Crashed

by Adam Tooze

  Obamacare was the scalp they wanted most and it ought to have been easy. As it had emerged from its congressional ordeal in March 2010, the Affordable Care Act was mangled and flawed. But for all their grim determination, in the critical first six months of the Trump presidency the Republicans could neither replace nor repeal it. What stood in their way was the inherent complexity of the subject matter and deep divisions within their party. But their failure also reflected the fact that the ACA, like any truly major piece of social or economic legislation, had created its own social constituency. Even an institution as deeply disappointing as the ACA was hard to budge once tens of millions of people came to depend on it and hundreds of billions of dollars began to flow through its channels. Indeed, among the states that benefited most from the extension of health coverage under Obamacare were Kentucky and West Virginia, diehard Trump country.55 As Trump took office, support for the ACA among the most important group of voters, Independents, had risen from 36 percent in 2010 to 53 percent.56 By the summer, when the desperate Republican congressional leadership made a last bid simply to repeal Obamacare without replacement, they had the support of only 13 percent of Americans.57 Not surprisingly, sufficient Republican moderates refused to go along.

  If they couldn’t repeal and replace Obamacare, what could they do? By the summer of 2017 it seemed that the incoherence of the Republicans, when faced with the complex reality of modern government, might prevent them from taking any effective action.58 The ACA fight had left little room on the legislative agenda. Trump’s promised infrastructure program was a will-o’-the-wisp. Tax reform was much discussed with no apparent action. Meanwhile, basic financial questions could not be dodged. The debt ceiling remained in place, and when the Treasury hit its borrowing limit in the spring of 2017, it was forced to resort to the familiar makeshifts.59 Treasury Secretary Mnuchin vainly called on Congress to raise the ceiling. But in the summer the House went into recess without a vote. In the meantime, the new director of the Office of Management and Budget was Mick Mulvaney, a founding member of the Freedom Caucus, which had diced with default in 2011 and 2013.60 He did not want to make concessions to the centrists or the Democrats. The extreme spending cuts demanded by his old friends in the Freedom Caucus had no majority. For Trump’s budget director a shutdown was not the worst option. If the United States was to crash into the debt ceiling and be forced to prioritize claims, a default in all but name, so be it.61 Astonishingly, the president seemed to agree. In May 2017 Trump tweeted blithely about a “good shutdown.”62

  As the summer came to an end, despite their control of both the White House and Congress, it seemed as though the Republicans would fail to resolve the budget issue. The real question was whether the Democrats would allow them to drive the United States off the fiscal cliff. When Obama was in the White House, the Democrats had pilloried the Republicans for failing to carry their share of the burden of government. Could they refuse to back the president, even if the president was Trump? Before this dilemma could really bite, natural disaster intervened. With Hurricane Harvey having devastated a large part of Texas and another hurricane roaring into Florida, neither Trump nor the Democrats wanted to look inactive.63 At a meeting in the Oval Office on September 6 the president did an about-face. He not only abandoned the Republican congressional leadership but also cut off his own Treasury secretary in midsentence to strike a deal with the Democrats. It was a dizzying inversion that sent pundits scrambling for historical examples of “independent” presidents who had risen above the American party system.64 The realities were more hard edged than that. With Chuck Schumer and Nancy Pelosi having saved the administration from a shutdown, Trump was only too happy to cheer on the Republicans as they returned to the attack.65 Scrapping Obamacare might not sell as a political proposition, but cutting taxes surely would. The Republicans in the House and Senate began urgent work on “tax reform.”

  The resulting tax bill that passed both houses of Congress in December 2017 was hugely controversial. The sugar coating, such as it was, consisted of across-the-board reductions in personal income taxation and cuts to exemptions that principally hit high-income local taxpayers in states that voted Democratic. But these were time limited. Within a few years many lower-income Americans would be paying higher taxes. Of more lasting benefit to the very wealthy was raising the estate tax threshold to $11 million. And what really mattered was a 40 percent cut in the rate of business taxation, which meant that profits could either be retained for growth or paid out to shareholders. Given the vast inequality in wealth holding and particularly in the holding of equity—the top quintile of the American income distribution owns 90 percent of corporate equity—the benefits go to the better off. Then for good measure, the Senate added the removal of the single-payer mandate that required all Americans to take out health insurance. Without this mandate, by most estimates, 13 million Americans would drop out of coverage. As many low-risk individuals left the insurance plans, the premiums for those who did remain would surge. DeLong’s fears were amply confirmed. In its redistributive impact and the scale of the giveaway, 2017 stood in comparison with the huge Reagan tax cut of 1981 and those of Bush in 2001 and 2003.66

  To ease the passage of their tax measures through Congress and to calm the nerves of fiscally conservative Republicans, the Treasury and fellow traveling Republican economists talked down the deficit implications.67 They resorted to the old Reagan-era arguments that lower tax rates would boost growth and thus raise government revenues. Even the notorious Laffer curve, purporting to show a positive relationship between lower tax rates and government revenue, made a comeback.68 But the vast majority of economists were scornful of these evasions. The tax cuts would clearly add to the deficit. Simpson and Bowles, who had headed Obama’s national commission on fiscal responsibility and reform, denounced the tax plan as a return to the era of “deficit denial.”69 In fact, it was not so much denial as hard-nosed political calculation. There was no way to cut the corporate tax rate to as little as 21 percent without incurring deficits.70 Nor did this scare the activist Republicans. As they saw it, the larger the deficits, the more urgent the need to move on to stage two of their program.71 With the tax cuts threatening to add a trillion and a half dollars to the national debt, spending cuts would be mandatory. Medicaid would be pared back as far as the law permitted and the rest of the federal government would be cut to the bone. These were the Republican tactics not of the 1980s but the 1990s. The congressional Republicans were starving the beast.

  Liberals were understandably indignant about the gross inequity of the tax proposal. The UN’s special rapporteur on extreme poverty, who happened to be touring the United States visiting some of the 40 million Americans who lived in conditions of deep deprivation, denounced the tax plan as “a bid to make the US the world champion of extreme inequality.”72 But even setting equity concerns aside, starving the beast was a failed fiscal strategy. Historically, the spending cuts that were supposed to follow on the tax cuts did not arrive. It was easier to rail against tax breaks than it was to get them repealed. Key areas of welfare spending had supporters even in the Republican ranks. At the same time the Republican plans to expand the army by 10 percent and raise the navy to 355 fighting ships would increase military spending, the largest element of discretionary spending, by $683 billion, or 12 percent, over the decade to 2027.73 Rather than shrinking big government, the main effect of Republican fiscal tactics was likely to be a further reduction in America’s already deeply inadequate tax base. Following the tax cuts, the federal government’s take of GDP would fall to 17 percent, a figure befitting an emerging market state rather than the government of an advanced economy.74

  In 2009, when a Democrat was in the White House appealing for Congress to provide a stimulus to the American economy as it plunged into the worst crisis since the 1930s, the Republicans had voted, to a man and a woman, against a stimulus. They denounced Obama’s Recovery and Reinvestment Act as a ruinous
demonstration of fiscal irresponsibility. Now, with unemployment at lows not seen since the boom time of 2007 but with Trump in the White House, they were working hard to deliver a ten-year $1.4 trillion stimulus. In their defense it might be said that given the sluggishness of the recovery and the large number of people who had retreated from the workforce during the crisis, there was a case to be made for running the economy hot.75 But even those who advocated such an adventurous policy found it hard to justify the Republican tax plan.76 America’s wealthiest did not need further benefits. Investment was certainly depressed, but it was not for lack of funds. America’s corporations had trillions of dollars in cash on hand. What was clearly long overdue was a public investment program, to make good the embarrassing deficits in America’s infrastructure. But there was little enthusiasm for that from Congress. The Republicans needed to end Trump’s first year in office on a high. They needed to deliver for their donors.77 The 2017 “tax reform” did both.

  When budget hawks inside the Clinton and Obama administrations had worried about deficits, what was on their minds was market confidence. How would the markets react to the latest round of spendthrift Republican policy? Increasing the debt by perhaps as much as $1.5 trillion over ten years ought surely to produce a reaction. Following the surprising election outcome, bond markets had been twitchy.78 Anticipating that the Trump administration would launch a major infrastructure drive and add further stimulus with tax reform, the markets expected the Fed to bring interest rate increases forward. Over the winter of 2016–2017 this prompted bonds to sell off and yields to rise. With the ECB and the Bank of Japan both engaged in QE, the dollar appreciated sharply, sending a ripple of uncertainty around the world of dollar borrowers. Their debt-servicing costs were going up. But then, as the reality of the shambolic Trump administration and the continuing self-paralysis of the Republicans in Congress became clear, the fever broke. Driven by tech euphoria, the stock market continued to boom. The Fed insisted that it would continue its stepwise increase in interest rates. But there were few signs of panic in the bond market.79 The tax cuts with which the Republicans ended the year produced a shrug from the bond markets. As one analyst commented: “Whatever grade you assign to the end result, the bond market and economists are adding an extra ‘minus’ to the grade. So, if you think it’s a ‘B’ effort, the market’s grade is a ‘B minus.’”80 The markets weren’t cheering but neither did the Trump administration have vigilantes on its tail.

  The congressional infighting over Obamacare and the Republican tax cuts was bare-knuckle American politics. But a clue to the relative calm in the Treasury market could be found in the same set of influences that had also preserved calm in the face of the Bush-era deficits of the early 2000s—the global demand and supply of safe assets. In the fall of 2017 the IMF published a remarkable table that showed the issuance of debt since 2010.81 As this data revealed, austerity and QE had led to a major reshuffling of security portfolios. Given the budget-control measures adopted in Europe, the active bond buying by the ECB and the even greater activism of the Bank of Japan, they were, for the foreseeable future, not significant suppliers of safe assets to global investors. Not only was the ECB hoovering up eurozone bonds, but Germany, the chief supplier of European safe assets, was running a budget surplus. On a global scale over the next five years, the United States would be the only source of safe, Treasury-grade assets for investors worldwide. Whatever you might think of the Trump administration, if you needed to park a large volume of funds in safe government debt, there was no alternative to US Treasurys.

  The Global Supply of Safe Assets Change in Stock of Advanced Economy Sovereign Debt by Region of Issuance and Holder (in $ trillions cumulative change since 2010)

  Source: IMF, Global Financial Stability Report, Ocober 2017, 19, figure 1.13, panel 4.

  IV

  The Republican campaigns to roll back Obamacare and cut taxes were of long standing. Trump’s targeting of Wall Street in his election campaign was more novel. But it made electoral sense. Almost a decade on from the financial crisis, the banks were still deeply unpopular. A poll in the summer of 2017 revealed that 60 percent of Americans still regarded Wall Street as a “danger to our economy,” and only 27 percent thought regulation had gone far enough or posed “a threat to innovation or economic growth.” Fully 47 percent of Trump’s voters wanted to “keep or expand” Dodd-Frank, as opposed to only 27 percent favoring repeal or scaling back. When it came to financial products and services, 87 percent of Republicans and 90 percent of Independents favored regulation.82 Wall Street lobbyists might wail against Dodd-Frank, but as the Obama administration insiders knew, it was they who had held back the popular tide running against the banks. And Trump, it turned out, was no different.

  His campaign attacks were politics pure and simple. The leaders of Wall Street had never liked Trump. They clearly preferred the Clinton brand. He had paid them back in kind and he had won. The question of who was boss had been answered. Trump’s about-face once in office was utterly unabashed. He would do as befitted a boss-president. There would be a bonfire of regulations and in particular those of his predecessor. The thought of doing a “big number” on Dodd-Frank pleased POTUS. And it pleased him also to bestow favors on and receive applause from powerful interests, even those he had previously made a show of attacking. As he told a meeting of CEOs in April 2017: “For the bankers in the room, they’ll be very happy.”83 To have favors lavished on them by the man who had pilloried them on the stump might seem topsy-turvy. But the bankers were not complaining. As the Financial Times commented: “Imagine going to the races, betting 98 per cent of your stake on the favourite [Clinton], which loses in the final stretch, and going home with huge winnings.”84 As far as Wall Street was concerned it turned out that the game of politics was heads I win, tails you lose. Neither the politicians nor Wall Street gave a second thought to the angry voters who had actually put Trump in the White House.

  To help with the gutting of Dodd-Frank it was only too easy to find bank lobbyists and business-friendly economists. And enthusiasm also came from the Republicans in the House. Led by Jeb Hensarling, who back in 2008 had spearheaded opposition to the bailouts and was now chairman of the Financial Services Committee, the House rapidly passed the so-called Financial CHOICE Act—where CHOICE stands for Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs. It not only defanged Dodd-Frank. It was libertarian purism. It would scrap the Volcker rule and make stress tests a biannual rather than an annual affair. It eliminated the Orderly Liquidation Authority, insisting that failing banks should simply be referred to the bankruptcy courts.85 Astonishingly, in the name of the freedom to choose, the CHOICE act even promised to gut Elizabeth Warren’s Consumer Financial Protection Bureau.86

  For an administration habitually decried as populist, the remarkable thing was how spectacularly unpopular such legislation would have been. Like ACA repeal, the CHOICE Act had little or no chance of passing the blocking position the Democrats held in the Senate. As in the battle against Obamacare, the struggle was best waged outside the spotlight. Even if Dodd-Frank remained in place, the regulatory regime was fair game. This was a legacy of the discretionary conception of financial governance that framed Dodd-Frank. Pursuing maximum freedom from congressional interference, Geithner’s Treasury had pushed for the agencies to have the widest possible latitude in their regulatory efforts. Now that discretion could be used to fundamentally change the regime of bank supervision without the need for legislation. Mnuchin’s Treasury began preparing a series of reports on its approach to financial regulation, opening the door to the bank lobby.87 By one count fully 75 percent of the bankers’ recommendations were incorporated into the Treasury’s new regulatory blueprint.88,89 Unpicking the Volcker rule, which had taken almost four years to assemble, began by asking the banks how they would like it changed.90 In November 2017 rather than scrapping the Orderly Liquidation Authority and rest
oring the role of the bankruptcy courts as the CHOICE Act had proposed, the Treasury decided that it preferred to retain control over the liquidation of a megabank in crisis.91 Even if there were to be no more bailouts, the prospect of another Lehman was not attractive. The Trump administration exposed the basic weakness of Geithner’s regulatory design. It depended on those operating the law to have a programmatic commitment to systemic stability. Without that, the legislation per se was largely empty.

  Arguably the most radical section of the CHOICE Act was the provisions pertaining to the Fed. They constituted an all-out assault on central bank activism as practiced by Ben Bernanke. In the future the CHOICE Act demanded near total transparency of all Fed meetings. The act called for the FOMC to declare a mathematical policy rule to justify its interest rate choices. As its default the act specified the so-called Taylor rule, named after John B. Taylor of Stanford University, a favorite of the Right and a longtime academic rival of Ben Bernanke. His rule called for interest rates to be set as the sum of: