The Case For People's Quantitative Easing

Frances Coppola

• Publisher: Polity
• Year: 2019
• ISBN:
  9781509531325
• Edition: 1
• Topic: Economics
• Subtopic: Economic Policy
• Index: Economics

In the wake of the 2008 financial crisis, central banks created trillions of dollars of new money, and poured it into financial markets. 'Quantitative Easing' (QE) was supposed to prevent deflation and restore economic growth.

But the money didn't go to ordinary people: it went to the rich, who didn't need it. It went to big corporations and banks – the same banks whose reckless lending caused the crash. This led to a decade of stagnation, not recovery. QE failed.

In this book, Frances Coppola makes the case for a 'people's QE', in which the money goes directly to ordinary people and small businesses. She argues that it is the fairest and most effective way of restoring crisis-hit economies and helping to solve the long-term challenges of ageing populations, automation and climate change.

1
The Great Experiment

‘They did not have to be so unfair’

On 15 September 2008 the biggest financial shock for decades struck Wall Street, as the investment bank Lehman Brothers filed for bankruptcy. Even though Lehman had been teetering on the brink of insolvency for the previous week, and there had been emergency talks with potential rescuers, no one expected it to fail. Surely, if no rescuer could be found, it would be bailed out, just as the mortgage giants Fannie Mae and Freddie Mac had been only two weeks before?

But the US Treasury saw no reason to bail it out. Lehman Brothers was an unregulated investment bank. It did not deal with the savings of ordinary Americans. Nor did it lend to ordinary American businesses or households. Allowing it to fail would send a message to other unregulated banks that they should get their houses in order.

The day after Lehman’s failure, the Federal Reserve took over the American insurance giant AIG. AIG had sold credit default swaps to all of the world’s major banks, and now they were claiming on their insurance. It was bleeding to death – but if it failed, it would take all those banks down with it. The Fed’s bailout prevented a global financial system meltdown, though buying AIG cost the Fed $85 billion. The decision to allow Lehman to fail was already looking expensive. But there was much worse to come.

As the impact of Lehman’s collapse rippled out through the financial system, asset prices crashed and banks started to fail. Ben Bernanke, Chairman of the Federal Reserve, and Hank Paulson, US Treasury Secretary, asked Congress for $700 billion to buy toxic assets from troubled banks. The Bill authorizing it was passed on 3 October. The bailout became known as the ‘Troubled Assets Relief Program’ (TARP).¹ It was the first – but by no means the last – asset-purchase programme in the aftermath of Lehman’s failure.

Despite its name, TARP made few asset purchases. Pricing toxic assets was simply too difficult. So, instead, the US Treasury purchased preference shares in distressed banks. Half of the TARP money went into buying banks. Nor were banks the only things the Treasury bought with TARP money. The giant carmakers GM and Chrysler received injections of, respectively, $51bn and $12.5bn, with a further $17.2bn going to GM’s banking arm GMAC (Ally Financial).²

The one group that didn’t benefit from TARP was homeowners. TARP was supposed to provide assistance to people at risk of losing their homes. But very little of the TARP money was used for that purpose. Banks, financial institutions and big corporations were all bailed out. But an estimated five million Americans lost their homes in the Great Recession. Why weren’t homeowners bailed out?

A significant obstacle was the nature of the American mortgage market. Unlike British and European mortgages, American mortgages are generally not held on the books of banks. They are sold on to giant warehouses, which package them up into securities and sell them to investors in the capital markets. Prior to the financial crisis, these ‘residential mortgage-backed securities’ (RMBS) were rated as prime quality assets, with low stable returns and minimal default risk. Pension funds and insurance companies invested in billions of dollars’ worth of them. The retirement savings of millions of Americans were thus invested in the mortgages of millions more Americans.

Since one person’s debt is another person’s asset, when you write off a debt, you also write off an asset. Writing off the mortgages underlying the securities would have wiped out the retirement savings of all those Americans. Debt jubilee for borrowers would have been Armageddon for savers and pensioners.

An alternative might have been to have paid off the mortgages, rather than writing them off. The cost would have been enormous – estimates were as high as $750bn.³ But the TARP programme provided $700bn to banks and financial institutions, and there were other financial injections too. The total cost of bailing out financial institutions and corporations was far more than $750bn. Why could the US afford to bail out financial institutions and corporations, but not ordinary people?

Underlying the US government’s reluctance to assist homeowners was a belief that they deserved their fate.⁴ People who lost their homes had borrowed recklessly, so should not be bailed out. This was to some degree true: property speculation was rife before the crash, and some borrowers were simply trying to profit from the bubble before it crashed.

But not everyone was a property speculator. Many of those who lost their homes had bought with a large mortgage at the top of the market. When the market crashed, and the economy followed, they ended up with a house worth less than the mortgage, and no job. So they handed in the keys and walked away. The problem was that separating out the ‘deserving’ homeowner from the ‘undeserving’ was just too complex. There was insufficient information about borrowers to be able to judge whether they were opportunists looking to make a quick return or families wanting a home. Some were both.

Whatever the reasons, the fact remains that few homeowners received help. The Economist magazine, in a piece entitled ‘They did not have to be so unfair’, highlighted the legacy of popular anger:

The US government cared a lot more about saving the incumbent banks and bankers than it did about helping regular Americans blindsided by the collapse of the housing market and the ensuing contraction. As a result, many Americans now believe that the rules are rigged against them for the benefit of a few politically connected financial speculators: privatized gains and socialized losses. It is difficult to disagree.⁵

Over the next decade, central banks and governments around the world were to spend an extraordinary amount of money on bailing out banks and propping up financial markets. Meanwhile, ordinary people, deprived of money by austerity-minded governments, risk-averse banks and miserly corporations, were forced to tighten their belts. The decade from 2008 to 2018 could perhaps be dubbed the Great Unfairness. But it has another name too – the Great Experiment.

Lessons from the Great Depression

Pouring money into banks and financial markets prevented the financial system from melting down. But it did not protect people from the economic consequences of bankers’ folly. As business failures and job losses mounted, the United States slid into the deepest recession since the 1930s. Fearing a repeat of the Great Depression of 1929–33 – the worst economic downturn of the twentieth century – the Federal Reserve cut interest rates to nearly zero and embarked on QE. As the Great Recession spread out across the world, other central banks followed suit, cutting interest rates to near-zero, supporting damaged banks, and doing various forms of QE. Governments joined in too, pouring money into their economies in a coordinated programme of fiscal stimulus.⁶ The Great Experiment had begun.

Like the Great Recession, the Great Depression started with a financial crisis – the Wall Street Crash of 1929. And like the Great Recession, it rippled out across the world. The misery of the Great Depression has been documented by writers such as Steinbeck⁷ and recorded in photographs from the time. The economic causes of the Great Depression have been extensively studied, and the policy responses to the Great Depression at the time have been seriously criticized.

One of the sternest critics of the Federal Reserve’s response to the Great Depression was Milton Friedman. He is the father of QE and the ultimate architect of the Great Experiment. In his pioneering book with Anna Schwartz, Friedman documented the changes in the money supply during the Great Depression (or the Great Contraction, as he and Schwartz termed it).⁸ As the Depression progressed, people stopped keeping money on deposit at the bank. Although the reduction in bank deposits was partially offset by rising holdings of physical currency, the total amount of money in circulation – bank deposits plus currency – fell by one third between 1929 and 1933.

Friedman concluded that it was the collapse in the money stock that turned a recession into a Depression. And he said that this could have been prevented:

Different, and feasible actions by the monetary authorities could have prevented the decline in the stock of money – indeed, could have produced almost any desired increase in the money stock …

Prevention or moderation of the decline in the stock of money, let alone the substitution of monetary expansion, would have reduced the contraction’s severity and almost as certainly its duration.⁹

Friedman proposed that in a disastrous economic slump such as the Great Depression, monetary authorities should put money directly into the economy. In 1968, in his book ‘The Optimum Quantity of Money and other Essays’, he suggested a novel way of doing it.¹⁰ ‘Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky’, he said. ‘And let us suppose further that everyone is convinced that this is a unique event which will never be repeated.’¹¹

Friedman’s ‘helicopter drop’ is a powerful image. Imagine New York’s famous ‘ticker-tape’ parade, but with real money instead of shredded paper. Banknotes fluttering down from the sky and littering the streets. People rushing to pick them up, perhaps fighting over them, maybe sharing them out. Groups of people might arrive with brooms, sweeping up the banknotes ...

Table of contents

• Cover
• Front Matter
• Introduction
• 1 The Great Experiment
• 2 Understanding Money
• 3 QE for the People: A Better Way
• 4 Some (Weak) Objections to QE for the People
• 5 Lessons for the Next Depression
• End User License Agreement