NDN Blog

Barring some unforeseeable event, Mitt Romney is virtually certain to be the GOP nominee for president. Judging by President Obama’s decision to make inequality a main theme of his State of the Union address, the White House has been counting on facing Romney. More than anyone else in national politics, Mitt Romney’s own deeds and words may be said to embody the dynamics which define the top end of contemporary inequality. He spent his adult life accumulating capital assets, he deployed those assets to earn higher returns than those available to middle-class people, and he took aggressive advantage of the highly favorable tax treatment accorded those assets.

Even so, why have wealth and economic inequality become powerful political issues today, when the fortunes of John Kennedy, both George Bushes, John Kerry, and even the billionaire Ross Perot did not? The big difference, of course, is timing. For one, the rich have become much richer, both absolutely and relatively. In 2007, the top 1 percent took home 23.5 percent of all of the income earned in the United States. That’s the same share the top 1 percent claimed in 1928. But for the next half-century, the income share of the top 1 percent fell slowly but steadily, reaching less than 9 percent of national income in 1976. Throughout those years, the incomes of everyone else grew faster than the incomes of those at the top, creating a vast American middle class. But since 1976, incomes at the top have once again grown faster than everyone else’s incomes, restoring their pre-Depression share.

That still doesn’t explain why the very rich in politics inspire so much more wariness and anger today than just 12 years ago, when George W. Bush’s wealth didn’t faze most Americans — and unlike Romney, he didn’t even earn it. After all, one standard liberal meme cites the data on median incomes in 1976 and 2010 to insist that most Americans have stagnated economically for 35 years. Behind those two data points, however, lies a more complicated reality which shows that most Americans did make real economic progress — until the last decade.

First of all, everybody ages; and as we do, most of us see our incomes move from somewhere below the median to somewhere above it. Moreover, real median incomes did increase at respectable rates throughout the expansions of both the 1980s and 1990s, although the recessions which followed took back some of those gains. From 1983 to 1989, real median income increased more than 2 percent per-year, before giving back nearly half of those gains in the 1990–1991 recession and its aftermath. It happened again from 1993 to 1999, when median income rose by nearly 2.5 percent per-year, and then gave back 30 percent of those gains in the 2001 recession and the following three years.

The reason Americans seem so much more skeptical of the very wealthy today, is that this pattern has broken down. Not only did median income fall for three more years after the 2001 recession, that was followed by annual gains of barely 1 percent from 2004 through 2007. Moreover, the 2008–2009 recession and the year following it took back all of those gains, twice over. The result is that by 2010, median income was back to levels last seen in 1996 and 1989.

Also, while the recessions of the 1980s and 1990s drove down median income, those losses were fairly concentrated near the bottom and at the top. The people most likely to lose their jobs in recessions are those in the second and third income quintile, and their incomes fall fairly sharply. At the top, most income comes from financial assets. And since recessions drive down both stock markets and interest rates, they cut sharply into and the capital gains, dividends and interest that especially enrich the top 1 percent. So, for example, the 1990–1991 recession and the initially slow recovery that followed cost an average household in the second income quintile more than 2 percent of their annual incomes. Moreover, the average household in top 1 percent saw their annual capital income fall by nearly 20 percent. In between, most Americans kept their jobs and held on to most of their incomes gains from the 1980s and 1990s.

So, from 1983 to 2000, the average income of the first three income quintiles — covering the less affluent 60 percent of Americans — grew steadily by an average of 1.3 percent per-year. People in the fourth income quintile — the equivalent of a $90,000 income today — did better. They registered average income gains of nearly 1.7 percent per-year from 1983 to 2000. Households in top-earning quintile did better still, with annual income gains of more than 4 percent from 1983 to 2000. And consistent with the top 1 percent’s outsized share of total income, those households way outpaced everyone else: Their incomes grew by nearly 10 percent per year from 1983 to 2000.

After 2000, most people’s gains first turned to losses, then grew slowly for a few years, and then fell back sharply in the 2007–2009 recession. But once again, the story is different for those at the top. To be sure, the incomes of the top 1 percent fell by nearly 30 percent from 2000 to 2002, along with stock and bond markets. From 2003 to 2006, however, those markets recovered, and the incomes of the top 1 percent increased 65 percent. More recent income data for the very wealthy are not yet publicly available. But while everyone else struggles to regain their financial footing, the top 1 percent has seen the S&P 500 and other market indexes already recover. And if all of this wasn’t enough to make Americans pause before making one of the country’s richest men the president, federal tax changes pressed by presidents over the same period have exacerbated the inequalities. That will be our topic for next week’s blog.

John Kennedy famously reminded us that life can be unfair. JFK’s focus, unsurprisingly, was on matters of greater import than wealth: To illustrate that “[t]here is always inequality in life,” he notes, “[s]ome men are killed in a war, and some men are wounded, and some men never leave the country. Life is unfair.” Mitt Romney has had a lion’s share of extraordinarily good luck in his life. Now, he will have to make his run for president at a time — perhaps the first such time in generations — when millions of Americans will be very wary of a candidate who grew rich while everyone else struggled just to hold on.

President Obama made inequality a major theme of his State of the Union address last night, an unsurprising choice as he prepares to face Mitt Romney. Everyone now knows that just last year Mr. Romney paid a smaller share of his $21 million income in taxes than the average American paid on a $50,000 salary. But if inequality was the President’s theme, his main subject was jobs. For Obama, faster job growth depends on more government. We need Washington, for example, to retrain workers, reduce college costs, and provide special supports for manufacturers. For Romney, the answer for job creation is, what else, less government: Washington needs only to cut regulation and reduce taxes, especially for the wealthy people and corporations who, in the Romney worldview, create the jobs.

But not so fast — there are other options as well. A new report from the NDN think tank suggests that certain kinds of new technologies can spur job creation more effectively than most government programs or tax cuts. The new study, conducted by Kevin Hassett of the American Enterprise Institute and myself, found that the rapid spread of new 3G wireless devices from 2007 to 2011 led directly to the creation of nearly 1.6 million new jobs. And those job gains occurred even as the overall economy was shedding 5.3 million other jobs.

Our analysis tracked shifts by consumers and businesses from 2G wireless phones to 3G smart phones and tablets, quarter by quarter and state by state, from July 2007 to December 2011. We then analyzed the links between the shift to the more powerful 3G devices and changes in employment, quarter to quarter and state by state. We did the math and found that every 10 percentage point increase in the use of those devices generated more than 231,000 new jobs within a year.

It makes clear and compelling economic sense. As a growing share of Internet use shifts to wireless devices, the people and businesses that use them become more efficient and productive. Those gains, in turn, create new value which ultimately leads to more job creation. The spread of 3G wireless devices also created a platform for new services — for example, in mobile e-commerce, mobile social networking, and location-based services. The growth of those new services also led to more job creation.

And the best news for jobs is that another technological shift is occurring right now, from 3G to 4G wireless devices. 4G wireless networks and the Internet infrastructure that supports them have the potential to drive significant new efficiencies and innovations across the economy. Jobs already are being created in 4G-dependent areas such as cloud-based services and mobile health applications. According to industry analysts, 4G wireless networks in the near future could be used to create a Smart Electricity Grid and a national public safety system.

This analysis, then, can provide a new direction for job creation efforts: Adopt spectrum and other policies that will promote the broad and rapid deployment of 4G

Still, there are also kernels of economic truth in the Romney and Obama positions. Romney is not wrong, for example, when he says that lower taxes are usually better for the economy than higher taxes. But there’s no evidence that lower taxes on wealthy people or corporations would produce many jobs. And in a period of trillion-dollar budget deficits, calls for tax cuts seem at best irrelevant, and at worst politically cynical and misleading.

The President is on firmer ground. Greater access to higher education and retraining should increase productivity and growth, at least over the long haul. Since the direct benefits from those efforts would presumably go to people from modest or middle-income households, Obama’s approach also could help address inequality. And since the President seems prepared to raise the revenues to finance his proposals, they could be more than political window dressing.

For all of these good points, these approaches are not the answer to slow job creation. For that, President Obama and Mr. Romney have to directly address the forces that actually create and destroy private-sector jobs. One such force is technology, and our new analysis shows that the 3G and 4G wireless technologies can create many more jobs than they may destroy, and do so quickly. Another approach could focus on reducing the additional costs that businesses bear directly when they create new jobs. That could mean cuts on the employer side of the payroll tax or new measures to slow increases in the health care costs that businesses bear for their employees. At a minimum, any of these approaches would produce more economic benefits for more people than all of the tax cuts promoted by Obama’s opponents.

Conservative conventional wisdom collided this week with a dose of economic reality, and the winner is reality. For two years, every Republican congressional leader and presidential hopeful has proudly insisted these days that austerity is the cure for a sluggish economy like ours. It is an approach embraced most memorably, of course, by Herbert Hoover, although Angela Merkel also pushes it today for the faltering Eurozone. In fact, austerity in the face of high unemployment, slow investment and weak demand has been decisively refuted by a half-century of economic analysis and policy. The best medicine for a slow economy is usually measures to jump-start investment and consumption funded by more private or public debt.

Congress has refused to let Washington play that role since the 2010 elections, so finally American households are stepping into the breach. Last week, we learned that employment rose sharply in November, and this week we found out why: Borrowing by American households jumped $20.4 billion in November. That’s the largest increase in ten years. This new willingness by Americans to take on new debt is the main reason why consumer spending is finally picking up, which in turn is the main reason why the jobless rate keeps on falling.

It would be rash to read too much into these new data, but they could be a powerful signal of stronger growth ahead. For three years, Americans have saved in order to reduce the burden of their outstanding debts. New Federal Reserve data show that it is working. In 2007, payments on mortgage, consumer and auto debts claimed a larger share of the incomes of an average household than at any time since 1980. But by the third quarter of last year, this household indebtedness had fallen to the lowest levels since 1994, providing a reasonable basis to begin borrowing again.

Moreover, the renewed willingness of average Americans to take on new consumer debt may also signal that housing values have finally bottomed out. Falling housing values — and Washington’s inability to do anything to help stabilize them — have been the single largest obstacle to a strong recovery. When home prices fall month after month, that not only increases the net debt of most homeowners; it also makes American homeowners poorer, month after month. And people who see their assets shrink, month after month and year after year, cut back on their spending. So, recent signs that consumer borrowing and spending are heating up again suggest that housing values may have finally stabilized. If that’s the case, the recovery may finally accelerate.

America’s new acolytes of austerity could still screw this up. In the last year, they tried to block payroll tax relief and extended unemployment benefits, and the truest believers among them even hoped to block an increase in the legal debt limit. All three of these matters will come back to Congress in coming months. The political landscape has shifted, however. The public now holds Congress in such low esteem — and especially House conservatives — that even fervent advocates of austerity may hesitate to repeat their wildly unpopular 2011 performance in an election year.

A stronger U.S. recovery could still fall victim to the European austerity caucus. Merkel continues to press austerity on the Eurozone governments, even as Europe slides into recession. Moreover, piling yet more austerity on economies in recession can only worsen the sovereign debt crisis which already threatens to pull down the Euro and major banks across Europe. Sometime next week or in the next few months, global investors may conclude that Merkel’s attachment to austerity will finally preclude meaningful steps to stabilize Italian and Spanish government debt. If that comes to pass, the ensuing financial crisis almost certainly would short circuit a strong American recovery.

For now, that recovery is in the hands of America’s households. Thankfully, they display more economic sense than many members of Congress or leaders of the Eurozone.

I released the following statement today:

"Today’s report that the U.S. economy created  200,000 new jobs, net of layoffs, certainly counts as strong gains for this recovery.  Of course, what constitutes strong job growth today would have seemed, at best,  moderate in the 1990s and 1980s, when the United States routinely created more than 300,000 new jobs per month.   Still, for the first time since the 2007-2009 recession, decent levels of job creation seem sustainable.  Business investment is growing nicely, creating jobs directly.  The trade deficit keeps falling, slowing the drain of U.S. jobs overseas.  And while consumer spending is still fragile, household debt continues to fall, setting the stage for a stronger recovery.  

If Washington would take steps to help stabilize housing prices, as Ben Bernanke called for this week, and if the Eurozone manages to avoid a financial meltdown, Obama could find himself presiding over a decent recovery by November."

You can find Rob's statement on Thursday about the promising ADP report showing similar numbers here.

A word of caution to President Obama's critics:   American families and businesses may be finally recovering from the economic beatings they suffered in the 2008 financial crisis and the extended unwinding of the 2002-2007 housing bubble.  The giant payroll company ADP, whose surveys have a good record of anticipating the official jobs reports, said today that private sector employment grew by an estimated 325,000 in December.  This follows several months of encouraging news on jobs from the Bureau of Labor Statistics.   Business investment and corporate profits also have shown renewed strength.   

Yet, GDP growth has been modest, mainly because consumer spending is still fragile.   Americans want proof that job creation is back and the value of their homes has stabilized.  The first factor may now be in place.   If housing prices stop falling - and Europe avoids a financial meltdown -- the American economy in 2012 is likely to be the strongest since 2007.

In Kansas last week, President Obama laid out the economic brief for his reelection. Its substance plainly recalls the program Bill Clinton offered in 1992. Both plans are built around new public commitments to education, R&D and infrastructure, some fiscal restraint to finance the public investments and unleash more private investment, plus some modest redistribution of the tax burden from working families to the wealthy. This formula still strikes the right notes politically, at least for those who aren’t diehard, pre-New Deal conservatives. But economically, this mainstream approach will face much greater hurdles today.

Most of the President’s conservative critics have focused on his call for more revenues from affluent Americans, starting with a surtax on millionaires. In fact, congressional Republicans not only have rejected the surtax; they’ve also suggested that they might hold payroll tax relief hostage until Obama agrees to make the Bush upper-end tax cuts permanent. It’s a bluff, and not a very good one: The GOP will stop the surtax on the rich, but they cannot be seen at the same time as raising taxes on everyone else. Whether or not Bush’s largesse for upper-income Americans survives will turn on who is inaugurated in January 2013.

This tax debate may pack a good political punch for Obama; but in the end, it doesn’t have much economic significance. Yes, a higher marginal rate, in itself, would have negative effects. But in the real world, a higher rate never operates by itself. The additional revenues may help bring down interest rates by reducing deficits and so spur business investment, as they did under Clinton. Or the same revenues could help finance public investments that make businesses more efficient and productive. And the truth is, the adverse effects of a higher tax rate on the wealthy, by itself, fall somewhere between quite weak and very weak. What else can an economist infer from strong growth in the 1950s when the top rate exceeded 90 percent, quickening growth in the 1990s after Clinton hiked the top rate, and more tepid growth after Bush cut the top rate?

The harder and more important issue is whether the combination of more public investment and smaller deficits, which worked so well for Clinton, will make much difference today. Like Clinton in 1992, Obama last week called for more federal dollars in the three specific areas that can boost productivity and growth in every industry, and which businesses tend to shortchange. This covers worker education and training, basic research and development, and transportation infrastructure. The theory, confirmed by the boom of the latter 1990s, is that these factors help make businesses more efficient and their workers more productive. Together, those gains translate into higher incomes and stronger business investment, especially if businesses don’t have to compete with Washington for capital to invest. And all of that should produce stronger growth, more jobs, and a much-sought-for virtuous circle.

The catch lies in jobs and wages. If the public investments allow businesses to become more efficient and productive, but those investments do not lead to higher incomes and more jobs, the only result will be higher profit margins. The whole virtuous circle will slow down or even stall out, much like what happened once the 2009 stimulus ran its course. In the 1990s, the strategy worked like a charm, because U.S. companies still responded to higher growth and productivity with strong job creation and wage increases. But those connections have weakened badly since then.

Consider the following. The Bush expansion from 2002 to 2007 saw GDP grow by an average of 2.7 percent a year, 30 percent slower than the 3.5 percent annual gains for a comparable period in the 1990s, say 1993 to 1998. But while the number of private sector jobs grew by more than 18 percent from 1993 to 1998, this rate fell to less than 6 percent from 2002 to 2007, a two-thirds decline from the earlier period . Even worse, the connection between productivity and wage gains broke down even more. In the 1990s, productivity grew 2.5 percent per-year, and average wages increased nearly in lock-step, by 2.2 percent a year. In grim contrast, productivity grew 3 percent a year from 2002 to 2007 while the average wage didn’t go up at all.

Clinton’s program could take strong job creation and wage gains virtually for granted. President Obama’s program will have to address these issues head on, and in ways that might attract some bipartisan support. Obama will also have to contend with additional hurdles, including the persistent economic drag from the financial crisis and, perhaps, from another round triggered by Europe’s faltering sovereign debt.

Here are three ways to begin.

First, while the President’s temporary payroll tax cut for workers provides some welcome stimulus, reducing the tax burden that falls directly on job creation on a permanent basis — the employer side of the payroll tax — would be more powerful economically.  We could cut employer payroll taxes in half, for example, and replace the revenues with a new carbon fee on greenhouse gases. In the bargain, the United States also would become the world’s leading nation in fighting climate change.

To address stagnating wages as well as slow job growth, the President should recast his training agenda as a new right. Most jobs today — and virtually all positions very soon — require some real skills with computers and other information technologies. All working Americans should have the opportunity to upgrade their IT skills, year after year. They could have that, and at modest cost to taxpayers, if Washington will give community colleges new grants to keep their computer labs open and staffed at night and on weekends, so any American can walk in and receive additional IT training for free.

Finally, U.S. multinationals have lobbied furiously, without success, for a temporary tax cut on profits they bring back from abroad. Give them what they want, if they will give the economy what it needs. We could let U.S. multinationals bring back, say, 50 percent of their foreign profits at a lower tax rate if, and only if, they expand their U.S. work forces by 5 percent. A 6 percent increase in a company’s U.S. workers would entitle them to bring back 60 percent of those profits at a lower tax rate, and on up to a 10 percent job increase and 100 percent of foreign profits.

That’s what it will take, just to begin, for an economically-powerful program of public investment and fiscal restraint to work its magic this time.

Everyone knows that unemployment is high today and unlikely to fall by much soon. Yet, a longer view of the official jobs data would startle most people, including virtually everyone in the media. Nearly three years into Barack Obama’s presidency, his record on private job creation has actually been much stronger than George W. Bush’s at the same point in his first term. Whatever the public perception, the real record provides strong evidence for both the relative success of Obama’s economic program and how hard it now is for American businesses to create large numbers of new jobs — as they did once so effortlessly, and without political prodding.

Let’s go to the numbers reported by the Bureau of Labor Statistics (BLS). In the first 33 months of George W. Bush’s presidency, from February 2001 to October 2003, the number of Americans with private jobs fell by 3,054,000 or 2.74 percent. Perhaps Americans were too distracted by Osama bin Laden to pay attention, or everyone was lulled by the dependably strong job creation of the 1980s and 1990s.  Whatever the reason back then, Americans are certainly paying attention to jobs now. Yet, few seem to have noticed that Barack Obama’s jobs record has unquestionably been much better. In the first 33 months of his presidency, from February 2009 to October 2011, private sector employment fell by 723,000 jobs or 0.66 percent. That means that over the first 33 months of the two presidents’ terms, jobs were lost at more than four times the rate under Bush as under Obama. 

To be fair, new presidents shouldn’t be held responsible for job losses or job gains in the first five or six months of their administrations.  Bush’s signature tax cuts, for example, weren’t enacted until June 2001; and while Congress passed Obama’s signature stimulus program earlier in his term, it didn’t take effect for several more months. But the story is the same when we start counting up jobs without the first five months of each president’s term. The BLS reports that from July 2001 to October 2003 under Bush’s program, U.S. businesses shed 2,167,000 jobs, or about 2 percent of the workforce. Over the comparable period under Obama’s policies, from July 2009 to October 2011, American businesses added 1,890,000 jobs, expanding the workforce by 1.75 percent. In fact, private employment in Bush’s first term didn’t begin to turn around in a sustained way until March 2004, 38 months into his term. By contrast, private employment under Obama started to score gains by April and May of 2010, 14 to 15 months into his term.

The same dynamics have played out with manufacturing workers. While they have taken a beating under both presidents, they suffered much harder blows under Bush than Obama. Setting aside, once again, the first five months of each president’s term, the data show that under Bush, 2,141,000 Americans employed in producing goods lost their jobs by October 2003, a 9 percent decline. Under Obama, job losses in goods production totaled 183,000 over the comparable period, a 1.0 percent decline.

Public perceptions, especially of Obama’s record, may be skewed by the collapse of the jobs market in the months before he took office. In the final, dismal year of Bush’s second term, from February 2008 through January 2009, American businesses laid off an astonishing 5,220,000 workers, 4.5 percent of the entire private-sector workforce. Obama and the Fed managed to staunch the hemorrhaging. But the huge job losses in the year before he took office have become a political hurdle which Obama must overcome before he can take credit for putting Americans back to work.

Apart from the obvious disconnect between conventional wisdom and what actually has happened with jobs, the data also speak to certain features of the labor market and the policies we use to affect it. For example, both presidents began their terms with large fiscal stimulus programs, backed up by more stimulus from the Federal Reserve. So, the record now shows clearly that when the economy is depressed, spending stimulus has a more powerful effect on jobs than personal tax cuts.

Beyond that, why couldn’t either president restore the much stronger job creation rates of the 1990s and 1980s? Obama’s economic team can point to the long-term effects of the 2008 housing collapse and financial crisis, especially the impact of four years of falling home values on middle-class consumption. But another factor also has been at work here, one which contributed mightily to the slow job creation under both presidents, and will similarly affect the next president.

The tectonic change from strong job creation of the 1980s and 1990s to the current times is, in a word, globalization. From 1990 to 2008, the share of worldwide GDP traded across national borders jumped from 18 percent to more than 30 percent, the highest level ever recorded. Intense, new competition from all of that additional trade has made it harder for American businesses to raise their prices, as competition usually does. That’s why inflation has remained tame for more than decade, here and nearly everywhere else in the world. The problem that American employers have faced — and still do — is that certain costs have risen sharply over the same years, especially health care and energy costs. Businesses that cannot pass along higher costs in higher prices have to cut back elsewhere, and they started with jobs and wages.

One irony here is that the Obama health care reform should relieve some of the pressure on jobs, by slowing medical cost increases. The administration’s energy program, still stalled in Congress, also might slow fuel cost increases, at least over time. So, if he does win reelection in the face of high unemployment, there is a reasonable prospect of stronger job creation in his second term than in his first one — or in either of George W. Bush’s terms.

Ground zero of the European sovereign crisis has moved from Greece to Italy, and that’s very bad news for Europe, the United States, and most everywhere else. For a year, Angela Merkel and Nicholas Sarkozy have looked for some way to both prevent Greece from defaulting outright and reassure bond investors that Italy’s sovereign debt will remain sound. This week, the price that Italy pays to borrow money soared as global investors determined that holding Italian bonds is increasingly risky. The salacious Silvio Berlusconi is on his way out, but that won’t change the market’s judgment that Merkel and Sarkozy’s stratagems have failed. Europe now faces a real and present danger that major banks across Germany and France, along with Italy and Greece, could fail soon. Such a meltdown would take down the American expansion with it.

It’s still premature for a post mortem. But for the past year, domestic European politics, not international finance, has squeezed the acceptable options to solve the Eurozone’s metastasizing sovereign debt problems. Merkel and Sarkozy have long known that their countrymen and women would pick up pitchforks if their governments moved to bail out big banks a second time. If that wasn’t enough to inspire street demonstrations, the contemplated bailout this time would go to stabilize financial conditions in other countries. So Merkel and Sarkozy came up with a plan that appeared to spare French and German taxpayers. Unfortunately, it also couldn’t pass a laugh test by worldwide investors:  The plan has Eurozone financial stabilization board raising $1 trillion from those investors to back up Italy’s debt, with a pledge that Eurozone governments would guarantee the first 20 percent of any losses. Think about it: Italy, Greece, Ireland, and Portugal , all hanging by a thread or worse, would help the rest of the Eurozone cover the initial losses from bonds used to bail out Italy, Greece, Ireland and Portugal — and if things go south, probably Spain as well.

The $1 trillion commitment kept a meltdown at bay for a few days, much as the Bush Treasury’s commitment to spend $700 billion to bail out Wall Street staved off a market collapse after Lehman failed. The original Paulson plan also didn’t pass the laugh test, but no one doubted that the U.S. Government could raise the $700 billion. This time, the Eurozone’s $1 trillion commitment has bought them at most a few weeks of breathing space, as investors wait for Merkel and Sarkozy to come up with a real plan to raise it. But those investors already are eyeing the exits. Interbank lending to Europe’s biggest institutions dried up this week, just as it did here in the days before Lehman sank. And interest rates on Italian bonds are now so high that, according to the industry’s financial models, Rome will be unable to service its debt much longer.

All of this means that neither global investors nor European taxpayers are prepared to bail out the Eurozone. Even at this very late date, however, there are ways out of this mess:  Under the least bad of the options left, the European Central Bank (ECB) would become the Eurozone’s bond buyer of last resort.  The ECB could pay for them by printing enough Euros, for starters, to stabilize Italian bond markets. It wouldn’t be pretty. The Euro would weaken. European interest rates might edge up as Europe slowed. And the ECB would have to come up with another credible plan to withdraw the excess Euros once the crisis passed. But the alternative is much worse.

In a period of worst case scenarios, here’s what could well happen later this month. Start with the fact that Italy alone has $2 trillion in outstanding government debt. Most of those bonds are held by Italian, French and German banks, including the biggest banks in the world. Anything approaching an Italian default would wipe out the capital of those banks, leaving them insolvent; and most of the Eurozone economies would grind to a halt.

It gets worse, because a financial meltdown centered on sovereign debt is much more dangerous than one triggered by mortgage-backed securities. In effect, a sovereign debt crisis strips sovereigns of their ability to act to contain the crisis. With Italy and Greece in default, for example, who will believe those governments as they move to head off general bank runs by, say, guaranteeing money market balances as the United States did successfully in the days after Lehman?  And if the biggest banks in France and Germany go down, Sarkozy and Merkel wouldn’t have the credibility to do much about it either.

The bad news doesn’t end with Europe. Our own big financial institutions, along with those in Britain and Japan, have thousands of deals going that involve the major banks in Germany, France and Italy. Overnight, all of those deals become suspect, which could spread financial panic beyond the Eurozone. And remember the credit default swaps that destroyed AIG?  No one knows precisely how many of those “guarantees” are out today against Italian government bonds and the commercial paper of French, German and Italian banks. The fact that no one knows could be a big problem in itself, since that, too, could breed a broader financial panic. In any case, there’s little doubt that those credit default swaps involve, at a minimum, hundreds of billions of dollars, Euros and pounds. That would leave American, European and Japanese financial institutions on the hook for those losses. And if they can’t make good on them, they could go down as well. Their only hope would be another bailout — if Congress could approve one before the Tea Party and Occupy Wall Street folks pick up their pitchforks.

All this is not yet inevitable. But much of it might well unfold, and probably in a matter of weeks, unless the Eurozone’s leaders face the grim music and finally find their way to a real program to head it off.

Seemingly out of nowhere, economic inequality is no longer the political issue that dares not speak its name. Since the days of Ronald Reagan, politicians who talk about reducing disparities in incomes or wealth have been promptly charged with “class warfare.” The stunning success of the Occupy Wall Street movement in attracting adherents and sympathizers could change that, at least for the current political season. What lies behind the movement’s surprising middle-class appeal, however, isn’t high unemployment or slow economic growth. The real reason is that the 2008 meltdown and its economic aftermath have cut the wealth of millions of average Americans by up to half — and Washington has been unwilling to do anything about it.

There is little controversy among economists that the fabled U.S. land of opportunity has become one of the world’s most unequal societies. Using the standard measure (the “Gini Coefficient”), America now ranks 93rd in the world in terms of economic equality. That puts us behind places like Iran, Russia and China. The poverty in those places is much worse, but the concentration of wealth is much greater here. According to the Federal Reserve, the top 1 percent of us in 2007 owned nearly 35 percent of everything of value, net of debt — that includes savings, stocks and bonds, real estate, art, furniture, clothing, on and on. Perhaps more important, the top 20 percent of Americans owned 85 percent of the country’s net wealth.

Yet, such striking inequality still cannot explain the appeal of Occupy Wall Streeters — I’ll call it the OWS movement — because comparable disparities of wealth have been around for a generation. Go back to 1983, and the top 1 percent of Americans owned 34 percent of the country, and the top 20 percent claimed 82 percent.

The answer here lies in the particular way that the financial and housing meltdown has affected middle-class families. Consider the following: While the bottom 80 percent held only 15 percent of the nation’s wealth in 2007, most of it was tied up in the value of their homes. We know that, because when we break down that 15 percent figure, we find that the bottom 80 percent held just 7 percent of all financial assets in 2007 but 40 percent of all residential real estate assets. And the housing boom topped out in 2007.

The reason the OWS movement resonates so broadly today lies in the subsequent loss of so much housing wealth.  The 2008 meltdown and its aftermath have driven down the value of residential real estate by about 35 percent. And that 35 percent included most or all of the equity that millions of middle class families had in their homes in 2007.  America already was a place where 80 percent of the people held only 15 percent of the country’s wealth. Now, do the math. About half of that wealth was in financial assets like savings and pensions (the Fed’s 7 percent figure), and the rest was in home equity. So, since 2007, the bottom 80 percent of Americans have lost up to half of their net wealth.

Those losses also aren’t distributed evenly:  Households in their 30’s and 40’s, for example, usually have almost everything they own tied up in their home equity, and which typically adds up to less than one-third of their homes’ value.  They’ve been wiped out, wealth-wise.  Older households, on average, have larger home equity, so they still have some modest increment of wealth. But if they’re approaching retirement or already retired, there’s also little they can ever do to make up their losses.

When middle-class Americans turn to Washington, they see the resounding success of the government’s efforts to stabilize the financial markets – where the top 1 percent derive most of their wealth. The rich are back to becoming even richer. That’s the way America has operated for at least the last generation. What grates on middle-class Americans this time is that they’ve been getting poorer. And Washington has done little to stabilize the market from which they derive most of their wealth, which is housing.

To be fair, President Obama can claim a little credit here, since he has proposed a series of initiatives to support housing, mainly by giving banks incentives to refinance more mortgages at favorable terms.  But the largest force driving down housing prices and wiping out middle-class home equity is sky-high home foreclosure rates.  The President hasn’t yet taken on those foreclosures, but he still has time to champion a new initiative.  For instance, he could call for temporary loans for families whose mortgages are in trouble, financed through lending by the Federal Home Loan Banks.

Mitt Romney, Obama’s most likely challenger, can’t call for anything.  Last week, Romney went to the state with the highest foreclosure rate in the country, Nevada, and made what may turn out to be a very costly mistake.  Embracing GOP dogma that “the right course is to let markets work,” he declared that Washington should let the foreclosure process “run its course and hit the bottom.”

Yet, this is the very process now hollowing out a good-sized slice of the American middle class.  Given Romney’s position, the issue provides a new opportunity for the Obama campaign.  Much more important, however, the problem itself presents a critical challenge for economic policy makers. If they and the next President ignore it, inequality in America almost certainly will enter a very nasty, new phase.

At last weekend’s IMF / World Bank annual meetings in Washington, the question on everyone’s minds was, what’s happened to Europe’s instinct for economic survival?  While our Congress squabbles over bookkeeping for disaster assistance, the talk in the corridors of the IMF was that Europe is two to three weeks away from financial meltdown.  It would start in the sinking market for Greek government debt, followed by turmoil in much-bigger markets for the public debt of Italy and Spain, as well as Portugal and Ireland.   And if Europe’s leaders can’t head that off, it will likely take down most of Europe’s large banks.  Angela Merkel, Nicholas Sarkozy and their counterparts across Europe get this.  What they don’t want to face is that the only solutions ultimately lead to a radical rewriting of postwar social contracts across the Eurozone.  

The financial carnage wouldn’t stop at the continent’s shores.   British banks have large holdings of Spanish, Italian and Irish government bonds, so they would be very vulnerable.   Our own banks sold most of their portfolios of European government bonds over the last year.  But U.S. officials worry privately that U.S. banks are holding unknown billions of dollars of credit-default swaps against both those bonds and the European banks that hold them.  That puts them in a position that recalls AIG in late August 2008, as insurance providers for a catastrophe that now lies somewhere between the possible and the likely.  Finally, a meltdown of European finance would mean horrendous recessions across Europe and an end to our own recovery.

The sober minded men and women at the IMF aren’t given to nightmare scenarios.  They believe in data, and it’s the analysis of those data that now points to impending crisis.   Over the last six months, for example, the shares of the largest banks of Greece, Italy, Spain and France have sunk 30 percent to 50 percent.  Even scarier, the costs to insure against the failure of those banks reached the same levels last week as they did here for Lehman Brothers a few weeks before its collapse.  And the costs to insure against the complete default of Greek, Italian and Spanish government debt – financial Armageddon -- have risen 60 percent to 80 percent.

For months, financial analysts and global investors have tracked the perfect storm now taking shape across the Eurozone.  But unlike the weather, European leaders know how to head off much of it and to contain most of the rest.  Yet, like Henry Paulson’s Treasury throughout much of 2008, Germany’s Merkel and France’s Sarkozy have spent the six months trying to ignore the undeniable.  The bottom line this time: Monetary unions across states or countries, like the Eurozone, work only when the full faith and credit of the whole stands behind the full faith and credit of each part.  

The classic example of a successful monetary union was the United States in the late 1700’s.  Under the Articles of Confederation, the southern states paid off their revolutionary debts, and their credit was sound – think of them as Germany, the Netherlands, and Northern Europe today.  But profligate Massachusetts, Connecticut and most of the rest of the north let their debts, both old and new, just pile up – they were the Greece, Italy, Spain, Ireland and Portugal of their day.  Resolving these debts hung up approval of the new U.S. Constitution, so the framers created a Bank of the United States which assumed the debts of the northern states.  In return, by the way, the credit-worthy southern states got to take the national capital away from New York and relocate it in a swampy track on the border of Virginia.  

A similar task now faces Merkel, Sarkozy and the Dutch and Finnish members of the Eurozone –- in effect, pledge their own good credit to guarantee the same for the Eurozone’s profligate southern countries.   So far, they’ve thrown a lot of money at Greece, hoping it would satisfy global investors.  We now know that hasn’t worked, and that much harder adjustments lay ahead. 

In fact, Europe’s crisis is even more serious than our own in 2008.  To begin, Europe’s banks hold the failing sovereign debts of the southern Eurozone countries as well as toxic assets left over from 2008.  Moreover, no one doubted the U.S. Government’s capacity to step in and bail out our banks and provide massive stimulus for an economy spiraling downward.  This time, it’s sovereign debt itself that’s under attack, so that option isn’t available for Greece, Spain, Italy, Portugal, or even France.   Washington also could head off bank runs when Lehman, AIG and Merrill Lynch collapsed, by guaranteeing everyone’s money market balances.  None of the Eurozone countries in such deep trouble today would have the credibility to take such a step.  So, if everything begins to unravel, there’s very little they can do to save their banking systems.  And such a banking crisis will hit Germany as well, since its private banks also hold many tens of billions of Euros in Greek, Spanish and Italian debt.  

There are still a few precious weeks left to head off this Euro-catastrophe.  The Eurozone’s rescue fund so far has focused on delaying Greece’s default.  In the next two weeks, it will have to, at once, inject capital into unknown numbers of large banks and buy massive amounts of Greek, Spanish, Italian and Portuguese debt on the open market.  The politics of pulling that off are daunting, because it will require the unanimous support of 17 Eurozone governments.  So far, only six have agreed, and they’re mainly the ones that would be rescued.  Of the others, Finland, for one, has put up impossible demands that will have to be dialed back.  And while Merkel now says she’s prepared to do what she said a month ago she’d never do, it’s unclear if her own party will go along in a vote scheduled for later this week.  

One reason for their opposition is that most of the bill will fall to Germany and the five other Eurozone countries that still have sound credit.  There are ways to stretch the bail-out capital, however.  The European Central Bank could underwrite it – it still says no to that -- or the rescue mechanism could guarantee losses of up to 20 percent on sovereign bonds.  But such moves are immensely complicated matters to work out in just a few weeks, especially when everything requires the unanimous consent of the Eurozone governments.  When Henry Paulson had to come up with a bailout plan quickly as Wall Street melted down, he managed to pull together three pages of general principles saying the Treasury could whatever it wanted.  That won’t wash this time.  

The second reason will be even harder to handle.  If the Eurozone can find its way to guaranteeing the sovereign debts of all of its members, their future debts will have to be centrally and uniformly constrained.  In short, the solution to the crisis could spell the end of each government’s autonomous right to conduct its own spending and tax policies, since that’s what generates sovereign debt.   That would require fundamental revisions of the long-time social contracts these governments have with their peoples, including provision for the world’s most extensive public pensions and health care coverage.   That’s the real reason Merkel, Sarkozy and the rest have spent so long denying the emerging crisis.  The next two to three weeks will tell whether they have the courage and vision to finally address it.