The Wisdom of Crowds
When populist rage leads to smart policy.
By Michael Hirsh and Daniel Gross NEWSWEEK
Published Jan 29, 2010
From the magazine issue dated Feb 8, 2010
John Dingell is one of the few people in Washington who remembers the last time so much populist anger gripped the country. It was early 1933, the worst year of the Great Depression. The Michigan congressman, now 83, was a wide-eyed kid listening to his father—also a congressman—speak at the family dinner table about losing his entire net worth of $7,500. "Americans all hated the damn bankers, they hated Wall Street," Dingell tells NEWSWEEK. "We had more communists in this country than there were in the Soviet Union because" of rage against the so-called banksters. No one knew this better than the incoming president, Franklin D. Roosevelt. The story is told that a supporter warned FDR that if he failed now, with the nation in chaos, he'd be known as "our worst president," and Roosevelt supposedly replied: "If I fail, I'll be your last president." FDR exhorted his New Dealers, "Above all, try something!" While it took time to get going, the hodgepodge of recovery programs he came up with—some successful, others not—managed to appease most of the populist outrage.
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Barack Obama isn't saddled with the same degree of economic disaster as Franklin Roosevelt; the nation suffers 10 percent unemployment, which is bad, but it's not 25 percent. Yet the 44th president may face a political problem almost as sticky. Obama, like FDR, must appease populist anger rising from both left and right. Obama's giant stimulus, his health-care plan, and his continuation of the Bush administration's various bailout programs have ignited a prairie-fire backlash from the right (fueled in part by cynical Beltway Republicans). They call themselves tea partiers. The left's outrage is less organized (it's the left, after all), but reflects a visceral sense that the president has coddled Wall Street and given short shrift to Main Street. "The Democratic base is out of patience here," says a senior labor leader. "We're at a breaking point." There's something deeper at work beyond politics. We've witnessed an epic failure of the establishment—political, financial, business, even cultural.
All of which adds up to a very unhappy moment for Obama. The president and the Ivy Leaguers he has surrounded himself with are not natural populists. Since its appearance on the scene in the late 19th century, the language of populism has been one of opposition and incitement, clashes and fights—the Eastern bankers vs. the Midwestern farmers, rich white urban elites vs. poorer rural whites. That's not the language Obama traffics in. When the cerebral Obama inveighs against "fat-cat bankers," the phrase doesn't trip off his tongue. He's a community organizer, not a rabble-rouser. And he must know that populism, generally speaking, has been the refuge for losers in the American political process. No populist candidate has even come close to the presidency, though Teddy Roosevelt hit the 27 percent mark with his Bull Moose run in 1912 (he'd already been president, after all) and Ross Perot amassed an impressive 19 percent in 1992. William Jennings Bryan, the original Populist candidate, was the Democratic nominee in 1896, 1900, and 1908, but received fewer votes in each successive campaign.
Above all, populist uprisings usually careen out of control, driven by mindless anger. To some extent that's what is happening now. By the time of his confirmation vote last week, Federal Reserve chairman Ben Bernanke had been blamed for everything from Alan Greenspan's deregulatory policies to the flawed oversight of Wall Street, even though most of the worst-hit financial institutions were outside the Fed's supervisory reach. Yes, Bernanke made mistakes—serious ones—in the run-up to the financial crisis. But he also arguably did more than anyone to pull the global economy back from the brink of a Great Depression. Bernanke survived, but his populist penance was to suffer the largest "no" vote ever in the history of the Fed chairmanship, 70 to 30, with damage to the Fed's reputation that could be permanent.
Even so, smart presidents don't confront the populists head-on, they defang them by giving them some of what they want. After FDR launched the New Deal—and John Dingell's father helped to write the Glass-Steagall law separating commercial from investment banking—the nation slowly recovered and Roosevelt's personal popularity soared. Populist rabble-rousers like Huey Long on the left and Charles Coughlin on the right lost their resonance (or, in Long's case, were assassinated).
In recent weeks Obama has tried to mollify both populist camps. To satisfy the left, he announced a $100 billion fee on large banks, a new jobs program, infrastructure investments, and middle-class tax cuts. He also abruptly embraced a proposal from one his most prominent progressive critics, former Federal Reserve chairman and sometime adviser Paul Volcker, to ban banks from risky trading. Appealing to the right—and, increasingly, a piqued center that includes deficit-hawk Dems like Evan Bayh—Obama has announced a three-year spending freeze for discretionary programs that don't include defense and national security, Medicare, or Social Security. Above all, hoping to appeal to both sides, Obama has become far more strident in speaking against Wall Street.
But Obama is going to need a lot more than his usual rhetorical flourishes in the months ahead. There's a perception, largely accurate, that one set of rules applies to one group of people—generally wealthy and well connected—and another set of rules applies to the rest. And worse, that the many are subsidizing the few, cleaning up the messes they made. In too many areas, there are zero-sum games, in which the private interests of those who have access to the levers of power are arrayed against the interests of the large mass of American citizens. Generally speaking, the people have come out losers: insurance companies against policyholders, borrowers against lenders, and, most recently and explosively, taxpayers against the banks. Regardless of how much of the bailout money comes back, there's no way to spin it other than as a transfer of wealth from public taxpayers to the shareholders, bondholders, and managers of large, poorly run financial institutions.
The bottom line: there can be such a thing as smart populism, too—and if there ever were a time for it, it's now. (As Treasury Secretary Timothy Geithner recently said: "Just because [ideas] seem populist doesn't mean they're not the right thing to do.") Accordingly, here's a NEWSWEEK guide to smart populism in the Age of Obama. If implemented correctly, these proposals would not only help to bring us out of recession, they could also begin to fix the deeper problems in the economy. And they might go a long way toward mollifying both left and right (though the right is likely to stay unhappy no matter what is done with the Dems in power). The general principles: replace policies that pander to corporations with ones that help people, give companies incentives to be better citizens, finance government operations more equitably, and stop the pernicious practice of socializing losses and privatizing gains.
Slash Wall Street compensation, systemically and permanently, and provide carrots and sticks to make the financial industry behave more responsibly. If Washington can create new laws to regulate Wall Street's trading practices, there's no reason our legislators can't do the same thing with compensation. One smart proposal has been offered by FDIC chairwoman Sheila Bair, a Republican; she would tie insurance premiums charged to the banks to how risky their business models are. Another proposal would tie any compensation to long-term performance and add "clawback" provisions—rescinding pay and bonuses—if trades go bad. Yes, Wall Street CEOs will surely whine that without giant pay-and-bonus packages, they'll lose their best talent. But guess what: that would also be good for the economy. In recent years those enormous pay packages have lured America's best and brightest students to the Street, and away from more productive endeavors. Math whizzes became "quants," inventing products like CDOs that added almost no real economic growth and nearly sank the global economy. If Wall Street compensation is reduced enough, maybe then our best brains will go into real engineering, or bioengineering, or medicine. Or making better iPads.
Cram down mortgages. Everyone in Washington is worried about the "moral hazard" of forgiving home-owner debt on bad mortgages—it will make borrowers lazy and careless in the future, critics say. (The tea-party movement was launched by CNBC reporter Rick Santelli's rant about this.) Funny, nobody makes the same argument when giant investment firms walk away from billion-dollar mortgages on apartment complexes and office buildings. Economists agree that one of the biggest dead weights on the economy is the vast number of mortgagees whose homes are underwater, amounting to at least a quarter of the nation's 45 million mortgages, according to the Center for Responsible Lending. Yet the Obama administration's ultracautious program for inducing lenders to give easier terms, called the Home Affordable Modification Program, simply isn't enough. Every time there's a renegotiation of terms, the banks earn another fee—and the rate of new defaults after a year under the program is as high as 75 percent.
It's time to reconsider some intelligent proposals that the financial industry hates but is now wealthy enough again to endure: writing down principal on the mortgages, and for those who are seriously underwater, letting bankruptcy judges "cram down" or reduce the amount of mortgage owed. This would give indigent mortgage holders the right to work through debts over several years under Chapter 13 of the bankruptcy code. It's analogous to what happens to troubled corporations when they declare Chapter 11: a judge oversees a deal between them and their creditors, and they often emerge with a clean slate. One such proposal by Sen. Dick Durbin, Democrat of Illinois, was defeated last year.
Fix "too big to fail" once and for all. Obama was correct when he said in his State of the Union that everyone is united in their hatred of the bank bailout. The progressives have always mistrusted Big Finance, and conservatives are upset that the proper functioning of free markets has been undermined by behemoths that no longer have to play by free-market rules. There are actually some signs that both sides are beginning to unite around the "Volcker rule." Even Brink Lindsey of the libertarian Cato Institute says that there's probably no other way but to keep traditional banks away from Wall Street wizardry. "If there's got to be a [federally] guaranteed sector, it at least should be boring," he says.
Crack down on market manipulation that is driving up the cost of basic commodities. Everyone's focused on mortgage debt. But one reason people can't pay it on time is the high cost of oil, gas, and food. To little notice, the actual physical supplies of commodities have not been determining market prices as much as the frenzy of buying and holding by customers of the big investment banks. A few simple rules curbing big-time commodity speculators by imposing "position limits" could help, but the Obama administration has not been backing up a few progressives on the Hill, like Sen. Maria Cantwell, Democrat of Washington, who've been fighting for such rules.
Cut payroll taxes while adding a tax on speculation. Here's another area where left and right might be able to agree. Conservatives note that if government wants to discourage something, it should impose more taxes on that activity. If it wants to encourage something, it should reduce those taxes. Fine, we want more payrolls—jobs, in other words—and less Wall Street–style gambling. So resurrect the idea of a tax on financial trading, which was floated many years ago by Nobel Prize–winning economist James Tobin—no radical populist. This would both raise revenue and send a signal. Meanwhile Sens. Chuck Schumer, Democrat of New York, and Orrin Hatch, Republican of Utah, have proposed a plan to boost hiring by exempting any company that brings on a worker who has been unemployed for at least two months from the 6.2 percent of Social Security payroll tax for the rest of the year.
More broadly, come up with a more rational, more progressive set of national tax policies. The right won't like this one, but it's a key way to restore long-term health to the economy. The Bush-era tax cuts gave us all that long-term fiscal budgetary pain without any of the macroeconomic gain. They are slated to expire, and so they should. Returning much of the tax code to the state it was in the 1990s—higher estate taxes, higher taxes on capital gains and dividends, higher taxes on the highest income brackets—is a necessary and responsible move.
What's more, the tax code persists in treating certain income—mostly that made by really rich people—as more equal than other income. A loophole in the tax code allows private-equity- and hedge-fund managers to pay capital-gains rates (as low as 15 percent) on income they get for managing money for other people. This should be eliminated. Here's the ultimate irony: during the Bush era in the 2000s, the tax climate for investing was never more favorable, and it was the worst decade for stocks in recent memory.
This is hardly a cure-all for what ails America, but then most of the populists aren't asking for a panacea. They're asking for answers. Barack Obama is still in a position to supply them, and here he might take some encouragement from FDR. Historian Alan Brinkley points out there are "interesting similarities between the trajectory of Roosevelt's presidency and Obama's. Both began with tremendous popularity and hopes and expectations, and by end of the first year of both of their terms there was quite a lot disillusionment." FDR responded with what became known as his "second New Deal"—ramming through an astonishing flurry of legislation that included the creation of Social Security and the Securities and Ex-change Commission and the Wagner Act (giving labor the right to organize and bargain collectively). "Roosevelt went through very much the same kind of uprising of anger in 1934 as Obama is experiencing," says Brinkley, but ultimately FDR managed to "outflank" it. Obama's got a more recalcitrant Congress to deal with, Brinkley notes, but he still has three more years (at least) to recover from a crisis that's far less serious.
If the president can manage to get ahead of the populist sentiment, rather than merely chase it as he's currently doing, he will begin to fulfill the hopes and expectations he raised in his campaign, and which now seem so deflated.
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