Reining in the Bond Markets – Public Policy in a Context of Ideological Capture

In Democratic Governance, Economic Planning, Economics, European Politics, Financial Crisis, Globalization, Industrial Policy, Inequality, Political Ideology, Political Parties, Politics, Politics of Policy, Progressivism, Public Policy, Public Sector, Regulation, Social Democracy, Taxes on February 14, 2012 at 11:15 am


In my last piece, I discussed the irrational nature of how the bond markets have reacted to the financial crisis and the recession that followed, simultaneously demanding austerity and then reacting to the recessionary crises their demands have created by demanding government intervention to provide growth (as long as it doesn’t result in inflation, higher taxes, or more borrowing).

As the Greek Parliament passes the kind of austerity that makes Andrew Mellon look like a bleeding-heart and Athens burns, we see European politicians demand further austerity at the same time that everyone realizes it’s not going to work. So how do we construct a new conventional wisdom amidst the tyranny of the old, and then how do we transform understanding into action?

Promoting Intellectual Change From the Inside:

The heavy lifting of constructing a new conventional wisdom shouldn’t actually start with the creation of new think-tanks or the publication of new books or blogs or the holding of conferences promoting new ideas – as counter-intuitive as that might seem. Part of the problem right now is that progressives love to create new intellectual institutions and spaces and groups, even if they’re duplicating infrastructure that already exists. What we don’t do as well is to consolidate different issue-oriented or ideological groupings into larger and more comprehensive groups, but what we really don’t do well is ideological policing.

Ideological policing sounds nasty and scary and totalitarian, but it’s actually a normal and healthy part of politics. All political movements need to decide what they believe in, and they can’t do that or move any kind of common agenda unless they’re willing, able, and capable of declaring who is and who isn’t part of their movement. While most progressives would have no problem with running David Dukes and his ilk from the party, there’s a tendency to be unwilling to apply rigorous standards on people who fit with some part of our agenda but who flagrantly are anti-progressive on others. This “oh, but he’s good on X” syndrome pops up all the time, which leads to a progressive movement and a Democratic Party that has to fight itself all the time on education, economic policy, unions, and other issues.

This process, which does get applied to politicians in Democratic districts (the bluer they get, the less tolerant Democratic activists get about partial adherence to Democratic platforms), needs to get applied to think-tanks, experts, and political operatives, especially when it comes to staffing Democratic administrations and legislative officers.

Ultimately, it needs to be applied to our national politics to the point where (for example) it’s political suicide to run as “socially liberal but fiscally conservative.”

Idiot-Proof Regulations:

The difficulty we have is that we have to use the government to reform corporations and industries who have huge sway over the government; how do we do this? Internal politics is a huge part of it; we have to replace the scions of the financial sector within the ranks of the bureaucracy, think tanks, and the party. However, in the mean time we need policies that will restrain the bond market no matter what political party is in power, in part because no political victory, no matter how sweeping it might seem, is ever conclusive.

One of the best tools we have to ensure that the bond markets are regulated no matter what is what I have called “idiot-proof” regulation. These are simple, bright-line rules that can be understood and monitored by those outside the government, and by laymen. Importantly, they’re also extremely simple to enforce – this makes it harder for even the most determinately apathetic or ideologically opposed official to quietly get away with not doing their jobs, and it makes it easier for the political system to pressure them to do something they don’t want to do.

The Glass-Steagall Act is a great example of idiot-proof regulation. What the law did was very simple: it prohibited commercial banks from engaging in investment banking, prevented banks from selling and underwriting stocks themselves, limited the amount of the banks income that could come from ownership of stocks, and established deposit insurance. Since these laws are so simple to keep track of and to enforce, they make it much more difficult for lobbyists or neoliberal activists elected or appointed to government positions to eliminate or weaken them without major controversy. They almost enforced themselves. As a result, they stuck around; despite a steady rightward march from 1968 onwards, it took thirty years for Glass-Steagall to be eliminated.

However, we can’t simply turn back the clock by restoring Glass-Steagall; the bond markets are much more complex and have accrued a level of political power they didn’t have when those regulations were initially written. New “idiot-proof” regulations are needed:

  • Tobin Tax à la Spahn – the Tobin Tax is perhaps the most well-known example of this kind of regulation, a small tax on financial transactions that reduces speculation by making the “churning” of rapid buying and selling prohibitively expensive. A Spahn variant of the tax, where the rate of taxation automatically increases with the volatility of trading and prices, is even more effective in curbing panics and bubbles – without the necessity of a well-funded, highly-motivated, and honest S.E.C to oversee financial markets. If this kind of tax was established in the E.U (and a EU-wide Tobin Tax is being pushed by the Merkel-Sarkozy duo to try to stave off defeat in their respective elections, as a kind of cover for their larger neoliberal agenda), speculative attacks on national debt (which have replaced speculative attacks on currencies that was a major Achilles heel of the previous global economic regime) would be slowed down, and panics would be much slower to spread from the specific case to entire categories of countries.
  • Counter-Cyclical Taxation of Financial Reserves – following the financial crisis, the Swedish central bank in 2009 began to charge banks for putting liquid capital on reserve, which ensured that Swedish banks didn’t hoard liquid capital after being bailed out, and instead had to begin lending again to businesses, preventing the kind of credit crunch we saw here in the U.S. A permanent policy here in the U.S of the Federal Reserve counter-cyclically taxing reserves held at the Fed would provide incentives against the kind of speculative lending seen at the height of bubbles and prevent the credit crunch that makes recovery slower and harder.
  • Differential Taxation Between SectorsI’ve written before about the potential to spur shifts in our economy away from non-productive concentrations of investment, such as the FIRE (finance, insurance, and real estate) sector which has metastasized so rapidly that a major motive behind the housing bubble and the derivatives bubble was a relentless demand for more (and more profitable) investment vehicles than really existed, prompting the invention of newer and riskier financial instruments. A differential tax – increasing income, corporate income, and capital gains taxes on revenue from the FIRE sector as opposed to manufacturing, services, infrastructure, transportation, technology, etc. – is a simple way to create a systemic incentive without getting into the weeds. Similarly to the Tobin Tax and the counter-cyclical taxation of reserves, differential taxes are transparent and easily monitored; either the taxes are being collected or they aren’t.
  • Yardstick Ratings Agencies and Other Institutions – one of the few silver linings in the European mess has been the move towards the creation of independent public ratings agencies, meant to counter-balance the often disruptive force of Moodys, S&P, and other private forecasters whose downgrades have in many respects created self-fulfilling prophecies of debt crises. The same thing has happened on a smaller scale in the U.S – in addition to the downgrading of U.S Treasuries, multiple states have been handled much rougher than financial instruments and Wall Street corporations, before and after the financial crash. Public ratings agencies here in the U.S could correct this market failure.

Central Bank Reforms:

While all of these policies would be quite useful, ultimately the central banks are the commanding heights that have to be seized if the bond markets are to be prevented from returning the world economy into another recession.

In the case of Europe, ultimately, the European Central Bank needs to start acting as a central bank – i.e, the Lender of Last Resort. Either by issuing Eurobonds or by lending to national governments directly, the ECB is the only source of finance out there that’s capable of financing a general recovery, which is the only way that European debt will ever be repaid. And ultimately, it’s in the ECB’s own interests to do so – in addition to the rise of hard-right (and to a lesser extent left) political parties, there’s a broad-based level of bitterness rising against European institutions that may very well wreck the EU regardless of whatever “reforms” the troika push through. And if the EU falls, the ECB falls with it.

Both the ECB and the Federal Reserve could both also bolster their foundations by democratizing their practices. Think about the sheer scale of financial power at their disposal – the Federal Reserve loaned or guaranteed seven trillion dollars in the financial rescue, all of which went into the banking system which promptly sat on the liquid reserves and largely refused to return to the kind of investment need to spur robust growth; the ECB has loaned out €489 billion just in December 2011, which could have employed thirteen million people across Europe (about 59% of the unemployed). There is no reason why central banks can’t make sweeping and dramatic change on unemployment and growth instead of limiting itself to pushing string in haut finance.


As I said in the last piece, in order for any of these policies to work, we need a new politics to replace those of neoliberal deference to the bond market – even if just for a short period. Keep in mind that the New Deal’s legislative victories happened between 1933-1938, but the effects have lasted to the current day. All we need to truly liberate ourselves from the tyranny of the bond markets is an opening and an understanding of what needs to be done in that window.

  1. […] of wealth concentrates political power in the hands of the wealthy, who in turn push for weakened regulations, cuts in progressive taxation, and weakening of potential threats from […]

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