The Financial Bailout and the Challenge for the States: De-Leveraging Working Families

According to The Wall Street Journal, "Fed and Treasury officials have identified the disease. It's called de-leveraging, or the unwinding of debt. During the credit boom, financial institutions and American households took on too much debt."

But let's not buy into a false equivalence of "financial institutions" and those "American households" borrowing beyond their means. Wall Street leverage was built on obscene wealth looking to become only more obscene, while the leveraging and debt of working families was driven by expanding income inequality, stagnant wages and rising health care costs that left families with less and less money available to gain a basic foothold in the American middle class.

As this Dispatch will emphasize, policymakers need to not just “de-leverage" the burden of debt speculators in the financial casino; they need to take action to reverse the economic burden on working families that has forced so many of them into debt in the first place.

The Real Crisis Facing Working Families

Let's be clear: the crisis we're talking about today is not shareholders losing a few dollars or even a few firms ceasing to exist and their traders losing their jobs. That just reflects the real crisis that has been sweeping across this nation for years. For regular families, it is not about financial speculation, but being driven into debt by what New York Times writer Steven Greenhouse has called in his recent book the Big Squeeze:

  • The bottom 90% of households saw only a 10% increase in real income in the three decades between 1976 and 2006, while the richest 1% saw a 232% income increase in the same period.
  • In the most recent 2000s business cycle, employment increased at only one-third of the pace of the 1990s cycle.
  • A quarter to thirty percent of the jobs actually created since 2000 were due to the housing bubble, a froth of jobs that are quickly disappearing. Yet, between 1995 and 2005, our nation has lost 3 million core manufacturing jobs that represented real wealth creation, almost all of that loss occurring during the 2000s business cycle.
  • Real costs burdening families have been escalating. The recent jump in energy prices comes on top of rising education costs, day care costs, and most punishingly, health care costs. One study found that 49 million Americans under 65 lived in families where more than 10 percent of family income went to health care costs, with 19 million spending 20 percent of income on health care.

The result of this squeeze of stagnant incomes and rising costs is unsurprising. With less money in their pockets, families were pushed into greater debt, which became a vice pushing many of those with homes into foreclosure as the housing bubble bursts and prices fall, especially as the predatory terms of their "subprime mortgages" sprung into action.

More Resources


State Leaders Saw the Subprime Mortgage Crisis Coming - But Feds Block Reforms

Even as those economic realities building up over years were ignored by national politicians and the mainstream media, those same national political leaders and media were lauding and even encouraging "financial innovation." At its core, this "innovation" meant using advanced technology to skirt regulation of things previously prohibited under the law and taking risks with debt that previous generations of regulators would have prohibited without the capital on hand to back up failed loans.

That those loans are going bad in communities across the country speaks to the real economic burdens on families; many families facing these burdens were lured into mortgages with "subprime" terms that left them in economic traps when the housing market went south.

Some in Congress actually recognized the problem of under-capitalized mortgages as early as 1994, when they passed the Homeownership Opportunity and Equity Protection Act. This law required the Federal Reserve to regulate the loan-origination standards of mortgage companies that were not otherwise government-regulated. But Fed Chairman Alan Greenspan failed to implement the law.

States Took Action but Feds Blocked Reform: Community organizations began agitating against "subprime loans," the polite term for predatory lenders targeting vulnerable working families. Pushed by these advocates, 30 states in the 1990s and 2000s passed laws to implement tougher standards on mortgage companies since the federal government was failing to implement the 1994 Act.

But adding insult to injury, the federal government not only failed to use the 1994 law to restrain predatory lending, it went to court claiming that law preempted state protections. As PSN detailed last year, the Office of the Comptroller of the Currency claimed in 2004 that federal law preempted Georgia's Fair Lending Act, which had offered protection against predatory lending, including outlawing extreme prepayment fees or penalties, unreasonable monthly payments, and increased interest rates after default. This was followed by the OCC preempting New Jersey's Home Ownership Security Act, which prohibited abusive lending practices, which was followed by OCC challenges to other state laws. The federal courts largely backed this federal preemption of state authority with federal courts striking down predatory lending laws in a number of states.

Whatever the courts decide now, the damage has been done. During the critical period of the recent housing bubble, as speculation and predatory lending ran amok, state regulators were so involved in defending their laws in court that their effectiveness was undermined and the costs are being borne by some of the most vulnerable borrowers in the market. A report by the Center for Responsible Lending released in December 2006 showed that as many as 2.2 million subprime borrowers face foreclosure on their home loans, but few at the federal level listened to the warnings.

While some national leaders and media are saying "we" all have to cut back to pay for the excesses of the financial failures, state leaders should be loud in proclaiming that most of us didn't create this crisis; in fact, most advocates for working families and most state legislatures took action early on to try to restrain subprime predatory lending. It was colossal stupidity and greed by the wealthiest financial corporations in the country, along with lax federal financial regulation and their active assault on those state anti-predatory lending laws that created this crisis. So responsibility and the costs should be borne by those who caused the problem and those who benefited from those excesses.

State leaders need to speak up against bad federal policy: One thing state leaders should be vigilant on is making sure that supposed "reforms" don't undercut their present ability to protect working families. Earlier this year, the Bush Administration, led by Treasury Secretary Henry Paulson, proposed a sweeping new proposal, its Blueprint for a Modernized Financial Regulatory Structure, to "reform" regulatory oversight of different financial sectors. But the proposal was little more than an industry wish list, including replacement of state regulation of insurance with a single federal regulator, which would likely preempt stronger consumer insurance protections at the state level. At the time, Michael McRaith, insurance director for the Illinois Department of Financial and Professional Regulation, noted that insurance companies, "[v]ery large, wealthy companies would get to choose the lesser level of regulations," much as banks were able to escape tougher state mortgage regulations for lax ones at the federal level. Even now, rightwing politicians are seeking to use the financial crisis to gut state insurance regulations. So state leaders should be loud in demanding that any federal policies not weaken the ability of state regulators to be an alternative check on financial abuses.

More Resources


Lessons from the $700 Billion Bailout: States Should Take Bold Action to Help Working Families

Now Washington is discussing stabilizing the financial system with $700 billion in federal investments. After an initial proposal that was a pure giveaway to the banks, some improvements by progressive national leaders may provide some taxpayer protections, though the proposal will still hardly address the real burdens facing working families. The final plan for some improvements, including some taxpayer protections, the principle of an equity stake for the government in firms bailed out, and helping mortgage holders. But given that the plan is initially being implemented by the same federal regulators who failed in the first place, these principles may well not be implemented in practice.

However, state leaders can learn some lessons from the whole credit crisis debacle and the bailout bill:

  • The Feds Won't Save Working Families by Themselves: While there were some discussions about increasing aid to states to help working families as part of the deal, this was largely blocked by conservatives at the federal level. The bottom line is that state policy leaders should not depend on the federal government to take on the fundamental challenge of easing the burdens on working families that underlie the original demand for subprime mortgages in the first place. State leaders should demand and lobby for whatever aid Congress will allocate to help states and families, but the states need to take leadership on this issue. The worst thing possible is for state governments to slash spending on education, health care and help for those same families in the middle of a recession.
  • Big Problems, Big Investments Needed: But the $700 billion committed by the federal government, whether this particular proposal is the right one or not, shows that our nation has the resources to address big problems if we have the political will. States need to make similarly bold, not incremental plans to address the real needs of working families. While the temptation is for states to cut back in hard times, they should instead be increasing their spending to counterbalance lower spending by working families.
  • Investments in Economic Growth Pay Dividends in the Future: In principle, the new version of the federal bailout would require banks whose debt is purchased to give the federal government an equity stake in those firms, so if they recover financially, taxpayers would see more of their investments paid back. The idea is that while government may make initial upfront investments, returns from economic growth and contributions from the wealthy who most benefit should ultimately fund such long-term investments. Just as the feds are projecting that upfront investments in the financial system will lead to a financial recovery and higher asset values that will help pay off initial investments in troubled assets, an even better investment is for states to help working families "de-leverage" their financial burdens. Investing in job growth, whether through education or transit or other means, will pay off in the longer term with higher tax revenues.
  • States May be the Only Institution that Can Borrow and Invest Effectively: A key lesson is that in an economic credit crunch, it is government and often only government that can continue to borrow and invest to keep the economy moving forward. State tax and bonding authority, if focused on real investments, can create jobs and put money in the hands of working families in a time of economic crisis. Notably, states have access to credit at less expensive rates than a private sector caught in the credit crunch and can therefore be a critical player in jumpstarting a range of initiatives.
  • Taxing the Wealthy for Economic Investments Makes Economic Sense:If the borrowing needed does seem too daunting, financially or politically, then raise taxes from your wealthiest residents, the one group who saw their incomes triple in the last three decades. Taxing the wealthy to fund long-term investments is not a punitive goal, but an economically rational one. Not only do the wealthy benefit the most from economic growth, as the federal bailout plan acknowledges, but money in the hands of the wealthy does not, contrary to supply-side economics, trickle down to working families. In fact, much of it gets flushed down speculative toilets, as during the S&L scandal in the 1980s, the dotcom meltdown, and the current speculative subprime crisis. A dollar of taxes collected from the wealthy and put in the hands of working families is a dollar that is almost guaranteed to be spent on goods and services in the real, not speculative economy, and far more likely to stay circulating in your state to multiply into broader economic growth.

States should be emboldened to reject the remaining holdouts of rightwing ideology and reinvigorate their regulations on behalf of working families and investments in real economic growth.

Inexpensive Ways for States to Help De-leverage Working Families

There are basic standards that we can return to the workplace and our economy that don't cost the state treasury much if anything, yet will put more money in the hands of working families and help them cope with their costs and debt burdens.

  • Raise the Minimum Wage: The most obvious action is to further raise the minimum wage, whose value has been destroyed by inflation in the last three decades. Compared to 1968, when the federal minimum wage was the equivalent of $9.34 per hour accounting for inflation, even the highest state minimum wage rates have lost value against inflation. States should be aiming to raise their minimum wage rates to that level or a bit higher, and then index it to inflation to avoid erosion over time. Part of that effort should be toughening enforcement of the law, to assure that those owed the minimum wage and overtime receive it.
  • Help Balance Work and Family: Given that it usually takes at least two incomes to sustain a household budget these days, helping families navigate the tensions between the demands of work and family are critical. States moving to enact paid family leave and paid sick days laws guaranteeing all workers time to care for themselves and family members without fear of losing their jobs are desperately needed.
  • Raise Labor Standards and Union Rights: States should work to raise wage standards across the board, including strengthening the ability of all workers to join a labor union to help them demand a fairer wage share of profits generated from their employers. These can include using government contracting rules to promote stronger prevailing wage standards in more sectors, extending bargaining rights to agricultural industries and groups of independent contractors denied bargaining rights under federal law, and expanding general free speech rights in the workplace to better protect workplace-based advocacy for workers rights.


More Resources


Long-Term Investments to Create Strong State Economies

On the other hand, there is no getting around the fact that we need to shift our economy from one where speculation has soaked up trillions of dollars to one that invests in good jobs for working families. And some of those investments need to be by state governments, because while they may require significant upfront costs, the results will permanently strengthen state economies, lower costs for taxpayers, and save money for both government and household budgets over the long-term, helping to pay off any borrowing needed.

  • Health Care: The reality is that our health care system suffers from similar problems to Wall Street speculation; too lax regulation, too much profiteering, and too much waste without real returns. Investing in comprehensive health care for all state residents will not just help working families burdened by health care costs, it will likely save money. Even though the United States spends substantially more per person than any other country, the World Health Organization ranked our health care system 37th in the world in 2000 with working families paying out of pocket costs at twice the international average. Clearly, we spend more, but we get less. In Why Not the Best?, the Commonwealth Fund found that we would save $100 billion in administrative costs if we reached top efficiency benchmarks achieved elsewhere in more integrated government-managed health care systems. So the returns from comprehensive health care investments could easily pay for themselves over time.
  • Infrastructure Investments: A report last year by the Urban Land Institute found that 83 percent of the nation's transportation infrastructure is not capable of meeting the nation's needs over the next 10 years. There is a $1.6 trillion deficit in needed infrastructure spending through 2010 for repairs and maintenance, yet the U.S is spending less than 1 percent of its GDP on infrastructure. Making serious new investments in infrastructure is critical to increasing productivity, expanding economic growth, creating jobs, and making our states more economically competitive globally.
  • Broadband: It is estimated that widespread adoption of high-speed Internet will add $134 billion to the U.S. economy annually and create 1.2 million new jobs per year. A recent study found that for every 1% point increase in state high-speed Internet penetration, employment is projected to increase by 0.2% to 0.3%. Assuring that all residents have access to affordable, high-speed broadband is critical for long-term economic growth, especially when we are competing internationally with countries like Japan where households have access to broadband 8 times our average speed at roughly 1/2 of the cost. Again, these are investments that will build permanent economic strength and jobs for working families.
  • Green Jobs and Clean Energy: Investing in energy independence and green jobs -- from retrofitting homes to alternative fuels to mass transit -- promises some of the highest returns on state investment possible. More energy dollars will go to creating jobs at home and help eliminate wasted energy use. In many cases, families just need help making the energy investments and new technologies that will lower their energy bills far more over time - a clear place where states can help families in ways that, while requiring upfront state spending, will help pay for initial investments over time.

In a time of crisis for working families, state leaders need to step up with both the money and political will to make the investments that will create both more job and better wages for workers. The reward will not only be the de-leveraging of the debt burden for those families but, over time, the higher tax revenues needed to pay back any bonds used to pay for these initiatives.

More Resources



The Real Crisis Facing Working Families

Center for Budget Policy & Priorities - Average Income In 2006 Up $60,000 For Top 1 Percent Of Households, Just $430 For Bottom 90 Percent
Economic Policy Institute - REVERSAL OF FORTUNE: Economic gains of 1990s overturned for African Americans from 2000-07
Brookings Institution - Bearing the Brunt: Manufacturing Job Loss in the Great Lakes Region, 1995-2005
Banthin and Bernard - "Changes in financial burdens for health care: National estimates for the population younger than 65 years, 1996-2003," Journal of the American Medical Association and "Financial burden of health care, 2001-2004," Health Affairs

State Leaders Saw the Subprime Mortgage Crisis Coming - But Feds Block Reforms

Progressive States Network - The Predatory Lending Bubble and How the Feds Made it Worse
Progressive States Network - Gutting State Regulation of Insurance under Bush Administration's Financial Oversight "Reform"
Center for Responsible Lending - Federal Preemption Favors Predatory Lending
Center for Responsible Lending - Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners

Inexpensive Ways for States to Help De-leverage Working Families

Progressive States Network - States Still Leading Feds on Minimum Wage
Progressive States Network - Paid Sick Days & Paid Leave Bills Approved in D.C. and New Jersey
Progressive States Network - Strengthening the Freedom to Form Labor Unions

Long-Term Investments to Create Strong State Economies

Progressive States Network, U.S. Infrastructure: An Economic Disaster Waiting to Happen
Progressive States Network, Health Care for All: Policy Options for 2009
Progressive States Network, Broadband and Technology Investments: Policy Options for 2009
Apollo Alliance, Clean Energy, Good Jobs
Commonwealth Fund, Why Not the Best?
EDUCAUSE, A Blueprint for Big Broadband