Why the Economy Grows Like Crazy Amid High Taxes

By Larry Beinhart, AlterNet

The raw truth is that the economy has grown faster when taxes were higher, but how can we explain that phenomenon?

The real-world effects of tax policy are counterintuitive.

They run exactly opposite the conventional wisdom. They defy what the Heritage Foundation calls common sense and what the American Enterprise Institute calls logic.

Reality laughs at the Laffer curve, calls Ronald Reagan wrong and says George W. Bush is a loon.

High marginal tax rates correlate with economic growth.

Examples include World War II and the Truman-Eisenhower years, when it was around 90 percent, and the Clinton years, when it was high relative to the preceding and following administrations.

Tax rate increases are followed by real economic growth.

Examples include Hoover in 1932, Roosevelt in 1936 and 1940, Bush the Elder in 1991 and Clinton in1993.

Moderate tax cuts are followed by a flat economy.

This is a generalization from one example: Johnson in 1964.

Large tax cuts are followed by a boom, a bubble and a crash.

1929, 1987 and 2008 are examples.

These are covered in more detail in the first part of the article "Tax Cuts: The B.S. and the Facts."

Why do high taxes create a stronger economy?

I used to run a small business -- a commercial film production company.

Every time we took a dollar out as personal income, it instantly turned into 50 cents.

If we didn't really need the money, that was an incentive to keep it in the company and to find ways to spend it that took it out of the taxable profit column but increased the value of the company.

High taxes create an incentive to reinvest profits into long-term growth.

With high taxes, the only way to retain the bulk of the wealth created by a business is by reinvesting it in the business -- in plants, equipment, staff, research and development, new products and all the rest.

The higher taxes are (and from 1940 to 1964 the top rates were around 90 percent), the more this is true.

This creates a bias toward long-term planning.

If a business is planning for the long term, it wants a happy, stable work force. It becomes worthwhile to pay good wages and offer decent benefits.

Low taxes create an incentive for profit taking.

It is easy to confuse profitability with wealth creation.

They are not the same.

President Eisenhower built the interstate highway system. There is no doubt that this gave the country an asset of great value, one that was very productive. It created great "wealth." But, aside from the construction companies that contracted the work, it was not profitable.

Selling subprime mortgages, trading in derivatives, packaging mortgage-backed securities and "flipping" condos were all very profitable but did not create wealth.

The theory is that if the rich can keep their money, they will invest in businesses that create jobs, more businesses, more tax revenue and greater "wealth" for the nation.

That sounds like logic and common sense. But is it, in practice, what happened?

Once tax cutting began, the culture of business changed.

It was no longer enough for a business to be a reasonably good business, making steady, reliable profits.

Indeed, that became a very bad condition for a business to be in. It made it a target for takeovers by people who were willing to milk them of their profits.

Among the ways you can get more profit out of a going business are:

• Cutting the workforce -- possibly sacrificing long-term productivity
• Cutting salaries -- who cares if the employees are unhappy? The balance sheet improves.
• Selling off assets -- who cares what happens in 10 years? We can take the money now.
• Outsourcing -- which sends the "wealth" somewhere else.

A whole host of devices were developed to do all of the above: junk bonds, leveraged buyouts, hostile takeovers, greenmail and the like.

Lots of money could be made that way -- for a small number of individuals. But it doesn't produce "wealth."

An environment in which profit-taking is cheap creates the conditions for a bubble.

Once you've taken your profit, and you have the cash in hand, you look for a place where you can get profits quickly, then again and again. Instead of examining how sound a company is, how well it's run, its debt load and its long-term prospects, other things become important -- such as the speed at which you can profit and the ease of entry.

Instead of investing in business -- which is difficult, slow and complicated -- investors go into markets.

They look for sectors that are hot. When investors find such an area, they flock to it. It heats up even more. People are seen making money, quickly and easily, simply by buying and selling, and they don't want to miss out.

Then there's a bubble -- which is followed by a crash.

Proponents of tax cuts take the position that taxes take money out of the economy.

That's flat out not true.

Governments don't keep the money they collect; they spend it. It goes right back in. It just takes a different route. It goes to different places.

The places that government puts money are important. More to the point, they are important for business.

All infrastructure is an invisible subsidy for all business.

It's easy to understand this when we're talking about roads.

It doesn't matter if your business doesn't ship anything by truck or even by bicycle. The fact that you can get to your office quickly and easily, that your mailperson can get to you without traveling on the back of a mule, is a subsidy of your business.

It's a little harder to see that when we're talking about soft infrastructure.

Laws, regulations and their enforcement. Social Security, unemployment insurance, public health and welfare. Education, research, support of sports, arts and culture. Parks and playgrounds. All of them create a society that is safer, more stable, and more able to produce and consume. They produce a better place in which to do business.

Tax cutters also claim -- and I paraphrase the essence of the argument -- that the money government gets disappears in wasteful stupidities.

There's some truth in that.

They might point out all sorts of cultural and scientific projects, like a museum for the Woodstock Festival, counting the fish in Waldon Pond or studying the sex life of prairie dogs. I would point to the Star Wars missile defense shield, farm subsidies, the ethanol program, the privatized non-reconstruction of Iraq and all of Halliburton's contracts.

But it is also true that businesses spend money on all sorts of wasteful stupidities.

I am sitting here wondering how anyone -- in fact, a succession of people -- could run a company with the power and resources of General Motors into the ground.

In the mythological marketplace, they should fail and suffer for their faults. In the real world, the arrogant fools who ran the place will walk away with millions, and the hundreds of thousands of people who worked for them and their suppliers, who offered services and goods to those in turn, will be the ones who suffer.

The point is that relying on the magic of the marketplace is like relying on any other kind of magic.

There are things that are necessarily done for the common good.

Clean water, sewer systems, garbage collection and public health initiatives create a healthy population, able to work and consume. Take those away, and we return to the plague years. Imagine what that does to business.

Polluted air, toxins in the groundwater, viruses and bacteria jump the borders of even the wealthiest communities.

Bad health created by lack of care for the common good becomes an economic drain on society.

This is not to say that a full-out, state-run economy is better than capitalism. It's not.

That produces different problems that are even worse.

It is not even meant to imply that all "sound" investments in "real" businesses stopped with tax cuts. They didn't. Start-up money and venture capital were relatively easy to come by. Lots of new and good businesses were built in low-tax environments.

But low taxes produced great excesses of negative activity as well. There is a propensity in business, and as a nation, to hollow out our businesses, and mortgage and sell off our assets, in order to grab short-term profits.

A sound economy is based on a mix of market and government actions -- and a host of other factors as well.

These explanations are speculative, a search to explain what is observed in nature, if you will.

What is certain is that tax cuts on the top brackets, and in particular on unearned income, do not produce healthy economic growth. Contrary to all expectations, tax hikes seem to produce the desired growth. All the explanations in the world, funded by all the right-wing anti-tax think tanks in the world, won't change that reality. If these explanations don't suit you, then supply a better one that will.

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Deregulator Looks Back, Unswayed

Lisa Krantz for The New York Times

During his time in the Senate, Phil Gramm led the fight against more government intervention in the financial markets.

By ERIC LIPTON and STEPHEN LABATON

WASHINGTON — Back in 1950 in Columbus, Ga., a young nurse working double shifts to support her three children and disabled husband managed to buy a modest bungalow on a street called Dogwood Avenue.

Phil Gramm, the former United States senator, often told that story of how his mother acquired his childhood home. Considered something of a risk, she took out a mortgage with relatively high interest rates that he likened to today’s subprime loans.

A fierce opponent of government intervention in the marketplace, Mr. Gramm, a Republican from Texas, recalled the episode during a 2001 Senate debate over a measure to curb predatory lending. What some view as exploitive, he argued, others see as a gift.

“Some people look at subprime lending and see evil. I look at subprime lending and I see the American dream in action,” he said. “My mother lived it as a result of a finance company making a mortgage loan that a bank would not make.”

On Capitol Hill, Mr. Gramm became the most effective proponent of deregulation in a generation, by dint of his expertise (a Ph.D in economics), free-market ideology, perch on the Senate banking committee and force of personality (a writer in Texas once called him “a snapping turtle”). And in one remarkable stretch from 1999 to 2001, he pushed laws and promoted policies that he says unshackled businesses from needless restraints but his critics charge significantly contributed to the financial crisis that has rattled the nation.

He led the effort to block measures curtailing deceptive or predatory lending, which was just beginning to result in a jump in home foreclosures that would undermine the financial markets. He advanced legislation that fractured oversight of Wall Street while knocking down Depression-era barriers that restricted the rise and reach of financial conglomerates.

And he pushed through a provision that ensured virtually no regulation of the complex financial instruments known as derivatives, including credit swaps, contracts that would encourage risky investment practices at Wall Street’s most venerable institutions and spread the risks, like a virus, around the world.

Many of his deregulation efforts were backed by the Clinton administration. Other members of Congress — who collectively received hundreds of millions of dollars in campaign contributions from financial industry donors over the last decade — also played roles.

Many lawmakers, for example, insisted that Fannie Mae and Freddie Mac, the nation’s largest mortgage finance companies, take on riskier mortgages in an effort to aid poor families. Several Republicans resisted efforts to address lending abuses. And Congressional committees failed to address early symptoms of the coming illness.

But, until he left Capitol Hill in 2002 to work as an investment banker and lobbyist for UBS, a Swiss bank that has been hard hit by the market downturn, it was Mr. Gramm who most effectively took up the fight against more government intervention in the markets.

“Phil Gramm was the great spokesman and leader of the view that market forces should drive the economy without regulation,” said James D. Cox, a corporate law scholar at Duke University. “The movement he helped to lead contributed mightily to our problems.”

In two recent interviews, Mr. Gramm described the current turmoil as “an incredible trauma,” but said he was proud of his record.

He blamed others for the crisis: Democrats who dropped barriers to borrowing in order to promote homeownership; what he once termed “predatory borrowers” who took out mortgages they could not afford; banks that took on too much risk; and large financial institutions that did not set aside enough capital to cover their bad bets.

But looser regulation played virtually no role, he argued, saying that is simply an emerging myth.

“There is this idea afloat that if you had more regulation you would have fewer mistakes,” he said. “I don’t see any evidence in our history or anybody else’s to substantiate it.” He added, “The markets have worked better than you might have thought.”

Rejecting Common Wisdom

Mr. Gramm sees himself as a myth buster, and has long argued that economic events are misunderstood.

Before entering politics in the 1970s, he taught at Texas A & M University. He studied the Great Depression, producing research rejecting the conventional wisdom that suicides surged after the market crashed. He examined financial panics of the 19th century, concluding that policy makers and economists had repeatedly misread events to justify burdensome regulation.

“There is always a revisionist history that tries to claim that the system has failed and what we need to do is have government run things,” he said.

From the start of his career in Washington, Mr. Gramm aggressively promoted his conservative ideology and free-market beliefs. (He was so insistent about having his way that one House speaker joked that if Mr. Gramm had been around when Moses brought the Ten Commandments down from Mount Sinai, the Texan would have substituted his own.)

He could be impolitic. Over the years, he has urged that food stamps be cut because “all our poor people are fat,” said it was hard for him “to feel sorry” for Social Security recipients and, as the economy soured last summer, called America “a nation of whiners.”

His economic views — and seat on the Senate banking committee — quickly won him support from the nation’s major financial institutions. From 1989 to 2002, federal records show, he was the top recipient of campaign contributions from commercial banks and in the top five for donations from Wall Street. He and his staff often appeared at industry-sponsored speaking events around the country.

From 1999 to 2001, Congress first considered steps to curb predatory loans — those that typically had high fees, significant prepayment penalties and ballooning monthly payments and were often issued to low-income borrowers. Foreclosures on such loans were on the rise, setting off a wave of personal bankruptcies.

But Mr. Gramm did everything he could to block the measures. In 2000, he refused to have his banking committee consider the proposals, an intervention hailed by the National Association of Mortgage Brokers as a “huge, huge step for us.”

A year later, he objected again when Democrats tried to stop lenders from being able to pursue claims in bankruptcy court against borrowers who had defaulted on predatory loans.

While acknowledging some abuses, Mr. Gramm argued that the measure would drive thousands of reputable lenders out of the housing market. And he told fellow senators the story of his mother and her mortgage.

“What incredible exploitation,” he said sarcastically. “As a result of that loan, at a 50 percent premium, so far as I am aware, she was the first person in her family, from Adam and Eve, ever to own her own home.”

Once again, he succeeded in putting off consideration of lending restrictions. His opposition infuriated consumer advocates. “He wouldn’t listen to reason,” said Margot Saunders of the National Consumer Law Center. “He would not allow himself to be persuaded that the free market would not be working.”

Speaking at a bankers’ conference that month, Mr. Gramm said the problem of predatory loans was not of the banks’ making. Instead, he faulted “predatory borrowers.” The American Banker, a trade publication, later reported that he was greeted “like a conquering hero.”

At the Altar of Wall Street

Mr. Gramm would sometimes speak with reverence about the nation’s financial markets, the trading and deal making that churn out wealth.

“When I am on Wall Street and I realize that that’s the very nerve center of American capitalism and I realize what capitalism has done for the working people of America, to me that’s a holy place,” he said at an April 2000 Senate hearing after a visit to New York.

That viewpoint — and concerns that Wall Street’s dominance was threatened by global competition and outdated regulations — shaped his agenda.

In late 1999, Mr. Gramm played a central role in what would be the most significant financial services legislation since the Depression. The Gramm-Leach-Bliley Act, as the measure was called, removed barriers between commercial and investment banks that had been instituted to reduce the risk of economic catastrophes. Long sought by the industry, the law would let commercial banks, securities firms and insurers become financial supermarkets offering an array of services.

The measure, which Mr. Gramm helped write and move through the Senate, also split up oversight of conglomerates among government agencies. The Securities and Exchange Commission, for example, would oversee the brokerage arm of a company. Bank regulators would supervise its banking operation. State insurance commissioners would examine the insurance business. But no single agency would have authority over the entire company.

“There was no attention given to how these regulators would interact with one another,” said Professor Cox of Duke. “Nobody was looking at the holes of the regulatory structure.”

The arrangement was a compromise required to get the law adopted. When the law was signed in November 1999, he proudly declared it “a deregulatory bill,” and added, “We have learned government is not the answer.”

In the final days of the Clinton administration a year later, Mr. Gramm celebrated another triumph. Determined to close the door on any future regulation of the emerging market of derivatives and swaps, he helped pushed through legislation that accomplished that goal.

Created to help companies and investors limit risk, swaps are contracts that typically work like a form of insurance. A bank concerned about rises in interest rates, for instance, can buy a derivatives instrument that would protect it from rate swings. Credit-default swaps, one type of derivative, could protect the holder of a mortgage security against a possible default.

Earlier laws had left the regulation issue sufficiently ambiguous, worrying Wall Street, the Clinton administration and lawmakers of both parties, who argued that too many restrictions would hurt financial activity and spur traders to take their business overseas. And while the Commodity Futures Trading Commission — under the leadership of Mr. Gramm’s wife, Wendy — had approved rules in 1989 and 1993 exempting some swaps and derivatives from regulation, there was still concern that step was not enough.

After Mrs. Gramm left the commission in 1993, several lawmakers proposed regulating derivatives. By spreading risks, they and other critics believed, such contracts made the system prone to cascading failures. Their proposals, though, went nowhere.

But late in the Clinton administration, Brooksley E. Born, who took over the agency Mrs. Gramm once led, raised the issue anew. Her suggestion for government regulations alarmed the markets and drew fierce opposition.

In November 1999, senior Clinton administration officials, including Treasury Secretary Lawrence H. Summers, joined by the Federal Reserve chairman, Alan Greenspan, and Arthur Levitt Jr., the head of the Securities and Exchange Commission, issued a report that instead recommended legislation exempting many kinds of derivatives from federal oversight.

Mr. Gramm helped lead the charge in Congress. Demanding even more freedom from regulators than the financial industry had sought, he persuaded colleagues and negotiated with senior administration officials, pushing so hard that he nearly scuttled the deal. “When I get in the red zone, I like to score,” Mr. Gramm told reporters at the time.

Finally, he had extracted enough. In December 2000, the Commodity Futures Modernization Act was passed as part of a larger bill by unanimous consent after Mr. Gramm dominated the Senate debate.

“This legislation is important to every American investor,” he said at the time. “It will keep our markets modern, efficient and innovative, and it guarantees that the United States will maintain its global dominance of financial markets.”

But some critics worried that the lack of oversight would allow abuses that could threaten the economy.

Frank Partnoy, a law professor at the University of San Diego and an expert on derivatives, said, “No one, including regulators, could get an accurate picture of this market. The consequences of that is that it left us in the dark for the last eight years.” And, he added, “Bad things happen when it’s dark.”

In 2002, Mr. Gramm left Congress, joining UBS as a senior investment banker and head of the company’s lobbying operation.

But he would not be abandoning Washington.

Lobbying From the Outside

Soon, he was helping persuade lawmakers to block Congressional Democrats’ efforts to combat predatory lending. He arranged meetings with executives and top Washington officials. He turned over his $1 million political action committee to a former aide to make donations to like-minded lawmakers.

Mr. Gramm, now 66, who declined to discuss his compensation at UBS, picked an opportune moment to move to Wall Street. Major financial institutions, including UBS, were growing, partly as a result of the Gramm-Leach-Bliley Act.

Increasingly, institutions were trading the derivatives instruments that Mr. Gramm had helped escape the scrutiny of regulators. UBS was collecting hundreds of millions of dollars from credit-default swaps. (Mr. Gramm said he was not involved in that activity at the bank.) In 2001, a year after passage of the commodities law, the derivatives market insured about $900 billion worth of credit; by last year, the number hadswelled to $62 trillion.

But as housing prices began to fall last year, foreclosure rates began to rise, particularly in regions where there had been heavy use of subprime loans. That set off a calamitous chain of events. The weak housing markets would create strains that eventually would have financial institutions around the world on the edge of collapse.

UBS was among them. The bank has declared nearly $50 billion in credit losses and write-downs since the start of last year, prompting a bailout of up to $60 billion by the Swiss government.

As Mr. Gramm’s record in Congress has come under attack amid all the turmoil, some former colleagues have come to his defense.

“He is a true dyed-in-the-wool free-market guy. He is very much a purist, an idealist, as he has a set of principles and he has never abandoned them,” said Peter G. Fitzgerald, a Republican and former senator from Illinois. “This notion of blaming the economic collapse on Phil Gramm is absurd to me.”

But Michael D. Donovan, a former S.E.C. lawyer, faulted Mr. Gramm for his insistence on deregulating the derivatives market.

“He was the architect, advocate and the most knowledgeable person in Congress on these topics,” Mr. Donovan said. “To me, Phil Gramm is the single most important reason for the current financial crisis.”

Mr. Gramm, ever the economics professor, disputes his critics’ analysis of the causes of the upheaval. He asserts that swaps, by enabling companies to insure themselves against defaults, have diminished, not increased, the effects of the declining housing markets.

“This is part of this myth of deregulation,” he said in the interview. “By and large, credit-default swaps have distributed the risks. They didn’t create it. The only reason people have focused on them is that some politicians don’t know a credit-default swap from a turnip.”

But many experts disagree, including some of Mr. Gramm’s former allies in Congress. They say the lack of oversight left the system vulnerable.

“The virtually unregulated over-the-counter market in credit-default swaps has played a significant role in the credit crisis, including the now $167 billion taxpayer rescue of A.I.G.,” Christopher Cox, the chairman of the S.E.C. and a former congressman, said Friday.

Mr. Gramm says that, given what has happened, there are modest regulatory changes he would favor, including requiring issuers of credit-default swaps to demonstrate that they have enough capital to back up their pledges. But his belief that government should intervene only minimally in markets is unshaken.

“They are saying there was 15 years of massive deregulation and that’s what caused the problem,” Mr. Gramm said of his critics. “I just don’t see any evidence of it.”

Original here

How to Bail Out GM

By Robert J. Samuelson

So it's come to this: General Motors, once the world's mightiest industrial enterprise, is now flirting with bankruptcy. Ford and Chrysler may not be far behind. Car and truck sales have collapsed. With cash reserves rapidly falling, GM may soon be unable to pay its bills. Here's the dilemma: GM and other U.S. automakers ought to be rescued to minimize damage to the economy, but the rescue should require tough conditions that neither the Democratic Congress nor the incoming Obama administration yet supports.
In a booming economy, a GM bankruptcy might be tolerable and useful. It would remind everyone of the social costs of mediocre management and overpriced unionized labor. But far from booming, the economy is declining at an apparently accelerating rate. By one survey, confidence among small businesses is at a 28-year low; in October, retail sales dropped a stunning 2.8 percent.

No one knows what further havoc a GM bankruptcy might inflict. The Center for Automotive Research (CAR) estimates an initial job loss of 2.5 million. The logic: If any of the "Big Three" went bankrupt, many suppliers would also fail; because car companies share suppliers, all U.S.-based manufacturers would suffer parts shortages. American production would virtually stop until new supplier arrangements emerged. "It takes 6,000 to 14,000 parts to make a vehicle," says Sean McAlinden, CAR's chief economist. "If you don't have one, you can't make it."

This may be too pessimistic. In a Chapter 11 bankruptcy, GM would "reorganize." It would suspend many existing debt payments and continue normal operations. Perhaps. The snag is that even in "reorganization," GM would require new loans that might be unavailable. "Historically, when companies go bankrupt, there's 'debtor in possession' financing -- investors lend you money, but they get repaid first. That market has evaporated because of the credit crunch," says auto analyst Rod Lache of Deutsche Bank.

Why run these risks when the 6.5 percent unemployment rate seems headed toward 8 percent? Just to satisfy a purist "free market" ideal? It doesn't make sense. But neither does it make sense simply to heave taxpayers' money at automakers. The goal is not to rescue the companies or workers; it's to shore up the economy and improve the U.S. industry's competitiveness. A bailout won't succeed unless other things also happen.

First, auto companies' existing creditors need to write down their debts. Even with federal aid, companies will shrink. McAlinden estimates that the country has surplus assembly capacity of about 4 million vehicles, much of it owned by the Big Three and destined to be shut. GM will need a $25 billion government loan to get through the recession and cover closing costs, says Lache. But GM already has $48 billion of debt. Unless the old debt is sharply written down, GM would be overburdened, and its rendezvous with bankruptcy would merely be delayed.

Second, labor costs need to be cut. By Lache's estimates, GM's hourly compensation -- wage plus fringe benefits -- totaled $71 in 2007, compared with $47 for Toyota's U.S. plants. Health benefits for retirees (many in their 50s, having retired after 30 years) are expensive. But the United Auto Workers opposes concessions. Government aid, says UAW President Ron Gettelfinger, is needed "so that auto companies can meet their health-care obligations to more than 780,000 retirees and dependents." The bailout should be more than union welfare.

Finally, automakers need a consistent energy policy. Congress demands that companies produce more fuel-efficient vehicles (35 miles per gallon by 2020, up from 25 mpg now). But politicians also want low gas prices. These goals are contradictory. To encourage consumers to buy fuel-efficient vehicles, Congress should mandate higher gas prices. Gasoline taxes could be raised gradually (say, a penny a month for four years, possibly offset by other tax cuts). Wild swings between low and high fuel prices have crippled the U.S. industry by erratically shifting buyer preferences -- to and from SUVs.

In bankruptcy, a judge can modify a firm's labor contracts and debts. GM needs the benefits of bankruptcy without the uncertainties, but the political process -- so far -- disdains that desirable bargain. The conditions that Democrats mention are mostly rhetorical gestures against high executive compensation and in favor of more fuel efficiency. The Bush administration resists additional assistance without saying why.

We are seeing the fallout of the open-ended $700 billion rescue of financial institutions. Boundaries need to be established. Who deserves support and why? Imposing tough conditions on automakers not only improves the odds of success but also -- by the sacrifices required -- makes the process sufficiently unpleasant to deter a stampede of other industries seeking handouts. In 1979, when the Carter administration rescued Chrysler from bankruptcy, the price was concessions from management, investors and labor. We should do as much.

Original here

If Detroit Falls, Foreign Makers Could Be Buffer

By LOUIS UCHITELLE

The failure of one or more of Detroit’s Big Three automakers would put a huge initial dent in American manufacturing, but in time foreign car companies would pick up the slack by stepping up production in their plants here, many industry experts and economists say.

Enlarge This Image

Bill Pugliano/Getty Images

More than 100,000 American workers, like those at this G.M. plant in Warren, Mich., could lose their jobs if G.M. failed.

Whether Washington should let that play out — risking hundreds of thousands of jobs — is a central question Congress will weigh this week as it hears testimony from Detroit leaders who are pushing for immediate federal intervention, before the next administration takes over in January.

“Barack Obama has made it clear he understands the importance of the industry. The question is, do we get that far?” Ron Gettelfinger, head of the United Auto Workers, said in an interview Friday, raising the prospect of a General Motors bankruptcy. “At this juncture, we are in a crisis that could have a major negative impact on this country.”

But many industry experts say the big foreign makers are established enough to take control of the industry and its vast supplier network more quickly than is widely understood.

“You would have an auto industry in the United States more like that of Mexico and Canada: foreign-owned,” said Sean McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Mich., which describes itself as a nonprofit organization that has “strong relationships with industry, government agencies, universities, research institutes, labor organizations” and other groups with an interest in the auto business.

The transition to that new equilibrium would surely be painful. The big American companies employ about 240,000 workers, and their suppliers an additional 2.3 million, amounting to nearly 2 percent of the nation’s work force.

The outright failure of General Motors would eliminate the biggest auto employer and more than 100,000 manufacturing jobs. That is roughly the number of jobs already lost this year at the nation’s automakers and their suppliers.

G.M. is rapidly running out of cash and appealing to Washington for a multibillion-dollar bailout to keep operating and continue the costly conversion to a leaner company producing efficient vehicles that people will buy.

G.M.’s collapse would probably bring down some of its suppliers as well. Since many of them ship parts and subassemblies to the other auto makers — domestic and foreign — auto production could be crippled until the supply system was reorganized around the newly dominant foreign car makers.

“The transplants, deprived of enough suppliers, would have to rely on imported vehicles while they scramble to reorganize the supply system,” Mr. McAlinden said, speaking of the foreign companies with manufacturing plants in the United States. “That would take them about a year.”

Given Chrysler’s weakness, the new kings of the auto industry would presumably be Toyota, Honda, Nissan, Volkswagen, Ford, Mercedes-Benz, BMW and Hyundai-Kia. (Volkswagen has not yet opened a plant in the United States, and BMW and Hyundai each have one plant.)

Like the Big Three, they would together dominate manufacturing in the United States, becoming big customers for steel, aluminum, plastics, glass, machine tools, computer chips and rubber.

Even in this year of plunging car sales, the automakers and their vast supplier network still account for 2.3 percent of the nation’s economic output, down from 3.1 percent in 2006 and as much as 5 percent in the 1990s, according to government data. More significant, economists say, 20 percent of the shrinking manufacturing sector is still tied to the automobile industry.

“I don’t think people appreciate the importance of this backward linkage to the rest of manufacturing,” said Sanford Jacoby, an economic historian at the University of California, Los Angeles. “The automakers play a big role in sustaining other manufacturers.”

Gradually, the auto industry has already become less American. The smallest of the Big Three, Chrysler, was owned for a while by the German company, Daimler, before it was returned to American ownership in the form of a privately held company in a much slimmer state than its once starring role in Detroit.

The American automakers, of course, have bought more and more parts from overseas. But 85 percent of their products are made in North America, compared with 60 percent for the foreign-owned automakers, said Dan Luria, research director at the Michigan Manufacturing Technology Center.

Vehicles built entirely abroad drive down the percentage at the foreign-owned automakers. The popular Toyota Prius, for example, is not yet manufactured in the United States. That will come soon, Toyota says. But given worldwide demand for the car, Toyota achieves economies of scale by centering production in Japan rather than using multiple sites.

Such an inclination on the part of foreign companies to keep their production out of the United States helps to explain the push by the Democrats in Congress to provide aid to keep the American automakers alive. The federal help would probably go first to G.M., which says it will run out of cash by early next year and be forced out of business without federal help.

Rather than collapse outright, a carmaker could file for bankruptcy protection. If it obtained financing, the company could then continue operating and slim down to a more manageable size, with cuts occurring over a period of months or years. But some of its operations could be taken over by another automaker or it could even be forced to liquidate.

“If the Big Three go down, a bunch of the suppliers go down, and the transplants share a number of the suppliers,” said Alan Reuther, director of the United Automobile Workers’ Washington office — trying in effect to enlist the foreign-owned makers in the effort to save the Big Three.

So far those manufacturers have stayed on the sidelines, avoiding any suggestion that they would like to see any of the American automakers disappear. “Toyota strongly believes that a strong market with vigorous competition is in everyone’s interest,” said Tina Ewald, a Toyota spokeswoman.

The Japanese automakers broke into the American market in the 1970s by exporting small, high-quality, fuel-efficient vehicles during an energy crisis. They began putting factories here in the 1980s, when import quotas and anti-Japanese sentiment threatened to restrict their American sales.

Fuel-efficient vehicles are still the strength of the Japanese and other foreign automakers at a time when such vehicles dominate what auto sales there still are in a rapidly sinking economy. The Big Three have not yet developed fuel-efficient cars as the mainstays of their fleets, and some in Congress are insisting they do that in exchange for any bailout.

But if the current downturn is prolonged, it might be too late. In an industry capable of making 17 million cars a year, sales have dropped to an annual rate of only 10 million vehicles made here.

“None of the Big Three — and perhaps not the transplants — can make money at 10 million,” Mr. Luria said. “The transplants are O.K. at 12 million and the Big Three at 15 million or so.”

Annual sales of autos and light trucks have been at least 15 million through most of the last decade.

The downsizing in response to the slump has been harsh. More than 100,000 jobs have disappeared since January at the automakers and their suppliers, one in every 10 jobs lost in the United States this year. The three American-owned companies were responsible for most of the loss. They employ 75 percent of the nation’s 333,000 total auto workers when foreign-owned companies are included.

The elimination of many more workers, most of them union members and earning upwards of $20 an hour, would be devastating in Michigan, Ohio and Indiana, where the American automakers and many of their suppliers are concentrated. In fact, many of those jobs may disappear even if the companies win government assistance.

But other employers would take their place over time. As the foreign companies stepped up production to replace what would be lost by an American company’s collapse, the transplants would add to their existing work force of 78,000, replacing many of the lost jobs, although at lower wages, with fewer benefits and at nonunion factories in other parts of the country.

The auto industry’s share of the gross domestic product would probably also revive, if the transplants were to build in the United States the vast majority of the cars they sold here, holding down imports.

Still, there would be one irreplaceable loss, Mr. McAlinden argued. “Right now, we do $18.5 billion of automotive research and development in a year,” he said, referring to innovative projects like the development of new types of batteries.

G.M. in particular is involved in the development of lithium ion batteries to power the next generation of cars. If G.M. disappeared, “the foreign companies would develop the batteries, but not here,” Mr. McAlinden predicted. “We would lose all the additional development connected to that technology. It would be a technology opportunity lost.”

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Drug dealers doing roaring trade on craigslist, say city investigators

BY PATRICE O'SHAUGHNESSY
DAILY NEWS STAFF WRITER

Drug dealing on craigslist has become so rampant that the city's special narcotics prosecutor has asked the online trading post to curb the ads, the Daily News has learned.

Bridget Brennan's undercover investigators have bought drugs offered on craigslist personals from dealers ranging from a Citigroup banker to an Ivy Leaguer to a violent felon using a halfway house computer. In the past four years, her office has prosecuted dozens of dealers.

"Ski lift tickets are here for sale ... Tina Turner tickets ... best seats around!" Offers like these appear virtually every day on craigslist, and they are thinly veiled ads posted by people hawking cocaine (ski) or crystal meth (cristina or tina).

"Despite devoting considerable resources to prosecuting these cases, drug dealing is still thriving on craigslist," Brennan wrote craigslist CEO Jim Buckmaster. Brennan said she was inspired to act by a recent agreement between craigslist and attorneys general from 40 states to curb prostitution ads.

"It's like shooting fish in a barrel," Brennan said of how easy it is to find dealers on craigslist.

One undercover said he just types "ski" in the search field and up pops ad after ad with offers.

"We respond to the ad, but it must lead to a meeting where the drug is exchanged for money, like any regular drug deal," the investigator said.

Ten days ago, craigslist unveiled sweeping new measures, in partnership with law enforcement and the National Center for Missing and Exploited Children, to stop its ads from being used for prostitution, child exploitation and other illegal activities.

Craigslist will require "erotic services" providers to pay $10 for each listing and pay with a credit card, which the police will be able to subpoena.

Brennan says the idea could be applied to drug ads.

"I would like members of my staff who have an expertise in prosecuting Internet drug sales to meet with you and explore ways to curb drug dealing on your Web site," her letter says.

In an interview, Brennan said the best course is "to work with them to screen out sellers. They would have to focus on commonly used terms and develop screening mechanisms.

"They'll offer ski tickets in July in New York, and Tina Turner tickets when she's not performing in town." Marijuana ads are more, er, blunt. It is usually referred to by name or as "420."

"We see lots of professionals, people with good jobs, doing it," Brennan said. "They are shocked to get caught."

One case involved a Citigroup vice president, Mark Rayner, 33, who was selling Ecstasy.

"Anyone want to go to roxy and get high and enjoy hex hector? E., K, Snow, tina, its all good," he wrote on craigslist.

He did the deal near his midtown office, giving an undercover agent 50 Ecstasy pills and 7 grams of cocaine for $1,200. He pleaded guilty to sale of a controlled substance and got five years' probation.

At the other end of the spectrum is Albert Rivera, aka Ray Rivera, 32, who was on parole for an armed robbery on a G train in 1994. While in a halfway house in Brooklyn, he engaged the undercover through craigslist.

He pleaded guilty and got a sentence of three to six months.

Craigslist did not respond to requests for comment.

poshaughnessy@nydailynews.com

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FBI agents speak out on injuries from faulty grenades

By Abbie Boudreau and Scott Zamost
CNN Special Investigations Unit

PHILADELPHIA, Pennsylvania (CNN) -- The explosion happened without warning around 4 a.m. in West Chester, Pennsylvania.

FBI agents were sitting in this car when a "flash-bang" grenade on one of the agents went off without warning.

FBI agent Donald Bain was sitting in his car in a parking lot with two other agents. He was armed and wore a Kevlar vest. He was also carrying a "flash-bang" grenade, a nonlethal weapon that emits a bright flash and deafening bang that's used to shock and disorient criminal suspects or the enemy in combat situations.

The three agents -- Bain, Thomas Scanzano and James Milligan -- were waiting for developments on a kidnapping that had turned into a hostage stakeout.

That's when, Bain says, the flash-bang grenade in his vest just blew up.

"The car is on fire," Bain recalled. "I was told later I was on fire. Smoke billowing in the car. It was obviously chaos."

Scanzano remembers "it was like being in combat. There was smoke and fire in the vehicle, and I knew that we were in trouble."

An ambulance rushed the three agents to a nearby hospital.

"To me, it felt like someone just whacked me in the back with a baseball bat as hard as they could," said Bain, recalling the incident, which happened four years ago.

Bain suffered severe bruising, a concussion and burns to his neck and ears. All three agents said they have experienced hearing loss.

"There was smoke, and it was like a grenade going off in the car," Scanzano said.

The company that manufactured the flash-bang grenade that Bain used is Pyrotechnic Specialties Inc., also known as PSI, based in Byron, Georgia.

Earlier this year, PSI, its chief operating officer, David Karlson, and three other defendants were indicted for fraud, conspiracy and money laundering. According to the federal indictment, PSI had a $15 million contract to supply flash-bang grenades to the military before it supplied them to the FBI.

The indictment states the company knew its flash bangs were defective and even knew how to fix those flaws, which would have cost PSI $3.72 per unit.

But, according to the indictment, many of the defective grenades the military was using were relabeled and then sold to the FBI and other local law enforcement agencies.

"In order to sell diversionary charges which had been rejected by, and were otherwise unacceptable to the Department of Defense, the defendants developed a scheme and artifice to defraud, and attempt to defraud, the United States of America, as well as state and local law enforcement agencies," the indictment states.

In a court filing, PSI's attorneys state the "indictment is lacking in detail, vague and/or confusing, however, either in regard to what particular conduct by PSI or Mr. Karlson is alleged to be wrongful; or what particular laws, regulations, rules or other authorities rendered any alleged conduct by PSI or Mr. Karlson wrongful, as well as many other areas."

CNN tried to speak with Karlson at PSI headquarters, but he would not comment. PSI attorney Craig Gillen also declined to comment. Send CNN's Abbie Boudreau your thoughts about this story

The criminal trial is scheduled to begin in January in Macon, Georgia. No court date has been set for the civil lawsuits.

"It drives me crazy," Scanzano said. "I don't sleep. I have tremendous headaches. I have the doctors claim severe hearing loss, but for all practical purposes, I'm deaf in my left ear."

Andrew J. Stern, a Philadelphia attorney, has filed civil suits against PSI on behalf of the three FBI agents.

"I don't know how someone looks themselves in the mirror every day in light of the kind of things that have happened here," Stern told CNN.

Stern has also filed a civil lawsuit against PSI on behalf of Dean Wagner, a master sergeant in the Army who also said he was seriously injured by a flash-bang grenade that he says prematurely detonated and was manufactured by PSI.

An emotional Wagner told CNN he was days away from finishing his second tour in Iraq when he was putting away his flash bangs. One of them exploded, severely damaging his right hand. The injuries were so severe that he ended up having his hand amputated.

Wagner said PSI officials have no idea how the incident has affected his life.

"They don't have a clue what it's like," Wagner said. "If they could experience that, or someone close to them would have to go through that experience, I'm sure it would be a different story and maybe they wouldn't have allowed it to happen."

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Inhofe: Cancel the 'blank check'

By JIM MYERS World Washington Bureau

He criticizes Henry Paulson for changing the $700 billion bailout plan.

WASHINGTON — U.S. Sen. Jim Inhofe said Saturday that Congress was not told the truth about the bailout of the nation's financial system and should take back what is left of the $700 billion "blank check'' it gave the Bush administration.

"It is just outrageous that the American people don't know that Congress doesn't know how much money he (Treasury Secretary Henry Paulson) has given away to anyone,'' the Oklahoma Republican told the Tulsa World.

"It could be to his friends. It could be to anybody else. We don't know. There is no way of knowing.''

Inhofe's comments, unusually pointed even for a senator known for being blunt, come on the heels of Paulson's shift in how he thinks the bailout funds should be spent.

Last week the Treasury secretary announced he was abandoning his plan to free up the nation's credit system by buying up toxic assets from troubled financial institutions. Instead, Paulson wants to take a more direct action on the consumer credit front.

"He was able to get this authority from Congress predicated on what he was going to do, and then he didn't do it,'' Inhofe said.

"So,

that's enough reason right there.''

Inhofe recalled earlier comments opposing Paulson's plan because the administration's point man did not have answers for a number of questions. He also recalled questioning the rush to get the bailout passed.

"I have learned a long time ago. When they come up and say this has to be done and has to be done immediately, there is no other way of doing it, you have to sit back and take a deep breath and nine times out of 10 they are not telling the truth,'' he said.

"And this is one of those nine times.''

Inhofe has laid out his legislative plans for this week on the bailout package in a letter to his Senate colleagues.

He wants to freeze what is left of the initial $350 billion — reportedly $60 billion, but Inhofe concedes he does not know for sure.

Then he wants a provision requiring an affirmative vote by Congress before Paulson can get his hands on the second $350 billion of bailout money.

Current law lays out a scenario where President Bush submits a plan on the second half of the funding.

Lawmakers have 15 days to disapprove it, but Inhofe questions that wording.

"Congress abdicated its constitutional responsibility by signing a truly blank check over to the Treasury Secretary,'' he wrote.

"However, the lame duck session of Congress offers us a tremendous opportunity to change course. We should take it.''

In the interview, the senator said his plans can provide "redemption'' for those senators who supported Paulson.

Inhofe's plan appears to be a long shot at this point. Senators originally approved the bailout plan by a 74-25 vote.

He does not know how much support he has among his Republican colleagues, and he concedes Democratic leaders could block it.

Bush also could veto it if it were to make it out of Congress.

Neither Senate Majority Leader Harry Reid's office nor the Treasury Department commented.

Reid, D-Nev., wants to use the upcoming lame duck session to push economic issues such as extending unemployment benefits and aid to the nation's ailing auto industry.

Inhofe opposes both.

"You don't stimulate the economy by giving away more money,'' he said.

In response to concerns expressed by some that allowing even one of the big automakers to fail would be too much of an economic hit for the nation, Inhofe said reality must be accepted.

"If we keep on nursing a broken system, then we can't expect to have a different result come later on,'' he said.

"I just think we have to draw the line someplace, and the time is here.''

---

Jim Myers (202) 484-1424
jim.myers@tulsaworld.com

By JIM MYERS World Washington Bureau

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Vacant homes, fewer people. This is Vegas?

By Brian Wargo

Sun Archives

• Measuring population in moving boxes (8-4-2008)
• Local downturn a hiccup or augur of a bleak future? (7-20-2008)

For all the numbers that define Clark County and its economic woes, this one may be the most startling:

Clark County, for years the fastest-growing area in the country, has shrunk in population by at least one measure: the growing number of empty residences.

The county’s most recent population estimate, in July, shows a loss of about 10,000 people since its last estimate, in July 2007.

The estimate is based on the number of vacant homes, condos and apartments in the county. Because residents displaced by foreclosures might have moved in with others, the population drop may not be as dramatic as estimated.

Undisputed, however, is the exodus from Clark County of workers in the homebuilding industry over the past

1 1/2 years.

The last major population drop occurred in the late 1920s, when the mining industry soured.

“It is a real important reflection of the breadth and depth of the recession we are seeing today,” said John Restrepo, an economist and principal at Restrepo Consulting Group. “Clark County has been one of the fastest-growing counties in the country for 20 years, and now we are not seeing growth.”

Clark County estimates this year’s population on July 1 was 1,986,146, down from 1,996,542 on July 1, 2007.

The decline came after 10 straight years of population increases averaging more than 60,000 and after Clark County officials boasted last fall that the county’s population had surpassed 2 million.

The Las Vegas metropolitan area was the fastest growing, by percentage, in the United States during the 1990s, and ranked fifth fastest growing from 2000 to 2005.

A reversal of the longtime growth trend is yet another shock to the foundation of the Las Vegas economy, analysts said.

Experts have long thought the lure of jobs fueled by the regular addition of giant Strip resorts and increasingly luxurious casinos in the locals market would ensure continuous growth.

In the past year, Palazzo opened on the Strip and the Eastside Cannery opened on Boulder Highway. Encore at Wynn Las Vegas is slated to open next month.

Yet the addition of more than 10,000 jobs was more than offset by the recession, sharply rising unemployment and a stagnant homebuilding industry.

For the number crunchers who have spent years studying the rapid rate of Clark County population growth, the decline is a jolt to the system.

“It tells us that we are much more connected to the national economy than people have thought in the past,” said Jon Wardlaw, the county assistant planning manager and demographer.

Clark County calculates its population based on the number of households and their occupancy rate. Wardlaw said the housing vacancy rate rose from 4.5 percent to 7 percent.

“There are more houses and apartments with nobody in them,” Wardlaw said. “They are either moving away or in with relatives, or combining households with someone.”

State Demographer Jeff Hardcastle said he is poring over data to come up with his own population estimate for Clark County.

Jeremy Aguero, a principal at Applied Analysis, said the numbers may not so much suggest the county’s population is shrinking as much as indicate a correction of previous overestimates.

“I don’t think we have lost population as much as we didn’t have as much as we thought we did in 2006 and 2007,” Aguero said.

Experts said the biggest culprit for any drop in population is the loss of about 10,000 construction jobs in the past year. Casinos have also been trimming jobs. The jobless rate rose to 7.3 percent in September.

A version of this story appeared in this week’s In Business Las Vegas, a sister publication of the Sun.

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Iraq's Cabinet approves U.S. security pact

BAGHDAD, Iraq (CNN) -- The Iraqi Cabinet on Sunday approved a security pact that would set the terms for U.S. troops in Iraq.

Members of the Iraqi Cabinet vote on the security agreement Sunday in Baghdad.

1 of 2

The agreement sets June 30, 2009, as the deadline for U.S. troops to withdraw from all Iraqi cities and towns, Iraqi government spokesman Ali al-Dabbagh said.

The date for all troops to leave Iraq will be December 31, 2011, he said.

These dates are "set and fixed" and are "not subject to the circumstances on the ground," he said.

Twenty-seven of the 40 Cabinet members in attendance voted in favor of the agreement, said Iraqi Foreign Minister Hoshyar Zebari. One minister abstained.

The Cabinet consists of the prime minister, two deputy prime ministers and 37 other ministers.

The approved draft will be sent to the Council of Representatives, Iraq's 275-seat parliament, where it will be put to another vote. "There is great optimism that they will pass it," said Industry Minister Fawzi Hariri.

Al-Dabbagh said the parliament speaker and his deputies will decide when the parliament will vote on the agreement. He said there were "positive attitudes" when the major political blocs met to discuss the draft plan on Saturday.

Under the Iraqi constitution, parliamentary approval is required for measures such as this agreement to take effect.

Al-Dabbagh told CNN it appeared that "most of the political parties had approved and agreed on the final draft. ... It is a good agreement that fulfills both Iraqi and U.S. interests and respects the sovereignty of Iraq."

Zebari said the parliament will reach a decision before it takes a 15-day recess on November 25.

In Washington, a spokesman for the National Security Council described the agreement as "an important and positive step."

"While the process is not yet complete, we remain hopeful and confident we'll soon have an agreement that serves both the people of Iraq and the United States well, and sends a signal to the region and the world that both our governments are committed to a stable, secure and democratic Iraq," said Gordon Johndroe.

"While there is still much work to be done, U.S. forces continue to return home and there will be 14 Brigade Combat Teams at the end of this year, down from 20 at the height of the surge," he added.

Earlier, Sami al-Askari, an adviser to the Iraqi prime minister, said the draft included changes that made it "satisfactory" for the Iraqis.

For months, the United States and Iraq have been negotiating a proposed status of forces agreement. It would set the terms for U.S. troops in Iraq after the U.N. mandate on their presence expires at the end of this year.

Many Iraqi officials say they will oppose any deal that hints at compromising the country's sovereignty.

Iraqi cleric Grand Ayatollah Ali al-Sistani said in a statement on his official Web site last week that he will "forbid any stance that targets the sovereignty of Iraq no matter how small it is."

In late October, Iraqi officials submitted several amendments to the draft plan to U.S. negotiators in Baghdad.

Zebari said at the time that the proposed changes called for a fixed timetable for U.S. troop withdrawal; a specific number of sites and locations that would be used by the U.S. military; and Iraqi jurisdiction over U.S. forces who commit certain crimes in Iraq.

Al-Dabbagh said the Cabinet on Sunday also approved a "draft framework" agreement between the U.S. and Iraq.

This agreement "establishes the principles of cooperation and friendship in the political, diplomatic, educational, health and environmental fields in addition to economic, energy, information technology, communication fields," al-Dabbagh said.

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