and speculators can see which way the trend is going and they all sell out, and the pensioners would be left holding the bag.

Just as they’ve been left holding the bag in employee stock ownership programs, where the stocks are managed by the employer. Right in Chicago you had Sam Zell, of the Tribune Company. He used the money he made in real estate to buy the Trib, and he paid off his financial backers by looting the employee stock ownership plan, and basically wiped it out by driving the Chicaco Tribune into bankruptcy.

That’s sort of a miniature model of what’s happening throughout the American industrial economy. The financial system, instead of helping industry develop, has turned into a looting process—not exactly what was anticipated a century ago.

CM: You write, “Bubbles always burst because they are financed with debt, which expands like a chain letter for the economy as a whole. Mortgage debt service absorbs more and more of the rental value of real estate and of homeowners’ income as new buyers take on more debt to buy homes that are rising in price.”

If debt causes bubbles, is the problem debt in general, or is it some sort of abuse of debt, or over-extending of debt?

“This is absolutely intentional. All of the Chicago school’s writings for the last fifty years have been on how to use neoliberal financial economics to lower wage levels and concentrate profit and interest and economic rent at the top of the economic pyramid.”

MH: It’s the way in which money is lent. For instance, fifty years ago (I came to New York in 1960 and worked for the savings banks as an economist), banks would lend up to 75% of a property’s value. New people had to save up enough to pay one quarter of the price as a down payment. And the savings banks were lending locally; they knew the customers, and they would keep the mortgages on the books.

But gradually that’s stopped happening. As banking spread out nationally throughout the United States, lending became more and more irresponsible. That’s what developed the junk mortgage market. By the time the bubble burst in 2008, banks were lending 100% of the value of property. You could buy a home with no money down. And in fact, the bank would give you an extra 2% so you could have it painted or have work done. So they were often paying more than the value.

And they were lending without any reference to income at all. Those were called “NINJA” loans: no income, no job, no assets. Essentially, the banks worked with fraudulent real estate brokers—many of whom they owned—and fraudulent land appraisers to pretend that property was worth much more than it was worth. And the result was what the FBI already in 2004 said was the largest wave of financial fraud in recent American history.

So the first thing Alan Greenspan and the FBI did was cut all of the fraud officers away from financial fraud, and put them on 9/11 duty looking for Arab terrorists (and of course they were told to look where the terrorists weren’t; as long as they didn’t look in Saudi Arabia they would be kept very busy). So suddenly the FBI was “short-handed.”

And then Obama came in. He had been backed by Robert Ruben, who was a Wall Street investment banker who had become Secretary of Treasury under Clinton, then went back to head Citibank, and essentially drove it under. My book tells about how Ruben drove Citibank under, and how, under Obama, the Justice Department refused to prosecute any of the crime and the financial fraud that had underlain the whole financial bubble.

This was amazing at the time. Obama had promised to write down debt to the ability to pay. In other words, if somebody couldn’t pay a high mortgage that was exploding in interest rates, the mortgage would be written down to what the same property would cost to rent. This would bring debt in line with the ability to pay and with the market price.

But as soon as Obama was elected, he appointed the people that his campaign contributors said. He put Wall Street in charge of the regulatory process, and the Justice Department refused to prosecute absolutely anyone.

Basically, criminals took over the Obama Administration, using him as a front man. He was quite open about this. Ron Suskind wrote a book describing how Obama met the Wall Street people and essentially said, “I’m the only guy standing between you and the mob with pitchforks. And my job is to protect you.”

Wall Street were his main campaign contributors, and what they wanted was exactly the opposite of what the public wanted. They wanted no debt write-down. They wanted to be able to evict 10 million American homeowners that were in arrears, but do it slowly enough that it wouldn’t crash the market. And they got what they wanted.

Obama has always been a genius in keeping the mob at bay while actually doing what his Wall Street campaign contributors wanted, and basically screwing his constituency. This has both local and global correlates. First of all, it’s exactly what he did in Chicago, when he first made billions for the Crown family and the Pritzker family by working with the real estate reverends at the University of Chicago to tear down black neighborhoods, basically get rid of low-income blacks and gentrify Hyde Park, all the while the “community organizer.”

He made so much money for the Pritzkers that Penny Pritzker introduced him to Robert Ruben and said, “This is our guy. He can really deliver his constituency up and screw them and they don’t even know they’re being screwed.”

But this goes far beyond Chicago and the United States. We also need to look at what Tim Geithner, the treasury secretary who was pretty much Wall Street’s bag man, and Obama did in Europe, insisting that Greece be made to repay its loans even though the IMF and other economists saw already in 2010-2012 that Greece couldn’t pay. Essentially, American financial fraud and financial takeover was extended from Wall Street all the way to London, Frankfurt, Paris, and other financial centers.

CM: You mentioned Greece, so let’s talk about that for a minute. You write, “IMF structural adjustment austerity programs of the type now being imposed across the Eurozone make the debt situation worse by raising interest rates and taxes on labor, cutting pensions and social welfare spending.”

Is wealth disparity inevitable? Is all this intentional? Is this about shifting wealth from one group of people to another?

MH: It’s absolutely intentional. The IMF and the Eurozone have spelled it out very clearly. Greece’s former finance minister Yanis Varoufakis and his adviser James Galbraith have been writing exactly how their negotiations went in the last half year since the SYRIZA party was elected in January. They said they explained to Europe that insisting on Greece selling off fifty billion euros worth of property, lowering wages, and cutting back pensions is going to push the economy into depression.

And the finance ministers of Europe responded to him, “We know. You’re right. But we don’t care. You owe us the money. Earlier governments (that we put in power) agreed to it, and we’ll wreck you. If you don’t pay the money to us, if you don’t reduce your wages by another ten percent, if you don’t make another twenty percent of your population emigrate, then we’re going to treat Greece like America treated Cuba and North Korea and Iran. We will isolate you.”

And that’s exactly what they did when prime minister Tsipras called a referendum there.

The idea of neoliberalism is as explicit in Greece as it was in Pinochet’s Chile—where it was first developed, essentially, by your own University of Chicago’s economics department. This is their intention, and all of their writings for the last fifty years have been on how to use neoliberal financial economics to lower wage levels and concentrate profit and interest and economic rent at the top of the economic pyramid.

CM: You write that your “experience with this kind of bank-sponsored junk economics infecting public agencies inspired me to start compiling a history of how societies through the ages have handled their debt problems.”

I find this fascinating. What can we learn, what can we apply today, from your research on—believe it or not—Sumerian debt practices? How has this all changed?

“When Smith and Mill and the classical economists talked about ‘free’ markets, they meant an economy free of rent, free of interest, free of parasitism. Today in the United States, the whole idea is that a free market is free for the parasites.”

MH: You mentioned the sanctity of debt at the beginning of the show. Between about 3500 BC and the time of Jesus, though, what was sacred was the cancellation of debt. Every Babylonian king, the first thing they would do upon taking the throne would be to proclaim an amnesty. Not only an amnesty for prisoners; it was a debt amnesty. The Babylonian word for this was andurarum. The earlier Sumerian word was amargi, and it meant, sort of, a free flow.

There were three parts to this debt cancellation, this clean slate. One, you’d annul personal debts. Then, bond servants would be freed, and anyone who had been pledged would be returned—for instance, if a family had pledged its slave girl, the slave girl would be returned to her original family, and if any family members were bond servants, they would be returned to their family. And finally, land rights would be returned to families that had pledged them for debt.

This is what maintained stability in Sumer, Babylonia, and the surrounding Near Eastern regions. And after Babylon conquered the Jewish land and the Jews returned to Israel, they also wanted to proclaim a new clean slate. The word in Leviticus for the jubilee year was deror, which was a cognate of the Babylonian andurarum, and was a literal translation of the Babylonian three-part policy of cancelling the debts, freeing the debt slaves, and returning the land that had been forfeited.

And when Jesus gave his first speech in the synagogue, he unrolled the scroll to Isaiah and said he had come to proclaim the clean slate, at a time when the Jewish rabbinical leadership under Hillel had developed legal small print, the prosbul clause that enabled debtors to waive their rights under the jubilee year, under Mosaic law. The whole fight within Judaism at the time of Jesus was over whether to maintain this policy that by that time had a 3,000 year pedigree.

CM: How did we evolve from that state of sanctity of debt forgiveness to an idea of sanctity of debt?

MH: By force and violence. By the Roman empire. When the Roman empire conquered any new region it was led by its financial class, the publicani knights, and they would absolutely descend on rich regions (the richest region of the empire at that time was Asia Minor, what today is Turkey and thereabouts) and strip the whole economy, reducing one quarter of the population to debt bondage or outright slavery and bringing on feudalism and the dark age.

That’s what happens when you don’t cancel the debt. Other countries, for thousands of years, had avoided falling chronically into debt peonage by the clean-slate cancelling of debt. Rome was the first society not to cancel the debts, and we know what happened: the whole of western Europe was plunged into a dark age.

And when it recovered, it maintained the Roman body of law which, in the name of preserving property, preserved rather the debt claims of creditors on property—the actual inverse of property. This was essentially a creditors’ takeover.

Out of the dark age, we had waves of military takeovers and seizures of land; an absentee military class took over the land and imposed land rent. And when capitalism developed in England and France in the 17th, 18th and 19th centuries, the major political fight of that era was how to free industrial capitalism from feudalism. How do we become industrial leaders if we still have this parasitic class of landlords and bankers?

The whole fight—from the French Physiocrats through Adam Smith through John Stuart Mill and onwards—was first of all to get rid of the land tax and nationalize the land (or else tax the rents) and to develop banking along industrial lines to serve industry instead of being predatory. Marx wrote a history of all this in volumes two and three of Capital and even more in volumes two and three of the Theories of Surplus Value. He believed that the destiny of industrial capitalism was very optimistic: it was going to finally free Europe from feudalism and get rid of the rentiers, which he called “excrescences” just adding all these prices.

And all that seemed to be happening—until World War I. World War I changed everything. Instead of the French and German industrial banking that was trying to transform banking and make it productive, there was a shift towards Anglo-American banking, which was simply based on lending against assets. That turned out to be what evolved into things like the mortgage bubble. The focus shifted away from the progressive industrial countries of Europe, especially Germany, into Britain and the United States, which had developed a much more predatory form of finance.

And finally, we had the University of Chicago come in (I should say I graduated from the University of Chicago, but my degree was in Germanic philology. I never went near the business school). The University of Chicago developed a new economic curriculum that expunged the history of economic thought from the courses, and that spread through America. Now you can get an economics PhD without any history of economic thought. They turned Adam Smith and Mill and Marx into a kind of mythology, and have them say exactly the opposite of what they actually meant.

When Smith and Mill and the classical economists talked about “free” markets, they meant an economy free of rent, free of interest, free of parasitism. Today in the United States—thanks to Ayn Rand and the Chicago school to name just a couple culprits—the whole idea is that a free market is free for the parasites.

CM: I’ve got one last question for you, Michael, and it’s the Question from Hell: the question we hate to ask, you might hate to answer, or our audience is going to hate your response. You talk about how financialization is killing the host, is a parasite on our economy. But these “job creators” in the financial industry have created jobs—in the financial industry. So even though it might be a parasite, doesn’t it at least create jobs and create a new industry? Isn’t that always better for revenue and the economy’s bottom line?

MH: This is the fiction that underlines our national income accounting. Under national income and product accounts (NIPA), the more that Wall Street earns, the more that it charges, the more GDP grows. Just like if you’re burgled and have to buy a burglar alarm, if you get sick and have to pay a doctor more, GDP goes up. There’s no distinction between product and overhead.

About a hundred years ago there was a radical change in economic thinking. Now the idea is that everybody earns whatever they make. We recently had the head of Goldman Sachs, Lloyd Blankfein, saying Goldman employees get paid more than anyone else (maybe $25 million a year for the partners) because “we’re so productive.”

But the question is, productive of what? The classical economists looked at what Wall Street and the financial sector and landlords made as overhead, paid as a transfer payment from the economy, not as part of the real economy. So yeah, Wall Street does employ people—people that make their money by taking away the jobs of other people. The more Wall Street employs and makes, this is transferred out, and the less the real economy has.

The finance, insurance, and real estate sector, the FIRE sector, is basically a subtraction from the product, and yet our statistics treat it as if its adding to the product. So there’s a confusion about which is the parasite and which is the host.

CM: Michael, it is always a pleasure.

MH: Thank you very much. It’s really good to be here. I wish I was back in Chicago.

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