NDN Blog

The Housing Crisis and Our National Attitudes Towards Saving

The Great Depression deeply affected the attitudes of the generation that came of age in the 1920s and 1930s. For example, it made the country thriftier and more Democratic. It took two full generations for other social changes to turn us into a society that was more Republican and saved much less -- shifts led, as before, by those who came of age in the bleak times of the 1970s. Our current economic upheavals are the most serious since the 1930s, so it’s appropriate to consider how they may affect American attitudes going forward. And the early surveys suggest that those who came of age during this crisis -- the Millennials born from 1982 to 2000 -- and now America’s largest generation by sheer numbers — already embody distinctive attitudes.

One way to glimpse how these tough times may affect our national psychology is to understand the forces that make times so tough. We’ll start today with an aspect close to people’s sense of themselves: their homes, or more generally, housing. We’ve all now lived through an historic housing bubble which, to begin, was very different socially from most bubbles in history: Unlike tulips, the South Seas, the 1920s stock market or other famous bubbles, this one was not primarily the business of speculators and affluent people. Nearly 70 percent of Americans own their houses, including most middle-class people as well as a broad swath of moderate and even low-income families. So, this bubble’s impact is being felt very broadly. That should be no surprise, since we give home purchases super-sized tax breaks and regulatory subsidies.

The irony is that while we go out of our way to encourage Americans to put their savings in this basket, in the form of home equity, we also encourage them to keep those savings small. First, we provide a large mortgage deduction which encourages people to buy houses -- and to buy way above what they could afford, but for that deduction. That’s one reason why housing prices generally trend upwards. But the way we provide the deduction actually cuts against saving much, since the deduction isn’t for what we “save” by owning our houses -- there’s no tax break for the downpayment, for example. Instead, it effectively encourages people to save relatively little, since they get to deduct only the interest on the mortgage loan, which represents what they don’t own or “save.”  The natural result is that most people borrow 90 or 95 percent of the value of their house --  just as Bear Stearns and Lehman Brothers did. We also encourage people to keep their “savings” in housing small, by providing tax breaks for them to pull out the equity in their houses in the form of tax-preferred refinancing and home equity loans.

The result is that large numbers of people end up saving relatively little by owning their houses -- and that’s especially the case when a housing bubble creates an illusion of significant savings. Federal Reserve data show that people’s home equity, or what they “save” through their homeownership, as a share of the value of their homes, has been generally falling for 60 years — which happens to be the time period since we enacted the major tax preferences for housing. Moreover, since 1985, that share has fallen from nearly 70 percent to 43 percent. Strikingly, this share remained stable during most of the bubble -- because as housing prices rose, people withdrew more and more of what they had “saved” as equity. And in the two years since the bubble first burst, home-equity savings has fallen by about one-third, from 60 percent to 43 percent.

Today, an estimated 12 million people are under water with their mortgages. Since they owe more than their houses are worth, the bursting bubble wiped out their life savings. Moreover, the data which show that people’s home equity is still equal to 43 percent of the value of their homes combines two very different groups of people: Nearly half of homeowners own their houses free and clear (mainly older people), while the other half has modest or little equity.
All of this could really change American attitudes toward saving. For one thing, the generation that came of age as these developments unfolded, along with everyone who staked their economic futures on ever-rising housing values, are much less likely to see housing as a safe way to save. That attitude correction in itself could provide a long-term drag on rising housing prices. There also are millions of people who counted on bubble-prices to fund their retirements. That’s been especially true of later Baby Boomers and early Baby Busters, the parents and older siblings of those coming of age in this period. A rude attitude adjustment is also coming for those who haven’t bothered to save much because they’ve counted on inheriting the elevated value of their parents’ houses.

The bottom line is that Americans once more may find themselves more inclined to save --  because now they have to -- and less inclined to use housing values to do it. Since stocks don’t seem much more attractive, that could mean more saving in the safest assets, which are Treasury bonds. And that would be just what an Administration and government determined to act big, bold and expensively, will need to carry out those plans.

Time to Face the Facts: The Economy Probably Won’t Get Better For Quite a While

Brace yourself for very anxious and stormy time, economically and politically, because there’s little prospect that the U.S. economy will improve for quite some time. The latest to weigh in is the Federal Reserve, whose new private forecast sees no growth in sight for the rest of this year and slow gains at best for 2010. The Fed always speaks cryptically (even among themselves). What it means is that the economy is still in free fall, with our best prospect for hitting bottom coming sometime this summer, and then bouncing around the bottom through the fall and into early winter. Why early winter? The only force out there to stop the decline is the stimulus package, which ought to kick in just about then. The Fed didn’t say so, but their view that any recovery is some time off and will be a modest one reflects the judgment -- one I share -- that the administration’s fixes for banking and housing aren’t up to the task.

The Fed also didn’t say so, but the outlook for much of the rest of the world is at least as gloomy, since so many Asian and European economies depend on Americans to buy what they produce and on U.S. businesses to invest in their countries. That’s not in the cards for some time. Trade is falling at a 20 percent rate here, at 30 percent rates across much of Europe, and at 30 to 40 percent rates in much of Asia. This week, for example, we found out that Americans’ purchases of foreign imports in February were down $62 billion from a year earlier. That translates into tens of thousands of jobs lost in a lot of other countries (and ultimately fewer U.S. exports down the line).

The Fed’s view should be a wake-up call for the administration, which still talks about a “V” shaped business cycle, where our deep decline will be followed by a strong and sharp recovery starting late this year. V-shaped recoveries are powered by unleashing suppressed demand: People cut back until they see the light at the end of the tunnel, and then they buy everything they had put off during the recession -- especially houses and other large purchases that require credit. That’s the scenario behind OMB’s risible forecast of more than 3 percent growth next year, followed by two years of more than 4 percent gains.

This misunderstands the very nature of what we’re going through, which is nothing like the other recessions of the last 50 years. This time, the economy’s circulatory system, banking and credit, isn’t working. Even if it were, American households aren’t holding back because their wages are down a bit. They’re being forced to downsize for the long term, because this crisis has wiped out 20 percent of their net worth. It’s even more serious than that, because most Americans used the fast-rising net worth they thought they had over the last decade to support their consumption. Mainly, we withdrew trillions of dollars from the once fast-rising value of our houses so we could go on vacation, buy new furniture, and send the kids to college. We had to do that, because for the first time in more than a half-century, most people’s wages and incomes stagnated during a “strong” expansion.

The current crisis will pass eventually, even as it takes much longer and exacts much larger costs for tens of millions of people than any downturn since the 1930s. When it does, the administration and the country will face once again the profound structural problem of the last decade -- of most people’s incomes stagnating in the face of strong productivity gains, and relatively little job creation during times of strong GDP growth. Addressing that will require all of the President’s skills, because it won’t change unless we slow down rising health care and energy costs, and educate and train everyone in many of the ways we now use to prepare only the top 20 percent of us.

The irony is that if President Obama can put in place policies for banking and housing that would work better than what his advisors have been willing to put out there so far, the economy could recover decently early next year. Then, he could have the political capital for the rest of his agenda, which is targeted just where it should be, on health care costs, energy, and education and training. But if he doesn’t pull off the recovery, none of the rest will happen -- and the Obama years could look a lot like the Bush era.

Is Cap and Trade a Dead Policy Walking?

In his February 24 speech to Congress, President Barack Obama asked Members “to send me legislation that places a market-based cap on carbon pollution.” So yesterday, House Energy and Commerce Committee Chair Henry Waxman took the first step by introducing his cap-and-trade plan. Yet sometimes, the political sands shift underneath a policy approach that was once viable, even embraced broadly, and its chances of becoming law ebb away. Until the media and the public make the connection between the policy and the new environment, the approach becomes a dead policy walking. It happened to Social Security privatization and the flat tax -- good riddance to both -- and now it appears to be overtaking cap-and-trade.

Cap-and-trade combines a regulatory cap on greenhouse gas emissions with a market-based scheme to trade as financial instruments the “permits” to produce those emissions. For all of cap-and-trade’s initial promise as an answer to climate change, the current financial crisis has made its vulnerabilities painfully clear. The strategy would have the government create trillions of dollars in new, asset-based financial instruments. These emissions-right-backed securities, like their cousins, mortgage-backed securities, also would throw off a host of new derivatives to be profitably traded by the “professionals.” Unsurprisingly, cap-and-trade’s fiercest promoters include Wall Street institutions that see emissions-permit trading as a lucrative new market that could earn them billions in new fees, commissions and, while it lasts, speculative gains. But after Wall Street’s meltdown, the proposition for another round of the financial merry-go-round that produced the worst economic crisis in our lifetimes seems either very naïve or very cynical.

That’s not the only tricky problem facing cap-and-trade. The other part of the policy’s design, the hard cap on emissions, ensures that the prices of the permits will be very volatile. Here’s why. The cap in cap-and-trade is set as a percentage reduction in annual emissions, figured from some baseline. The problem is that no one can forecast with precision how much energy American businesses and households will need from one year to the next, because no one knows how cold the winter will be, or how hot the summer, or how fast the economy will grow a year from now. When energy companies see that demand is going to outpace the forecast, so they will need more permits to keep on selling energy, the price of those permits will rise sharply. It’s not just theory: We use a small-scale cap-and-trade program to reduce the emissions that produce acid rain, and the price of those permits moves up and down an average of more than 40 percent per year. In the same vein, Europeans adopted their own cap-and-trade system for energy emissions a few years ago, and the price of their permits has moved up or down by an average of 17 percent per month.

For years, economists have worried that this basic feature of cap-and-trade would produce new volatility in energy prices. They’ve also cautioned that the result would likely be less investment in climate-friendly fuels, since no one would know what the price of their carbon content would be. Now there’s another, equally serious problem: The unavoidable volatility of the prices of emission permits also would attract furious financial speculation, since speculators live off of volatile prices. And we now know the risks that we all run when rampant speculation occurs in financial instruments tied to our economic foundations, such as housing -- or energy.

Like the excesses that helped create our current crisis, the financial markets for emissions permits also could well produce serious insider trading and manipulation. That’s because the final purchasers of the permits, large energy companies and utilities, would see shifts in demand for the underlying energy coming before anyone else. This information would create golden opportunities for insider profits and market manipulation, and erecting a “Chinese wall” inside the companies to segregate the production division from the trading division would work no better than it has on Wall Street. That may explain why until its own collapse, Enron was a prominent advocate of cap-and-trade.

The only reason to play another round of Russian roulette with the economy would be if cap-and-trade were the only way to address climate change. Happily, it isn’t: Many economists and some politicians support the major alternative, carbon-based taxes with rebates. This approach would create no new financial instruments to trade and abuse, and produce no additional price volatility, because the price of carbon would be set. It also would be relatively simple to administer and enforce. And it can be designed to recycle its revenues in payroll tax reductions or rebates. In this way, the carbon tax would change the relative price of different forms of energy, based on how much damage they do to the climate, while protecting people from the additional, direct costs of the tax itself. The revenues could also be recycled as a flat payment to each American household, providing relatively more help to low and middle-income families. The policy’s only real weakness is that it has no cap. But the tax rate could be adjusted periodically if actual emissions exceed its goal. And modeling shows that a carbon tax of about $50 per-ton of CO2 would produce slightly larger reductions in emissions than last year’s leading cap-and-trade proposal, the Warner-Lieberman bill.

For years, many politicians and environmental leaders have believed that any kind of tax to deal with climate change would be dead on arrival. That may be changing, especially if the tax is paired up with rebates to take away much of its political sting. More importantly, the costs and lessons of the financial crisis may effectively swamp the prospects for cap-and-trade. If cap-and-trade has become a dead policy walking, those who care deeply about climate change will find that a carbon tax system has become the last, reasonable policy standing.

The New Treasury Program: Sound Economics, Resting on Some Wishful Thinking

The Administration’s new program to wring the toxic assets out of the banking system is a huge bet which, like most of the previous reforms for the current crisis, is based equally on sound economics and a good dose of wishful thinking. The truth is, it couldn’t be otherwise: We’ve never experienced this kind of crisis before, so we cannot know which reforms will actually work.

The essence of the new Treasury program are the creation of new, public-private partnerships to purchase the bad assets held by Citigroup, AIG and others. The government and private funds or other entities would each put up one-twelfth of the money to buy tranches of toxic paper, and the other five-sixths would be borrowed by the private parties with federal guarantees for their lenders. One aspect of the plan that requires a good dose of faith is that reasonable prices can be set for these assets by using auctions. This aspect assumes that a number of private parties will bid on each tranche of assets and so set a reasonable price. The hope here is that the federal guarantees for the loans to buy these assets will unlock hundreds of billions of dollars in new financing, and that could well be the case. Score one for the Treasury: They’ve found a way to create a market for these assets, something which eluded the Paulson Treasury when they proposed auctioning off assets of unknown and dubious value.

Here’s the catch: The banks now holding these assets -- Citi, AIG, and so on -- have already written down their value on their books. And it’s impossible to say whether these write-downs -- "marking to market" in a market that hasn’t been operating -- are in the neighborhood of the prices which the Treasury auctions will produce. Selling them will increase "liquidity" in the banking system, which means there will be buyers for what’s being sold. But liquidity isn’t the main problem here. The core of the financial system crisis is that many of the largest institutions look like they’re insolvent or nearly so, and so unable to use the asset side of their books to provide new flows of credit for the economy.

Here’s where the pricing of the bad assets becomes important for the rest of us. If these institutions receive roughly the same price from the auctions as they’ve already assumed in their write-downs, they’ll be as insolvent as they were before the new program. One hope underlying the program is that the assets will auction for much more than their current owners believe they’re worth, bolstering their capital. Or, alternatively, there may also be the hope that all of the financial activity involved in selling off these toxic, "legacy" assets will bolster general confidence, so that businesses will be more willing to borrow and other institutions will be more willing to lend to them. In that case, the renewed economic activity could improve conditions for the sick institutions, slowly bringing them back from the edge of bankruptcy.

Much like the Treasury’s approach to stemming foreclosures in its new housing program, this approach addresses directly the secondary problem of liquidity, in the hope that doing so will affect the essential problem, which is that these institutions are bankrupt or nearly so. The alternative which the administration so far rejects is to address the core problem directly, with transitional or brief "nationalization" -- take over the sick institutions, pull out the bad assets (without having to value them), and then sell off the rest to another bank or group of investors, who would reopen it as a healthy bank that could resume lending. There are serious risks in that approach as well, both economic and political. The Republicans would surely go on a predictable tear denouncing it. More important, the market might believe that it was only the beginning of government takeovers, and pull back on a range of financial activities so far less affected by the systemic crisis. But if the current strategy doesn’t work, the only other option apart from transitional nationalization will be to ask the country to put up with an indefinite period of recession and stagnation, until the system slowly rights itself. Eighty years after the last systemic financial crisis, the option of "sit tight and wait for the markets to correct themselves" -- Hooverism in a pure form -- should be wholly unacceptable, both economically and politically.

Inflation Down the Road Could Cost Taxpayers -- And We Can Do Something About It

The Federal Reserve yesterday announced $725 billion in new purchases of Fannie Mae and Freddie Mac securities to hold up housing finance, along with plans to buy $300 billion in Treasury securities. Before this latest program, the Fed was already running the most expansionary modern monetary policy since the Weimar Republic. On top of $2 trillion in guarantees for a broad range of private securities, the Fed has been gunning the monetary base at an extraordinary rate. Consider the following: The Fed normally expands the monetary base, which forms the basis for credit and the overall money supply, by an average of 1 to 2 percent per month. In September and October of last year, they expanded that base by 58 percent; in November and December, they increased it another 50 percent.

The Fed was right to do all this, in a deliberate if desperate attempt to push enough juice into a severely strained and strapped financial system, to enable it to get back on its feet -- or at least to not slip into a coma. It hasn't worked so well yet, because the financial system and economy are sicker than anyone thought. And now we’re caught in a vicious circle: The financial system’s woes pushed the economy off the cliff, which then took most other economies in the world with it, and now the problems of our economy and everyone else's are intensifying the financial system's weaknesses.

And the Treasury is out in the markets every day selling the government's securities, even when the Fed's not buying. And like some titans on Wall Street, they may be making a bad bet with your money. The bet here is that inflation will be nothing to worry about for another decade; and if that's wrong, taxpayers will pay a big price. At issue here is what's called Treasury Inflation Protected Securities, or TIPS, securities which pay those lending to the government a set interest rate, like any other Treasury security, but one figured off a principal amount that adjusts upward every six months to take account of inflation. At the price TIPS are now fetching, the market is betting that inflation will be nothing to worry about for another decade. And the Treasury is backing up that bet by selling TIPS at very low prices.

The market and the Treasury backing it up are almost certainly wrong this time. Here's what may well be happening: When markets heat up or melt down, they have a tendency to assume that their conditions will persist for as far as they can see (or invest). That can explain what's happening in the TIPs market: They’re selling at a rate and return which assume that today’s extraordinary deflation will just keep on going, for years into the future. That's possible -- but it's very, very unlikely. The economy eventually will stop contacting; and when it does, prices will stop going down. In fact, through the booms and busts of the last 50 years, the U.S. inflation rate has consistently averaged about 2.5 percent per year over any extended period.

Moreover, once the economy recovers this time, the extraordinary steps we're taking to bring about that recovery will almost certainly produce strong inflationary pressures. First, we're currently embracing the most expansionary fiscal policy in our history (at least for peacetime), with multi-trillion-dollar deficits -- and necessarily so for an economy contracting at a six to seven percent rate. And on top of that is the Fed’s unprecedented monetary expansion.

Whatever White House or congressional leaders say about education, climate or health care, the economy and the financial system, and only that, will remain the President’s central focus and task for the rest of this year and well into 2010.

Eventually we will succeed -- and when we do, our wildly expansionary (if necessary) fiscal and monetary policies will extract a cost. One principal cost is almost certain to be higher than normal inflation -- and that's when the TIPS issue will bite us. If inflation is much higher five years from now than the TIPS market expects today -- and you can bet on that -- people who bought TIPS when everyone expected very low inflation will end up making a killing as the value of their securities is adjusted way upwards for the higher-than-expected inflation. We estimate that will cost taxpayers as much as $80 billion in additional debt-service costs. Fortunately, there’s an easy answer: The Treasury can buy back the outstanding TIPS and reissue the debt in conventional securities. Current TIPS holders would get the current value of their securities, and taxpayers could save enough to finance an awful lot of college assistance, health care for children, or R&D in climate-friendly fuels and technologies.

At a time when nearly everywhere we turn, it costs us all billions or even trillions of dollars, wouldn't it be satisfying to save some real money -- and without raising anybody’s taxes or cutting anybody’s program?

For more information, see the new study, "The Benefits to U.S. Taxpayers from an Open Market Buyback of Treasury Inflation-Protected Securities," at this site.

How Long the Recession Could Last – and Why it Matters So Much

The leaders of the Republican Party (and plenty of their followers) continue on their strange path of denying the most basic economic logic in the midst of economic crisis and opposing whatever the President says or does. Happily, the Obama administration knows economics, and they seem to generally know themselves. Yet, they may still overestimate the extent of their powers, especially their ability to turn around the economy anytime soon without serious, new initiatives.

For a meltdown that follows none of the regular rules or patterns of garden-variety recessions, the stimulus we’re providing for consumers and the subsidies for housing and banking may well be insufficient to drive a respectable recovery in 2010 and even 2011. Yet, the President’s budget forecasts – and depends upon -- economic growth of 3.2 percent next year and 4.0 percent in 2011. This is a picture of a traditional, “V-shaped” recovery, like 1983-1984. It’s what happens when a deep recession suppresses the normal buying impulses of households and businesses until the early signs of recovery, when all of the suppressed demand comes back with a vengeance. The result is a strong bounce back, just of the sort assumed in the budget.

But this is anything but a traditional recession, and there’s little reason to expect a traditional-shaped recovery. The stimulus will help, as will another round likely to come this summer. They may well be enough to stop our decline, but alone they won’t sustain enough growth in demand to push the economy much out of the cellar. Here’s the crux of the problem facing the President’s economic team – and ultimately all of us: People are pulling back sharply on their spending not only because they’re afraid they might lose their jobs, or already have. In addition, they’re suffering the greatest wealth losses in their lifetimes, especially in the value of the homes that constitute most families’ biggest asset. That means that a real recovery may require a much more aggressive housing program to stem the decline in housing values as well move foreclosure rates back towards normal. If that’s beyond the administration’s reach, this recession could go on until the housing cycle unwinds on its own, or as long as another 18 to 24 months.

Besides consumers (and government), the only sources of demand in the economy are business investment and exports. We can forget about a revival of U.S. exports driving growth, at least for more than another year. That’s because much of the rest of the world is in worse shape than we are. Most of them are much more dependent on their own exports recovering than we are, so their recovery may depend on Americans buying their exports. On top of that, most countries still aren’t providing any large scale stimulus – we, along with China and Spain, are the exceptions. So, a revival of our exports will likely come only after our own consumer demand recovers, to help fuel demand in other countries for our exports. That, too, would put recovery as much as two years distant.

That leaves business investment to fuel a recovery in time to help support the President’s plans in education, health care, climate, and most other things. But what businesses are prepared to invest when consumers here and abroad are buying so much less of whatever those businesses produce? That’s particularly so when it’s as hard as it is today for most companies to borrow funds to invest. This brings us back to something else we already know: A real recovery will also require a much more aggressive banking strategy from the administration and Congress, to force the bad debts and bad banks out of the way so that normal lending can start again. Since so many of those bad debts involve housing, a revival of business investment will likely have to follow the stabilizing of housing values. Here, again, there’s little reason to expect this will happen in time to make help fund the administration’s budget proposals.

We all have to begin to think about what the policy and political landscape will be, if we don’t put in place more effective housing and banking programs than we now have, so we’re still mired in serious recession a good year from now. One change seems certain: Much of the political energy now fueling initiatives in health care, energy and climate would seep away. After another year of hard times with no relief in sight, the other thing that will matter to most voters and politicians will be the economic crisis that President Barack Obama was elected to end.

The President knows full well – or should – that containing health care and energy costs, especially those borne by businesses, will be critical to breaking the mold of the last expansion, when most people’s wages and incomes stagnated, or worse, even as productivity, growth and profits rose handsomely. The saddest implication of our present predicament is that another 18 to 24 months of serious recession could leave untouched the deep, underlying economic problem that the President and his party were really elected to solve.

GOP Economic Policy as an Exercise in Grief Management: Denial, Anger & Rush Limbaugh

The leaders of the Republican Party, reeling from their painful string of defeats, seem stuck in two of the classic stages of grief, denial and anger. This week, Rush Limbaugh replaced Bobby Jindal as the leading and most colorful example. Limbaugh may seem like too easy a target, since talk radio always tends toward hyperbole. Nonetheless, the essence of the message from the presumptively addled Mr. Limbaugh is that Americans would be better off if the President’s economy program failed. Even if their homes slip into foreclosure and their kids have to drop out of college, American families would at least escape the degradations of “socialism” or, as another popular conservative pundit put it, “left fascism” (that’s from the hard-right blogger and historian, Ron Radosh).

The rhetorical excesses of talk radio and the Web would hardly be noteworthy, if the same strain of non-thinking didn’t also dominate the Republican Party’s current economic positions. Let’s set the stage: of the three natural sources of demand in a market economy, consumers have stopped spending, businesses have stopped investing, and exports have fallen off the proverbial cliff. That leaves government stimulus as the only possible source of new demand to at least slow the accelerating downward momentum of the economy and most of the people in it. Perhaps the best explanation, then, for why every Republican in the House and all but three GOP senators voted “no!” on the President’s stimulus is, well, denial and anger.

To be sure, economic ideology almost certainly plays a role here, too, on top of their denial (about the consequences) and anger (about no longer calling the shots). This came through vividly at a conference I attended earlier this week for the National Chamber Foundation. My panel was asked to talk about whether the Administration’s plans foreshadowed a permanent change in the relationship between the public and private sectors. Set aside the fact that the leaders of the central private institutions in this drama, big finance, have begged Washington to amend that relationship long enough to preserve their jobs and the assets of their bond holders. 

At the panel, a well-turned-out executive from a major private equity company (and former Bush Treasury official) laid out what once could have been the reasonable conservative position -- stimulus weighted to tax cuts, a banking rescue that avoids taking over anybody (or dictating anybody’s compensation), and tax-based measures to reduce foreclosures. As a matter of economics, he got his targets right, even if his approaches are weaker than those favored by the Administration. But at least his response suggested that he wants the economy to recover, regardless of who gets the credit. 

Not so from the other member of the panel, Brian Westbury, who on top of being an economist with a Midwestern financial advisory is also the economics editor of the American Spectator and a frequent writer for the Wall Street Journal. He provided an economic-cum-ideological gloss for the denial and anger expressed by the flamboyantly-frustrated Mr. Limbaugh. Westbury’s prescription was no stimulus, no banking rescue and no program for foreclosures. The only constructive government action he could imagine was to jettison current “mark-to-market” rules. Those rules say that the balance sheets of banks and public companies have to reflect the actual market value of their assets and liabilities. So, for example, when a mortgage-backed security goes bust, you have to write down its value while preserving the liability of the money borrowed to purchase it and still owed. 

In this view, none of what seems so important to the rest of us -- collapsing demand, investment and trade, huge job losses, rising bankruptcies -- matters for government policy.  The only thing Washington should do here is to change how the financial losses from these events are reported. This isn’t economics; it’s a prescription that follows from a hard-edged ideological view that government can do nothing of value for an economy, regardless of conditions.   

Unhappily, this cramped understanding isn’t limited to the pages of the American Spectator and the Wall Street Journal op-ed page. Bobby Jindal put the Republican Party on record for much the same view in his awkward response to the President’s address to Congress. He even cited the colossal inadequacies of the Bush Administration’s response to Katrina as proof that the private sector is always the best answer to any problem or catastrophe -- even if it’s under water at the time.

I honestly can’t believe that they’re really so dull-witted. A better explanation for Jindal and Limbaugh, along with commentators like Westbury and Radosh, is that they’re still grappling with the grief of losing the support of the American people -- and the power that came with it. They’re stuck in denial and anger. And that’s a very bad position from which to consider the best policies for a nation and world economy in crisis.   

The Economic Logic in President Obama’s Speech to Congress

President Barack Obama's superb address Tuesday night had an underlying, unifying logic which some may have missed, but which hopefully those reading this will recognize.  

First, on the financial and economic crisis, he embraced the three basic steps we have urged since last September: on top of a stimulus aimed at long-term investments and helping the states – that’s now done – there will be new requirements that banks getting help from taxpayers use that assistance to expand their lending, and new steps to keep people in their homes and bring down foreclosure rates. It’s just economic common sense – but that’s precisely what most of official Washington casually casts aside in favor of scoring short-term, political points. (Take a look at Gov. Bobby Jindal’s empty and sneering response to the President’s speech. His repeated citing of Katrina as a model for government action, by itself, should be a career-ending act).

The President also laid out a domestic agenda for the rest of his first term, and it looks like the most sweeping since FDR and LBJ. I suppose that personal blogs, by definition, are no place for humility, so here it is straight. The three cornerstone Obama initiatives -- slow down our fast-rising health care costs, expand energy conservation and our use of alternative fuels, and give everybody new chances to upgrade their working skills -- are the exact prescription laid out more than a year ago in my book, Futurecast: How Superpowers, Populations and Globalization Will Change the Way You Live and Work. It’s also been a regular theme of this blog and a series of papers issued by NDN.  

Here, too, it’s just economic common sense, for a world being transformed by globalization.  The underlying logic of the President’s program springs from the fierce new challenges Americans face under globalization to their jobs and incomes. Globalization has made competition much stronger, and that competition leaves American businesses and their workers in a bind. Their costs have been rising very fast, especially for health care and energy, but intense global competition makes it harder for companies to raise their prices to cover these rising costs. The result is that the wages of most American stopped rising since about 2002, even as they became more productive. And most can’t find higher wages by getting new jobs, because before the current crisis began, the same forces had made this period the weakest for job creation since World War II.

The President understands that coming out of the current crisis isn’t enough, if we just return to another period of growth without wage gains or healthy job creation. He also understands another theme of Futurecast and NDN's work, namely that about half of Americans also need new skills if they aspire to jobs with a real future. That’s the basis for the third plank of the domestic agenda he laid out last night -- genuine, new access for young people to go to college or receive other, post-secondary training, and new opportunities for everyone else to upgrade their skills

President Obama’s first speech to Congress already ranks as the most serious and thoughtful presidential address on the economy in decades. Perhaps it took an historic crisis to break through the political cant and mental laziness that has gripped our economic agenda for so long. But the President is using this moment to put forward not only meaningful answers for the crisis, but serious, long-term remedies for much deeper economic problems which other politicians routinely ignore. That’s presidential leadership of the sort we haven’t seen since, well, FDR.

An Economic and Political Primer on the Administration's Plan for the Housing Crisis

President Barack Obama today announced a plan to cut foreclosures and reboot new mortgage financings, at least when the economy shows signs of new life. The fact of offering a plan is an advance, given that Bush and his people did nothing and proposed nothing, even as the crisis reached critical mass. As we have written here since the crisis first broke, keeping people in their homes is fundamental to solving the larger economic problem. Again, it’s the fast-rising foreclosures and mortgage delinquencies that are eroding and destroying the value of hundreds of billions of dollars in mortgage-backed securities and the credit default swaps that “back them up” (sic). And it’s the falling value of those securities and swaps, in turn, which has led to the effective bankruptcy of financial institutions that had leveraged themselves to their eyeballs to buy them or issued them and then kept them (and how dumb was that?).

While the act of proposing anything serious puts the Obama Administration ahead of its predecessor, passing such a low threshold is hardly very meaningful -- especially since the problems continue to worsen. More than nine percent of mortgages today are either in foreclosure or delinquent, two to three times the numbers from just two years earlier; and if everything continues to unravel, those numbers could double in another year. If that happens, there won’t be many large, U.S. banks left standing. Many of the homeowners now in trouble could manage, if they just could refinance at current rates. But banks quite naturally see someone in financial trouble as a poor credit risk for a new loan, which is what refinancing is. And the fall in housing prices means tens of millions of those people can’t qualify to refinance. That’s because refinancing is available today only if you owe no more than 80 percent of the original mortgage’s value. The catch for millions of families is that as the value of their home goes down, their existing mortgage (the one being refinanced) accounts for a greater percentage of the value being refinanced. In the worst cases, people just walk away from a $200,000 home with a $300,000 mortgage -- and who would refinance one of those? In millions of other, less extreme cases, the falling prices simply disqualify people for refinancing.

The Administration wants to address this precise part of the problem, by providing $75 billion in subsidies to banks to defray half of the cost of refinancing for several million homeowners at risk of losing their homes. Mortgages owned by Fannie Mae and Freddie Mac are also eligible here, and they’re the ones most likely to actually see their interest rates reset, since the government owns Fannie and Freddie and can direct them to do it. It will be harder to convince bankers already staring at enormous losses already on their books or soon to be there, especially if they’re worried that their bondholders could sue them for resetting loans. The plan also has some $100 billion for the Treasury to keep buying more of Fannie and Freddie’s failing mortgage-backed securities since, as we also have said repeatedly, until foreclosure rates return to normal, the biggest bank bailout in the world won’t prevent more banking losses.

There are more direct ways to address foreclosures. We could provide direct loans to tide over those in trouble, or Fannie and Freddie could reset the loans of everyone in trouble. The problem is that anyone advancing such a common sense approach would become a very large political target -- and not just for reflexively-critical House Republicans.

How could the president or his advisors explain to those who work hard and spend less, so they can keep their mortgage payments up to date, why they don’t qualify for a lower interest rate from the government, when their neighbor who spent more or just had harder luck does qualify? More plainly, how does the government choose who would qualify for such direct help without enraging most of those who wouldn’t? In effect, the Administration plan finesses this problem by letting banks choose, without compelling them to do so. But what if the economy continues to worsen and the plan doesn’t work, which is a very real possibility? Indeed, don’t be surprised to see the Administration revisit it six months from now with a much less “voluntary” approach.

The Fallout of the Great Recession for Trade

UPDATE:  This post was picked up by Reuters and internationally syndicated, appearing in papers worldwide over the weekend. From the Reuters article:

Some economists argue globalisation, in the sense of the
increasing integration of different countries in the world economy, is
the cause, acting as a transmission belt from one suffering economy to
the next.

"With globalisation, the world can suffer the central
cost of protectionism -- a deep fall in trade -- without passing any
new laws or regulations," Robert Shapiro, head of progressive think
tank NDN's globalisation initiative, said in a blog.


"The crux of it is that as the share
of what the world produces that's traded across borders rises -- 18
percent of worldwide GDP was traded in 1990, compared to 30 percent in
2006 -- a serious recession in a few large places moves quickly around
the world, driving down global trade," said Shapiro of NDN, a former
undersecretary in the U.S. Commerce Department.

In other words weak demand in one country increasingly affects others because they are more dependent on exports.

The new trade data out today show, unhappily, that the surest way to drive down our trade deficit is a deep recession that cuts into the money Americans have to buy imports. In December, the trade imbalance fell to less than $40 billion, a 35 percent drop from its $62 billion level last July. (It’s all seasonally-adjusted). The last time the trade deficit was this low was November 2003. Imports shrank by $74 billion from $230 billion in July to $174 billion in December, or nearly 25 percent. Of course, the same thing is happening to our trading partners: our exports also fell 21 percent, from $168 billion to $134 billion. Since we import so much more than we export, the decline in imports really drives down the overall deficit.

This is a window into something new and important: with globalization, the world can suffer the central cost of protectionism -- a deep fall in trade -- without passing any new laws or regulations. The crux of it is that as the share of what the world produces that’s traded across borders rises -- 18 percent of worldwide GDP was traded in 1990, compared to 30 percent in 2006 -- a serious recession in a few large places moves quickly around the world, driving down global trade. That’s particularly serious for countries that really depend on exports, which means most of the developing world. The global data are still sketchy, but it looks like in the last months of 2008 and the beginning of this year, exports (month-to-month) fell 25 percent in China, 33 percent in Korea, and 40 percent in the Philippines. To see how serious this is, consider that exports represent about 40 percent of GDP in all of those countries. It’s even worse in Taiwan, where exports account for 62 percent of GDP and fell 44 percent rate in November, compared to a year earlier. The other deeply trade-dependent region is Europe, where serious problems coming from this massive slowdown in trade will hit home within the next few months. 

The serious problem which they and others will face is fast-rising job losses by the people who produce the exports and those who make the goods and services that those workers purchase. So, as the world slides into this Great Recession, calls for new forms of protection for export industries are cropping up all over the place. We certainly hear these calls here, even though the United States for decades has been generally more accommodating of our trading partners than they have been toward us. We’ve pressed for more trade liberalization, pressed for it earlier, and stuck with generally low trade barriers and an aggressive global economic footprint more than our major trade partners. Countries like Japan, France and Germany don’t provide a very high threshold on these matters, to be sure, but we have consistently cleared it.  

Yet, here we are today, on the brink of passing a “Buy American” provision that will bar the use of foreign-made manufactured products and goods in many projects supported by the stimulus package. President Barack Obama said he wanted the Senate to dial it back, since he understands that it would invite real retaliation that would injure more export-industry workers. So the Senators added a caveat that the restrictions can’t violate our WTO obligations. Here’s the translation of that: “Buy American” will mainly target developing countries, because Japan, EU nations and other advanced countries are all signatories to WTO agreements to not discriminate against other countries in many areas, including government procurement. China, Brazil, India and most other developing nations are not yet signatories. So, we can expect a good dose of tit-for-tat protection from those countries. And that could disrupt the production networks and supply chains of some of our largest global companies, such as Boeing, Pfizer, Dell and Coca-Cola. At a time of grave economic turmoil and peril, this can’t make any sense.

And we’ll still be vulnerable to legitimate, tit-for-tat from Europe and Japan, since they currently apply lower tariffs in many areas than mandated by the WTO. That means they could raise their tariffs without violating their WTO agreements -- and we could do the same in the next round of retaliation.

The best way to cauterize this drive for protection is to take a deep breath, and make sure that workers have greater means to protect themselves. The Administration is offering some of that, for example in health care benefits for those who lose their jobs. We can go well beyond health care, however, especially in real opportunities for working people to expand or deepen their skills and abilities. That remains a serious gap in the stimulus, which hopefully the first Obama budget can rectify. 

Syndicate content