Financial Meltdown

Today, as Republicans release a manifesto labeled as an alternative budget and President Obama meets with CEOs of major banks, we're pleased to present you with some helpful thinking on these issues.

First, though, I'd like to draw your attention to an April 1 NDN event: The G-20 Summit and Beyond: Challenges Facing The Global Economy. This event, to be held at NDN and hosted by NDN President Simon Rosenberg, will feature NDN Globalization Initiative Chair Dr. Robert Shapiro and Dr. Moisés Naím, the Editor-in-Chief of Foreign Policy magazine. Click here to RSVP.

• The New Treasury Program: Sound Economics, Resting on Some Wishful Thinking by Dr. Robert Shapiro, 3/25/2009 - Shapiro points out that, since we've never seen this kind of crisis before, there's little way to know what will work to fix the financial system, but that doing nothing is unacceptable.

• Hope and Optimisim II by Michael Moynihan, 3/16/2009 - Moynihan looks at some recent developments in the financial world and sees cause for cautious optimism. 

• Weekly Kos Poll, GOP Still at 16 Percent, Messaging the Economy by Simon Rosenberg, 3/14/2009 - The strongest argument for President Obama's economic plan is that, despite strong productivity and GDP growth over the last eight years, the typical American family saw its standard of living decline.

• How Long the Recession Could Last - and Why It Matters So Much by Dr. Robert Shapiro, 3/12/2009 - Shapiro arguest that the Great Recession is anything but traditional, so there's little reason to expect a traditional recovery.

• Sustainable Funding for Sustainable Infrastructure by Michael Moynihan, 3/9/2009 - The old system for infrstructure funding is inadequate for creating a robust, clean infrastructure driven future.

• GOP Economic Policy as an Exercise in Grief Management: Denial, Anger & Rush Limbaugh by Dr. Robert Shapiro, 3/5/2009 - Shapiro puts on his psychologist hat and argues that the only explanation for the current Republican thinking on the economy is that they are angry and in denial about losing.

• The Utter Bankruptcy of Today's Republican Party by Simon Rosenberg, 1/28/09 - Rosenberg argues that Republican opposition to the economic recovery package represents the ideological bankruptcy of the party.

• A Stimulus for the Long Run by Simon Rosenberg and Dr. Robert Shapiro, 11/14/2008 – This important essay lays out the now widely agreed-upon argument that the upcoming economic stimulus package must include investments in the basic elements of growth for the next decade, including elements that create a low-carbon, energy-efficient economy.

• Accelerating the Development of a 21st Century Economy: Investing in Clean Infrastructure by Michael Moynihan, 10/18/2008 – NDN Green Project Director Michael Moynihan outlines a strategy for investing in clean infrastructure that will help create long-term prosperity.

• Back to Basics: The Treasury Plan Won't Work by Dr. Robert Shapiro, 9/24/2008 - As the financial crisis unfolded and the Bush Administration offered its response, Shapiro argued that, while major action was needed, the Treasury's plan would be ineffective.

• Keep People in Their Homes by Simon Rosenberg and Dr. Robert Shapiro, 9/23/2008 – At the beginning of the financial collapse, NDN offered this narrative-shaping essay and campaign on the economic need to stabilize the housing market.

• Making the Struggle of Every Day People the Central Focus of the National Debate by Simon Rosenberg, 8/17/2008 - As the 2008 presidential campaign entered a crucial phase, Rosenberg argued that political leaders must focus on raising the wages and incomes of Americans.

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.

With new, frightening unemployment numbers out today, take a look at some of NDN's latest thinking on the economy. What government policies are needed to stabilize the financial sector? Why is the Republican minority so obstructionist? How should everyday Americans deal with their balance sheets?

• GOP Economic Policy as an Exercise in Grief Management: Denial, Anger & Rush Limbaugh by Dr. Robert Shapiro, 3/5/2009 - Shapiro puts on his psychologist hat and argues that the only explanation for the current Republican thinking on the economy is that they are angry and in denial about losing.

• Protect Savings, Prevent Bank Runs Now by Michael Moynihan, 3/3/2009 - Moynihan advocates for fully insuring deposits to prevent panic.

• Spend? Save? The debate continues by Simon Rosenberg, 2/11/2009 - Building on a previous post, Rosenberg follows the growing debate about whether American families should be focusing on saving.

• The Utter Bankruptcy of Today's Republican Party by Simon Rosenberg, 1/28/09 - Rosenberg argues that Republican opposition to the economic recovery package represents the ideological bankruptcy of the party.

• A Stimulus for the Long Run by Simon Rosenberg and Dr. Robert Shapiro, 11/14/2008 – This important essay lays out the now widely agreed-upon argument that the upcoming economic stimulus package must include investments in the basic elements of growth for the next decade, including elements that create a low-carbon, energy-efficient economy.

• Accelerating the Development of a 21st Century Economy: Investing in Clean Infrastructure by Michael Moynihan, 10/18/2008 – NDN Green Project Director Michael Moynihan outlines a strategy for investing in clean infrastructure that will help create long-term prosperity.

• Back to Basics: The Treasury Plan Won't Work by Dr. Robert Shapiro, 9/24/2008 - As the financial crisis unfolded and the Bush Administration offered its response, Shapiro argued that, while major action was needed, the Treasury's plan would be ineffective.

• Keep People in Their Homes by Simon Rosenberg and Dr. Robert Shapiro, 9/23/2008 – At the beginning of the financial collapse, NDN offered this narrative-shaping essay and campaign on the economic need to stabilize the housing market.

• Making the Struggle of Every Day People the Central Focus of the National Debate by Simon Rosenberg, 8/17/2008 - As the 2008 presidential campaign entered a crucial phase, Rosenberg argued that political leaders must focus on raising the wages and incomes of Americans.

In today's Wall Street Journal, Michael J. Boskin, former Chair of the Council of Economic Advisors for President George H.W. Bush and a Senior Fellow at the aptly named Hoover Institution, lays out a list of conservative talking points against the President’s budget. Dr. Robert Shapiro laid out a pretty compelling analysis of the problems with this type of thinking, but the real issue with the column is that, preceding the talking points, Boskin says this:

Obama's Radicalism Is Killing the Dow

A financial crisis is the worst time to change the foundations of American capitalism.

It's hard not to see the continued sell-off on Wall Street and the growing fear on Main Street as a product, at least in part, of the realization that our new president's policies are designed to radically re-engineer the market-based U.S. economy, not just mitigate the recession and financial crisis.

The column proceeds with the list of conservative complaints about the budget, and provides no substantive reason why President Obama’s allegedly flawed budget blueprint is specifically making the Dow tank.

I have another reason in mind why the Dow might be tanking. Let's try it on for size:

The economy is in the tank.

That's right, the actual state of the economy, including the massive financial and housing crises, is the actual force driving down the stock prices of the large companies that comprise the Dow Jones Industrial Average. It's not that Obama is some sort of radical. (Take a look at David Brooks today, who comes around on the notion that Obama and his people are pragmatists, even if he’s not fully on board with their brand of pragmatism.) Rather, it's that the American economy is in its worst shape since the Great Depression.

The causation (more on causation from Mankiw today) Boskin implies (and he's by no means the only one, the media – especially business media – is obsessed with attributing the ups and downs of the Dow to various policies or how confidently the President is speaking, or how much the budget weighs or quickly it can be deep fried), is largely misplaced, and ultimately dangerous. There are times when markets react to government policy, and that's been happening somewhat lately too, but, right now, the Dow is in the tank because that's where the economy is, and its not getting fixed by today's closing bell.

According to Congressional Quarterly yesterday, House Democrats are gearing up to demand more TARP funding for foreclosure prevention. House Speaker Nancy Pelosi and House Financial Services Chairman Barney Frank have been collaborating on a bill that would close a loophole found in the original bailout language. This bill would take much needed steps towards redirecting funds and keeping people in their homes.

House Speaker Nancy Pelosi said Monday she has directed House Financial Services Chairman Barney Frank , D-Mass., to write a bill that would enforce language in the bailout law intended to keep people in their homes.

“It was very clearly spelled out in the initial legislation that funds would be used for mortgage foreclosure forbearance,” Pelosi said, adding that the foreclosure language was essential for winning Democratic support to pass the broader bailout bill.

But when Treasury Secretary Henry M. Paulson Jr. abandoned the asset purchase program, instead favoring capital injections for banks, the foreclosure prevention language also fell by the wayside. So far, Paulson has resisted calls to do more to offer direct help for struggling borrowers. 

Pelosi emphasized that some of the last batch of potential TARP funding should be provided to mortgage foreclosure relief, but she added that she had set no set goal for how much should be provided to help homeowners. “As much as is needed,” Pelosi said. “Because that is really what is going to get to the core of the financial crisis. . . . People are losing their homes. . . . Communities are affected.”

Many Democrats are outraged with how TARP bailout funds have been handled by the Treasury. While the bailout language states explicitly that efforts must be made to prevent housing foreclosures, Treasury Secretary Henry Paulson has largely ignored it and focused on capital injections for banks. NDN applauds Pelosi and Frank for undertaking this effort, as we have argued since September that keeping people in their homes is essential to abating the financial crisis. For more on NDN’s campaign to keep people in their homes, click here.

It has now become conventional wisdom that the housing crisis is at the root of the financial meltdown – an argument NDN has been making since September. 60 Minutes gave voice to that shared sentiment last night, devoting almost the entire program to housing issues and President-elect Barack Obama discussed the very same topic in his weekly YouTube address.

The first 60 Minutes segment, an interview of House Financial Services Committee Chairman Barney Frank, discusses the broad range of issues facing the influential Massachusetts Congressman, including the current financial and housing crises.

With news coming today that the United States lost 533,000 jobs in November, policymakers have begun to realize that, in addition to TARP like bailout plans and the stimulus package that President elect Obama will indubitably pass as his "first order of business," more must be done to address the underlying causes of the financial meltdown. High among these is instability in the housing market, and as NDN has argued since September, more must be done to keep people in their homes.

Thankfully, the effort to do just that is gaining steam, both here and abroad. British Prime Minister announced his effort to staunch foreclosures, and Federal Reserve Chairman Ben Bernanke "warned that the soaring number of foreclosures threatened the economy. He then proposed some ideas — government-engineered loan modifications, and more taxpayer money to help people refinance — to keep people in their homes."

More on the ideas being floated from the New York Times:

"The public policy case for reducing preventable foreclosures does not rely solely on the desire to help people who are in trouble," Mr. Bernanke said. "More needs to be done."

At the Treasury Department, meanwhile, top officials continued to work on a plan to bolster the housing market by subsidizing 30-year home mortgages with rates as low as 4.5 percent — a level that home buyers have not seen since the early 1960s.

Both actions highlighted how economic policy makers have come almost full circle. Since the financial crisis began last summer, both the Fed and the Treasury had focused almost exclusively on patching up the financial system — propping up banks, Wall Street firms, money market funds and issuers of commercial debt.

Months ago, NDN President Simon Rosenberg and Globalization Initiative Chair made the economic case for doing more to keep people in their homes. For more on that campaign, click here.

The Washington Post reports to today that the FDIC and Treasury Department are close to a deal that would keep people in their homes. Since NDN began its Keep People in Their Homes campaign a month and a half ago, momentum has steadily built to restore stability to the housing market.

From the Post:

Negotiators for the Treasury and Federal Deposit Insurance Corp. are nearing agreement on a plan to have the government guarantee the mortgages of millions of distressed homeowners in what would be a significant departure for the federal rescue program, which has so far directed relief exclusively to banks and other financial institutions.

The plan, which sources said could cover as many as 3 million homeowners in danger of foreclosure and cost $40 billion to $50 billion, would go well beyond previous government and private-sector initiatives. Critics say these have attracted too few lenders or offered too little aid to homeowners to stem the foreclosure crisis.

But with economic anxieties continuing to mount and political pressure growing for expanded help to homeowners, federal officials could announce a new program to cover as much as $600 billion in mortgage loans in the coming days, sources said. They spoke on condition of anonymity because the negotiations were ongoing.
...

"The key to our economic recovery is in addressing the root cause of this crisis -- the housing crisis," said Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee. "Federal agencies and financial institutions must do more to modify the mortgages they hold in order to stop foreclosures and help families keep their homes."

Also, on Tuesday in the Wall Street Journal, Andrew Caplin, Thomas Cooley, Noel Cunnihgham, and Mitchell Engler wrote an op-ed called "We Can Keep People in Their Homes." NDN's argument, that arresting the financial cave-in involves, at its core, keeping people in their homes, looks to have reached the tipping point. We urge those involved in negotiations to make this a reality. 

From recent action on Capitol Hill, it looks as though the federal government may ultimately take action to keep people in their homes. As Sam mentioned in his daily round-up (a relatively new NDN product that has become a must read in the mornings), FDIC Chariman Sheila Bair’s testimony to the Senate Banking Committee yesterday was well-received, and details of the plan are expected in weeks.

From the New York Times:

With foreclosures mounting, Bush administration officials said Thursday that they were preparing to step up efforts to help struggling homeowners.
A senior policy maker told a Senate committee that the administration was working on a plan under which the government would offer to shoulder some of the losses on loans that are modified.

The insurance program could cost tens of billions of dollars, according to a person briefed on discussions about the plan, and would be run by the Treasury Department under the $700 billion financial rescue bill Congress passed earlier this month.

The remarks about the plan, made by Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation, came as a new report showed that foreclosure filings jumped 71 percent in the third quarter from a year earlier. At the hearing, Congressional Democrats criticized the administration for not doing enough to help homeowners even as the Treasury and Federal Reserve have moved to inject hundreds of billions of dollars into banks and the financial system.

Ms. Bair, who has been one of the most ardent proponents of loan modifications, acknowledged that more needed to be done. "We are behind the curve," Ms. Bair told the Senate Banking Committee. "We are falling behind. There has been some progress, but it’s not been enough, and we need to act and we need to act quickly and we need to act dramatically."

The Washington Post's front page also has coverage on the proposal. For well over a month, NDN has been arguing that the federal government must take decisive action to keep people in their homes, as stanching forecloures is a key ingedient to stopping the financial cave in. Thankfully, it finally looks as though the federal government will act. For more on the NDN Keep People in Their Homes campaign, click here.