Why are some members of Congress opposed to investigating and punishing war profiteering?

The following is the text of a commentary delivered by Michael Meeropol over WAMC radio on October 6, 2006.

Did you know that the US Congress has rejected efforts to punish, investigate and criminalize war profiteering?

Yes, that’s right. This past February, the House on a mostly party-line vote rejected an effort to forbid expenditures from going to any contractor, “…if the Defense contractor audit agency has determined that more than $100,000.000 of the contractor’s costs involving work in Iraq … were unreasonable.”[1]

Meanwhile, the Senate on an equally party-line vote, rejected an amendment to an appropriation bill “to prohibit profiteering and fraud relating to military action, relief and reconstruction…”[2]

What’s going on here?

The key to understanding this issue is in attempting to define the term “war profiteering.” Can we be precise or must we accept an “I know it when I see it” position as did former Supreme Court Justice Potter Stewart, about pornography?[3]

Whenever a nation goes to war and buys supplies and equipment from private businesses, unless the government forces businesses to sell at a loss, the deal will lead to increased profits. But profiteering and merely profiting are different concepts. Profiteering implies that profits are too high. But how is that possible? How can a price voluntarily arrived at between two parties – one party the US government – be too high?

Well – one way is if the business fails to deliver the product promised. The business gets its money and the government gets little or nothing of what was promised. Anecdotal evidence abounds in any war -- [4]

This is clearly fraud – and should be punished severely.

But what if the product paid for is actually delivered – how do we define war profiteering then? The only economic argument would be that the price charged and the profit earned is much higher than the price and profit that would have been high enough to induce the business to supply the particular product --- In other words, if there were no war, the business would be satisfied to get, say, a 20 % profit – but now they’re getting 40%.[5]

Why does a business gets such a great deal? Because there’s little or no competition – and because the government is very anxious to get production started quickly. Because the stakes in wartime are so high, these extra costs don’t seem to matter at the time – But of course they do.

The House Bill proposed to allow the Pentagon’s own internal audit agency to investigate whether any defense contractor was either padding costs in order to commit fraud or overcharging in other ways. Note that each contractor under that proposed bill would have $99 million in “wiggle room” --- only “unreasonable” charges over $100 million would trigger sanctions.

During the Korean War Congress decided that all businesses were probably going to earn quite high profits and an excess profits tax was imposed. They didn’t even bother to discriminate between unreasonably high profits and just high profits. That made some sense because it is difficult to prove that a specific cost charged is “unreasonable…” Such an allegation would certainly be contested and the time it would take to settle the matter would be time wasted and remember there’s a war on![6]

So there was an excess profits tax during the Korean War. By the way, this very high tax did not interfere with procurement – there is no evidence that Korean War soldiers were short on equipment.

Given the Bush Administration’s unwillingness to support any tax increase, the Korean War solution was never an option during this war. So why weren’t the proposals aimed at punishing and investigating specific acts of war profiteering unanimously approved? -- Why were they defeated in partisan votes?

The answer lies in the difficulty of proving the existence of war profiteering. What Republicans probably feared was that efforts to punish war profiteers would degenerate into a partisan effort to make the President and his big business buddies look bad – with lots of charges and no real resolution of the problem. An effort ostensibly to pursue war profiteers would in the end contribute to reducing the public’s support for Bush’s war.

I would guess that’s why Republicans including NY State Republicans voted against it.[7]


[1] The references is to an amendment to a Defense Appropriations bill. The bill was H.R. 4939. The amendment was H.AMDT.746: The amendment called for inserting the following: \ SEC. __. None of the funds appropriated or otherwise made available by this Act shall be obligated or expended by the Secretary of the Army or his designee to award a contract to any contractor if the Defense Contract Audit Agency has determined that more than $100,000,000 of the contractor's costs for contracts involving work in Iraq under one or more Army contracts were unreasonable.

[2] Even more significantly, a proposal by Senator Byron Dorgan of North Dakota to establish a system for investigating fraud and abuse has never even made it out of committee. (S. 2361)

[3] One can find the quote at the following web site: htp://www.brainyquote.com/quotes/quotes/p/potterstew117308.html
The actual full quote is “I shall not today attempt to define this kind of material but I know it when I see it.”
For a full background discussion see Movie Day at the Supreme Court or "I Know It When I See It": A History of the Definition of Obscenity by Judith Silver at http://library.findlaw.com/2003/May/15/132747.html#Scene_1
[4] During World War II, a Senator from Missouri, Harry S. Truman made a name for himself by driving, “…thousands of miles around the country going from one defense plant to another documenting waste and fraud. [Truman] then headed the Senate Special Committee to Investigate the National Defense Program -- the Truman committee, for short. The process saved American taxpayers $15 billion (in 1940s dollars). And by uncovering faulty military equipment, he prevented the deaths of hundreds if not thousands of U.S. soldiers.” The quote is from an OP-ED piece in the St. Louis Post-Dispatch entitled Fighting War Profiteering, Truman Style by Sarah Williams posted on the AlterNet web site on March 6, 2006March 6, 2006http://www.alternet.org/story/33131/ Unfortunately, there is much evidence that a lot of the same is happening in Ira q. The article goes on to mention a few examples. For more details, there is a new documentary by Robert Greenwald called IRAQ FOR SALE. At their web site, iraqforsale.org there are a number of links and a number of references to books that specifically relate to war profiteering in the current war.

[5]Economists call this return “rent.” For economists rent is not what you pay the landlord. Instead it is a payment over and above the payment that would induce you to sell a product or provide a service. Imagine you own a house on a small (1/2 acre) piece of land overlooking the ocean and you want to sell it. You bought it ten years ago for $200,000 and if you had invested the $200,000 in the stock market you would have averaged a rate of return of, say, 10% a year. That would have doubled the value of your $200,000 investment. One might say that any payment above $400,000 (let’s fix on $420,000) for that piece of land would be sufficiently high enough to induce you to sell. However, this year, there are 3 or 4 millionaires anxious to buy that house. You know if because a house right next door to you sold for $1 million. So you get them bidding against each other and you end up getting $1.2 million. The difference between the $420,000 you would have been willing to sell for and the $1.2 million you received is called “rent.” It is a pure return to scarcity and does not reflect what economists call the opportunity cost of the land and house. In the case of military contracting – the company would make a fine profit at a much lower price but the government is in a hurry and does not carefully scrutinize the details of the bid and does not put enough fine print in their to control the behavior of the military contractor and the result is that the government pays much more than it had to pay and the company makes more than the product is actually worth in terms of real costs.

[6] The Korean War began in the summer of 1950. During the fiscal year 1951, individual income tax revenues rose from 15.8 to 21.6 billion dollars while corporation income tax revenues rose from 10.4 to 14.1 billion. Total federal receipts rose from 14.4 percent of GDP in fiscla 1950 to 16.1 percent in fiscal 1951 to 19.0 percent in fiscal 1952. In fiscal 1953 which was the year of prolonged negotiations till the armistice was signed that summer, receipts fell to 18.7 percent of GDP. The tax increases were so significant that in fiscal 1951, even though defense expenditures rose from 5 to 7.4% of GDP the budget went from a small deficit (-1.1% of GDP) to a small surplus (1.9% of GDP). [See Economic Report of the President (any year) Tables B-79 and B-80.]

[7]You can inspect the votes of Representatives at the following site: http://home.ourfuture.org/straighttalklive/war-profiteers_house.html
A quick check shows one NY State Republican, Representative John Sweeney as not voting. The New Hampshire Republicans split with Jeb Bradley voting yes and Charles Bass voting no. New Jersey members of Congress split perfectly along party lines while Rob Simmons was the only Connecticut Republican to vote yes.

THe Housing Bubble is Deflating

The following is the text of a commentary delivered over WAMC radio by Michael Meeropol on September 1, 2006.

WHAT DOES THE HOUSING BUBBLE MEAN FOR US?[1]

Have you been worrying about being able to afford to buy a house? Or worrying about how long it’s taking you to sell your house? Or worrying that your house has been losing value on the market? Welcome to the world of the housing bubble.

Last week, on Friday and again on Sunday, the New York Times in four separate pieces weighed in on the question.[2] There was unanimous agreement that there is, indeed, a bubble in the value of real estate that has started to deflate but is that bubble in danger of popping?

Let’s start at the beginning. What do we mean by a “bubble in the value of real estate?”
We start with “supply and demand.” The price of housing depends on the supply of newly built homes and those placed on the market by individuals wishing to move. The demand is the desire of those with sufficient income to purchase these homes.[3]
If a price is determined by the interaction of supply and demand with a large number of buyers and sellers (so as to ensure competition), most economists would argue that this market price is the “right” price. So what’s a bubble?

The term “bubble” describes a situation where the price of something rises way out of proportion to its “real value.” So when is a market price not the “right” price but a “bubble” price?

Recall the demand side of supply and demand. Demand includes the ability to purchase (you have to have sufficient income to offer cash or to qualify for a mortgage as in the case of most real estate transactions) coupled with a desire to purchase.

Suppose your desire to purchase is based on the fear that if you don’t buy now, the price will go up so much that you won’t be able to afford to buy later. Suppose your desire to purchase is based on the speculative assumption that no matter how high the price is, it will keep going up and you’ll always be able to sell it at a profit in the future? If enough people believe that prices will continue to go up, then they will pay a high price today in anticipation of having to pay an even higher price tomorrow.[4]

Also, the phenomenal increases in incomes recently achieved by the top 10% of the population allow those individuals to pay rising astronomical prices.[5]

Note, in these cases, demand is based not only on the desire to buy a house to live in it but on those wild expectations of ever increasing prices. This creates a speculation in real estate and the momentum feeds on itself. This can go on for years. Robert Schiller, the man who helped coin the phrase “irrational exuberance” made famous by Alan Greenspan, calculates that this bubble has driven existing home prices to unprecedented heights since 2000.[6]

It is clear, now, that the bubble is contracting. Those wildly optimistic expectations have now been replaced by more realistic ones.

The question is, will prices fall slowly or precipitously – and will the fall affect the entire economy or be restricted just to the real estate industry?

The fear is that as prices fall and construction activity slows, not only will the economy take a hit as construction spending declines, but people will stop taking out home equity loans and thus slow down their personal consumption expenditures. The resulting decline in spending is something we all need to worry about.[7]

Since 2000, the housing bubble has carried the economy – real estate has accounted for 44 percent of all the jobs created.[8] Those who believe the deflation of the bubble will do no harm to the rest of the economy are counting on private business investment to pick up the slack.

But investors need to believe there will be consumers for their increased production and if people carrying big mortgages experience declining home equity and decide to slow down spending, then investors will not invest. The deflating bubble could mean trouble for all of us, not just those who can’t sell their houses.


[1] I would like to acknowledge by debt to Dean Baker, director of the Center for Economic Policy Research for alerting me to the existence of the housing bubble years ago. I urge anyone interested in this issue to check out the CEPR www.cepr.net where there are numerous articles on the housing bubble.

[2] On the OP-ED page, columnist Paul Krugman wrote “Housing Gets Ugly” (New York Times, 8/25/06: A23) in which he asserted that there is now no question that there has been a housing bubble and the only remaining question is whether the deflation will be slow enough to create a “soft landing” or whether the bubble will “pop” leading to a precipitous decline in housing prices which would produce at the very least a “housing led recession.” Two news articles complemented his column that same day. “New-Home Sales and Goods Orders Fall Markedly” (New York Times, 8/25/06: C-3) stated that in July new home sales fell at an annual rate of 4.3%, home sales (all homes) fell below the pace initially predicted and inventories (homes waiting to be sold) “jumped to a 10-year high, pointing to a rapidly cooling housing market.” As if that weren’t enough evidence, the article also reported that “The supply of homes available for sale … rose to 6.5 months, the highest since a 6.8 month supply in November 1995.” The other article described in detail the various “sweeteners” that sellers in the high end market (over $1 million) were adding to their homes in order to sell them without reducing the published price. (“Homes for Sale, By Anxious Owner: Sweetened Deals in a Slow Market” by V. Bajaj and D. Leonhardt, New York Times, 8/25/06: C1). On Sunday, August 27 there was a detailed article about the deflation of the housing bubble asked whether the result will be “A soft landing, a long slump, or a hard crash?” (See D. Leonhardt and V. Bajaj, “Read Between All Those For-Sale Signs” New York Times; Section 4, p. 1)

[3]Technically, supply and demand are a series of price-quantity alternatives in the minds of all the buyers and sellers in any given market. In the case of housing, sellers are all those who might potentially sell their house (in other words supply in the economists sense is not just those homes on the market – the number of homes currently on the market represents some “points” on the total supply curve). However, in the real world, people usually think of the supply of something as the actual number being offered for sale. Those who “demand” housing are those currently in the market to buy housing. Unlike the inventory of houses for sale, this number is harder to estimate. It would require reading the mind of virtually everyone who could afford to buy a house!! Nevertheless, it is often indirectly measured by how long houses stay on the market and what is happening to the price of houses. If homes stay on the market a short period of time and their prices are rising, we can say there is “strong demand” for housing. By contrast, if homes stay on the market a longer period of time and the prices are falling, we say there is “slack demand” or even “falling demand” for housing.

[4]The demand side of the market is obviously based on the incomes of the individuals who might consider purchasing a particular product as well as their tastes and preferences (Americans, for example, have a much greater desire to own their own homes than many Europeans which is why homeownership is so widespread in this country as opposed to equally affluent countries in Europe) and the prices of alternative things they might buy. In addition, expectations of future price movements and future income play a major role, especially in a “big ticket” purchase like a home. (For most Americans it is the largest single purchase they will make in their lifetime.) A rise in positive expectations will increase the number of people willing to buy a house at the current price and even increase the desire of people to buy houses at a higher price than today. This latter phenomenon explains why prices of houses can have risen so rapidly since 2000 and yet the sales of new and existing homes has also risen rapidly.

[5]Most commentators have not focused on this point but it is extremely important. Median incomes have not grown very much. Median real wages have actually not grown at all during the current recovery. (See S. Greenhouse and D. Leonhardt, “Real Wages Fail to Match a Rise in Productivity” New York Times, 8/28, 06: A-1. See the table on p. A-13 for details. “Even for workers in the 90th percentile of earners – making about $80,000 a year – inflation has outpaced their pay increases over the last three years …”) Though much of the earnings of the super-rich come in the form of income from the ownership of property – particularly stocks but including real estate – wages received by the top 10% and 1% of salary and wage recipients have grown much faster than average wages so that the share of wages going to these top groups has also risen significantly. When high income individuals bailed out of the stock market after the stock market bubble burst beginning in June of 2000, many of them chose to invest in real estate which created the white hot “high end” market. This market was featured in a New York Times Magazine story in the Fall of 2005 about the largest company specializing in building what have derisively come to be called “McMansions”. At that time, Robert Toll, the CEO of Toll Brothers argued that the boom would go on forever. He noted that when it comes to supply and demand for housing for millionaires, his company had the supply and the millionaires were creating the demand. In answer to a question about why he was so optimistic about the luxury home market, he told the University of Pennsylvania Law School Alumni Magazine: “I don’t see any reason for it not to continue to be a good market. The doomsayers are predicting that there will be an implosion that will come from the recognition that the market is just floating on air and not sustainable and that it’s going to wreak havoc on the economy. I think that’s a lot of bull. I think housing price escalation will continue. It won’t be as fast as it’s been in some markets but it’s not going to be as slow as it was. The creation of wealth has been phenomenal. Families making $100,000 or more have grown six times faster than the general population. The population has grown by 80 million in the last 30 years. (Yet) we’re building fewer homes on average this decade than we did in the 1970s. So with this tremendous growth in population, tremendous growth in wealth and slackening supply, you get a great imbalance, and when supply dwindles and demand grows what gives is price.” (See http://www.law.upenn.edu/alumnijournal/fall2005/alumni_briefs/page03.html) However, on August 22, 2006 we discover from Business Week online that:
“Luxury home builder Toll Brothers Inc. said Tuesday [August 22] that its third-quarter profits fell by 19 percent as the housing-market malaise weighed on sales and caused the company to abandon some building locations. The Horsham, Pa.-based company also cut its earnings estimate for the full year, signaling that it doesn't expect the housing market to stabilize soon. Investors have given up on flipping properties for a quick profit and builders have slashed prices to move homes, especially on the luxury end.Robert Toll, chairman and chief executive, told analysts during a conference call that he doesn't yet see signs of improvement nationwide. ‘I don't see a turnaround in any of the markets,’ he said. ‘I don't see any forming a bottom’."
(http://www.businessweek.com/ap/financialnews/D8JLMKV80.htm?sub=apn_home_up%26chan=db). In other words, despite Mr. Toll’s assertions last October, the demand at that time was in fact “floating on air” – the hot air of unrealizable speculation – a classic case of a bubble.

[6]Shiller is a Professor of Economics at Yale University and he was briefing Alan Greenspan in December, 1996 about the danger of a stock market bubble. He described the markets at that time as “irrational” and two days later Greenspan shocked the stock market by using the term “irrational exuberance”in a speech delivered before the American Enterprise Institute. [See Robert Shiller, Irrational Exuberance (Princeton, Princeton University Press, 2005): 1 and the endnote on 231] Unfortunately, in order to reduce the danger of a market slump in response to his statement, Greenspan began to backtrack and for the rest of the 1990s was actually a cheerleader for the stock market gains, refusing to support, for example, the raising of margin requirements on the sale of stock to calm down the speculative mania that ultimately led to the dot-com bust. Shiller’s book Irrational Exuberance was initially published in 2000 and fortuitously it came out just as the stock market peaked and began to slide. In 2005 he published a second edition in which he wrote a new chapter focusing on the real estate bubble. (See Ibid: 13)

[7]Much of the mortgage refinancing since 2001 has been a result of lower interest rates. But often what comes with it is a utilization of the equity built up in a home as a result of the rise in its sale price to increase current consumption. If home prices stop rising, then people will not be able to re-finance and turn their accumulated equity into current consumption. We can see how this has affected consumer behavior by measuring consumption outlays (personal consumption expenditures plus interest payments and transfer payments to other individuals) against disposable personal income. For most of the decade of the 1990s, the ratio was between 93 and 95% but in the last three years of the 20th century as a result of the stock market boom, many people felt secure enough to increase their personal consumption expenditures so that in many cases it exceeded their current incomes. This is an example of what economists call the “wealth effect,” the idea that if the stock you own goes up in value you don’t have to save as much so you can consume all of your current income and even increase your indebtedness. This led to personal outlays over 96% in the last three years of the 20th century. The same principle is on display during the early years of the 21st century when people see the values of their houses increase and they therefore borrow that equity and spend it. The ratio of personal outlays to disposable personal income was above 97% for the first years of the decade and over 100% (leading to a negative personal savings rate) in 2005. [See Economic Report of the President, 2006: 318]

Unfortunately, when the value of housing stops rising and interest rates rise so that refinancing is no longer attractive, that increase in consumption virtually stops. That is what is beginning to happen now (Fall, 2006).

[8] See D. Leonhardt and V. Bajaj, “Read Between All Those For-Sale Signs” New York Times; August 27, 2006: Section 4, p. 1.