By James H. Nolt
“Corruption is a constant, but scandal is a variable.” This aphorism is one of several coined in my book International Political Economy: The Business of War and Peace. It applies well to the impending student loan debacle now hitting the headlines in the midst of a seemingly (but actually not) unrelated stock market crash.
The bullish phase of any business cycle typically hides much fraud and corruption behind the camouflage of universally rising asset values. This is possible because ever-expanding borrowing based on the collateral of the rising asset values conceals the vulnerability of the leverage that sustains the boom.
However, as soon as asset values peak and begin to turn down, massive losses will occur. One way to distribute them is to begin to expose the inevitable scandals previously disguised beneath the bullish bacchanalia. Some of the bulls are exposed for their fraudulent use of leverage, and they become not only bankrupted but are occasionally even subjected to legal retribution.
Of course, the timing of scandals is of immense strategic importance. The underlying problem may exist for years, but its sudden public “discovery” is often quite deliberate.
The crisis of 2008 illustrates this principle. Extensive fraud in the subprime mortgage market was only exposed by the big financial institutions after they had already begun to short the market themselves and unload their bullish assets onto unsuspecting suckers rather than carry too much of this toxic waste on their own balance sheets.
The impending student loan crisis is just now surfacing in a big way. But, like the subprime crisis of 2008, it is being exposed piecemeal fashion: just enough to generate public pressure for Congressional action but without exposing why this problem has broader implications for the economy.
However, like the subprime mortgage loan crisis of 2008, the student loan debacle is important not just for the students indebted and defrauded, but also for numerous investors and financial institutions that own these loans, now subject to escalating default rates, or derivative bets based on their value.
Hillary Clinton has put the student loan problem at the forefront of her presidential campaign not just because solving it could be good for the students and former students concerned, but even more because moral outrage at the plight of students and their parents is a vehicle to focus public attention on the investors and financial institutions desiring a public bailout as a result of their exposure to the consequences of rapidly rising loan default, as in 2008.
The difference from 2008 is the partisan realignment. In 2008, President Bush was in charge; Republicans were forced to fall into lockstep with their party leader and commander-in-chief to approve a massive increase in public obligations required then to bail out banks and investors.
Now a Democrat is in the White House, and the Trump and Tea Party insurgencies are defying the Republican Party establishment with its close ties to Wall Street financial interests, as well as Obama, Clinton, and the Democratic Party establishment (similarly awash in Wall Street financing). But the partisan realignment now underway threatens to fundamentally disrupt the “business as usual” pattern of insider politics that scared politicians into hasty authorization of the 2008 bailout.
The subtext of both Sarah Palin’s Tea Party attacks on “crony capitalism” and Bernie Sanders’ fulminations against the “billionaire class” shows a certain surprising convergence of appeals to both the Democratic and Republican voters who are “mad as hell and not going to take it anymore.” What both right-wing and left-wing populists are “not going to take any more” is the blank check bailouts that Wall Street expects again when the leveraged losses from the latest bull run start to pile up. The media and the public are still in the dark as to the true stakes of this game.
Washington is not as scared as the bulls on Wall Street. Washington politicians of either party will get their largesse in the form of contributions from nervous investors no matter which way the chips fall, but on Wall Street, there are indeed trillions of dollars at stake on the outcome of public debates. What ultimately divides the establishment of both parties from their insurgent base is thus far largely unspoken in public. The issue is how Washington will deal with the second great financial crisis of this century, now looming.
The political establishment of both parties is poised to do what they did in 2008—bail out the biggest bullish investors with public funds rather than allow “too big to fail” bankruptcies as asset prices fall. Whether bailouts will include students suffering under their loan burdens or subprime mortgage holders facing eviction from homes they could not afford is as doubtful as last time around if the party establishments have their say.
On the other hand, the insurgents of both parties want to extend bailouts more broadly and with less burden on the tax payers. How is this possible?
Few people are saying so publicly, but the tried-and-true recipe for broad bailouts of debtors while at the same time not raising taxes is inflation. Nearly all debts are denominated in a fixed currency value. The real debt burden falls whenever the value of the currency itself falls. Conversely, creditors who own those loans, including many of the great financial institutions, are loath to allow the value of their loan assets to decline from inflation. If loans would otherwise default, big creditors much prefer that the government step in to pay the balances due to avoid defaults impacting corporate balance sheets. Such “crony capitalism” was indeed the main thrust of the 2008 bailout.
However, Trump, the Tea Party, and their seemingly unlikely fellow traveler, Bernie Sanders, are preparing the public for a strident campaign against the next insider rescue package.
There is some difference between bailout views of Tea Party Republicans and Sanders socialists. The Tea Party activists are funded by rich debtors who would like their debts to be eroded by inflation but do not want their taxes raised to pay for the sort of publicly-financed bailouts that both the Democratic and Republican Party establishments approved last time around.
Sanders, on the other hand, seems to be less reticent to raise the tax burden on the rich, perhaps including a new tax on Wall Street transactions, and more interested in broad debt relief that might include inflation of past debts and increased public spending to finance job growth, enhancing the capacity of ordinary people to pay their debts rather than go bankrupt. The Republican campaigners, except for Rand Paul, also envision massive new increases in public spending—either military spending (Cruz and several others) or infrastructure spending on roads, bridges, and a wall on the southern border (Trump).
The unspoken subtext of this election is the showdown, in advance, between the current bipartisan orthodoxy of a strong dollar with public bailouts of any “crony capitalists” who face default during 2016’s debt-deflationary crisis and a weak or inflated dollar as a broad solution to the problem of excessive indebtedness. Next week I will explore how subprime mortgages are again in the picture.
James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.
[Photo Courtesy of Angela Radulescu]