When Wall Street stumbles, others pick up the tab

By DON McINTOSH, Associate Editor

For six weeks, working people have been looking from the sidelines at a financial system meltdown, while government has taken panicked, inconsistent, expensive and so far ineffective action to stop it. Ordinary citizens didn’t engineer the collapse, but they may be footing the bill — through lost retirement savings, lowered wages, and the taxes they pay.

On Sept. 16, the Federal Reserve announced the biggest ever government bailout of a private corporation — the $85 billion rescue of AIG, one of the world’s largest insurance companies. That was the appetizer.

The meal, and what a big meal it will prove to be, is a fallback plan proposed by U.S. Treasury Secretary Henry Paulson — $700 billion in taxpayer funds to buy up exotic Wall Street creations.

With outraged constituents calling in 10-1 against that idea, the U.S. House of Representatives rejected Paulson’s proposal 228-205 on Sept. 29. But then the U.S. Senate took it up, passing the same basic plan but adding $150 billion in unrelated tax breaks and other federal spending. The Senate bill passed 74-25 with support of Barack Obama (D-Ill.), Joe Biden (D-Del.), and John McCain (R-Ariz.). [Oregon Republican Gordon Smith and Washington Democrat Patty Murray were for it, while Democrats Ron Wyden of Oregon and Maria Cantwell of Washington voted against it.]

The more expensive bill then passed the House Oct. 3 by 263-171, five days after it had rejected it. [Washington Democrat Brian Baird voted for the second bill, as did Oregon Democrats Darlene Hooley and David Wu, and Republican Greg Walden. Oregon Democrats Earl Blumenauer and Peter DeFazio voted against it.]

The $700 billion figure is by any reckoning a colossal amount of money. It’s $2,300 for every man, woman, and child in the country. It’s equivalent to half the regular federal budget (not counting Social Security, Medicare and Medicaid). It’s more than the year’s spending on the Iraq War. It’s almost one-and-a-half times as much as the budget for the Department of Defense. It’s more than 12 times what the federal government spends on education in a year.

So the new law gives Paulson the $700 billion to purchase “troubled assets” of nearly any kind from financial institutions of any kind, in accordance with whatever terms, conditions, procedures and policies he determines, at whatever price he determines, except that he’s not supposed to pay more for an asset than the seller paid to acquire it. He’s also supposed to develop a program to insure assets, including mortgage-backed securities, that were created before March 14, 2008. And he’s required to report back to Congress periodically about how it’s going.

Because the money to buy these securities will most likely be borrowed, it’s a little like the Wall Street practice of “buying on margin.” The securities Paulson buys will have to earn back their value, plus the interest on the purchase price, for the taxpayer not to lose money in the long run.

“I believe this is one of the greatest financial mistakes in the history of this country,” said Oregon Congressman DeFazio, a fierce critic of Wall Street who was the first to speak against the bill on the House floor.  

The AFL-CIO and Change to Win labor federations also opposed the bailout plan.

There were alternatives, DeFazio said — including several that he proposed. DeFazio wanted the government to handle this crisis like it had handled the savings & loan crisis in the 1980s: having federal bank examiners carefully look over the books and make judgments about which institutions could be saved with the least amount of federal investment. And DeFazio proposed a way to make Wall Street pay for it too, with a small tax on sales of securities.

But the Democrats were panicked, and stampeded, DeFazio said. In the House, 172 Democrats voted for the bill, while 63 voted against it. Republicans voted 91 for and 108 against.

A week after the vote, DeFazio was still fuming.

“Henry Paulson is a Wall Street speculator,” DeFazio said. “He made an unbelievable fortune, left with three quarters of a billion dollars for running Goldman Sachs, gave himself a $39 million bonus the last year he was there, and he created these financial weapons of mass destruction that are destroying our economy. And we’re going to turn to this guy for advice? And we’re going to put our trust in him, and give him $700 billion of our money and let him buy anything he wants at any price? That’s the bill that passed.”

But the Paulson plan is not a giveaway to Wall Street, says Monte Johnson of Portland-based Quest Investment Management, an adviser to union pension funds. “That is political season rhetoric,” Johnson said. “This was designed to thaw the pipeline of credit.”

In September, the credit pipeline began to “freeze” because banks held so many assets that had lost value, and stopped lending to each other — fearing the money would be lost if the borrower went bankrupt. Even the market for “commercial paper” (unsecured short term corporate loans) was grinding to a halt, as money market funds, a major buyer, stopped buying. Large companies were at risk of running out of money and failing to meet payroll obligations.

Johnson points out that taxpayers will have a chance to be repaid when the government sells back the securities it’s now buying.

Workers too, have a stake in Wall Street — above all through their pension plans. Stocks have lost a fifth of their value almost overnight, and that will have an impact on retirement security.

There are two basic kinds of pension plans, and both are under threat because of the crisis. So-called “defined contribution” plans, popularly known as 401(k)s, are typically invested in stocks, and they’ve lost value in the crash. In 401(k) plans, individual workers shoulder the risk if investments do poorly. And it’s been a bad year: Over the past 12 months, more than half a trillion dollars in value has evaporated from 401(k) plans.

In the more traditional “defined benefit” plans, the employer or employer group assumes the risk: They commit to paying retirees a fixed monthly check, and they set aside money to make sure they are able to meet that obligation. That money is invested. But this year, those pension fund investments lost value. That will put pressure on employers to increase contributions to help make up for the losses. And that could have an impact on workers’ wages.

Many unions take part in jointly-trusteed pension plans with employers. Typically, how much employers contribute to those pension plans is part of the contract that unions negotiate. Because of the recent losses employers are likely to want to increase pension contributions — and that would leave less money available for pay raises.

In the coming weeks and months, pension fund trustees will start to get a better handle on how much their funds have lost in this crisis. In the 2001 recession, many pension funds lost 20 to 30 percent of their value, and it took several years to overcome those losses.

Congress may end up relaxing the rules on defined benefit pension funds to give them more time to make up for the losses. They’ve done that in the past, but this time, they may have an additional reason: The Pension Benefit Guaranty Corporation, the federal entity that insures pension funds, may itself be in trouble. PBGC collects premiums from pension funds and pays out if the funds can’t meet their obligation to retirees. Until February, the PBGC had 75 percent of its reserves in bonds — low-risk debt instruments which hold their value over time. But that month, arguing that the PBGC needed to increase returns in order to lessen the likelihood that taxpayers would be called on to cover its liabilities, the PBGC Board reduced bonds to 45 percent of the mix, and put the remainder in higher risk investments.

In April, the Congressional Budget Office warned that was a bad idea, because it meant PBGC was more likely to experience a decline in the value of its portfolio during an economic downturn — the point at which it is most likely to have to assume responsibility for a larger number of underfunded pension plans. That warning now looks prophetic.

Ultimately, so much of the current crisis could have been avoided if the titans of finance had acted more like a little credit institution at 9955 SE Washington St. in Portland. IBEW & United Workers Federal Credit Union is a non-profit financial cooperative that is run in the interest of its 14,526 depositors — local union members and their families. Their $60 million in deposits are managed conservatively.

There are 83 credit unions in Oregon with approximately 1.4 million members. Some are associated with union locals. All credit union depositor accounts are federally insured up to $250,000.

“Our members are also union members,” said credit union president Barbara Mathey, “and people join unions because they like that extra security.”

The credit union makes mortgage and consumer loans, but only to members, and only if loan officers are sure borrowers aren’t in over their heads. And it doesn’t sell the loans to other entities, but holds them until they’re repaid.

The current financial meltdown began when a housing price bubble popped — a bubble that low government-set interest rates and lax private lending standards helped set. If DeFazio’s skepticism of Wall Street orthodoxy had held sway, or if Mathey’s prudent practices had been the norm in banking, workers might not now be facing a season of uncertaint.