Great Recession


Steve Pearlstein Excoriates AIG Chief Edward Liddy

This morning I linked to a WaPo op-ed by Edward Liddy, the chief executive of A.I.G. in which he says, basically, that there was no way he could have avoided paying the $165 million in bonuses to current and former A.I.G. employees because, well, a deal's a deal.

I missed, however, this column by Steve Pearlstein, in which he rips Liddy into a million liddle pieces-- excoriating him for a lack of creativity, and a failure to understand that it's no longer business as usual on Wall Street.  

Here's where it gets good:

After all, if the government hadn't stepped in, AIG would have gone bankrupt and those whiz-bang traders could have lined up with all the other unsecured creditors at the bankruptcy court to see how much money they might receive three or four years down the road. And the government could still put the company into bankruptcy anytime it chooses.

Moreover, the Justice Department would surely have been within its rights to launch an extensive civil and criminal investigation into whether those bonuses were granted as part of an ongoing conspiracy to defraud shareholders -- a conspiracy in which the traders were knowing participants. As part of that investigation, prosecutors could have also prepared a public report to the Treasury, the Federal Reserve and Congress listing the names and home addresses of all the traders who were slated to receive the bonuses, along with a detailed description of their role in creating the mess that brought down the company. There could even be a chart listing their salaries, bonuses and other perks over the past decade.

Pearlstein is right on, here.  Liddy's inability to anticipate the backlash this has caused, and his staggering inside-the-box thinking is indicative of an endemic failure to comprehend how the ground has shifted. So many of the old rules just don't apply anymore.

AIG's Bonuses - More Than Expected

Josh Marshall is reporting tonight that the total amount of bonuses being paid out by AIG is way more than expected. Hundreds of millions more. 

Remember AIG has received more money than is contained in the entire home foreclosure initiative, and almost half as much as is in the first year of the stimulus plan just passed.  The sums are staggering. 

I assume the Administration's response to this will be swift and certain - and unpleasant for AIG and others involved.  

On the Path Forward

This morning I reflected on the emerging economic debate.  In doing research over the past few days I was struck by this passage from a paper Dr. Rob Shapiro authored back in 2007, The New Landscape of Globalization: How America Can Reap Its Rewards and Reduce Its Costs, which I still feel is fresh and very pertinent: 

Where We Go from Here

We cannot entirely avoid these hidden costs of globalization, but we can outsmart and outrun them. There are many proposals to cushion their effects, through measures such as wage insurance. Those measures may help for a while, but by themselves they tacitly accept the underlying dynamics as inevitable and inalterable. A better approach focuses directly on affecting those dynamics. To begin, we will have to relieve some of the cost pressures on businesses, which in the more intensely-competitive environment of globalization hold down wages and job creation even as growth and productivity increase. Reforming our health care and energy practices, in short, is now the number one jobs and incomes issue, and one on which American workers and American businesses have real common cause. Both areas are already major public policy issues. Recognizing how the enormous increases in health care and energy costs of recent years directly and substantially affect wages and jobs should give greater sense of urgency to finally addressing both areas, in specific ways that will slow those increases.

In addition, we also should expand our public investments and other commitments in those areas in which American workers and businesses have advantages in the global economy. In an increasingly idea-based economy, the education of every American child should specifically include advanced skills in information technologies. Every child can and should have continuing access to a personal laptop computer in the school for 21st century instruction and at home for their homework. A recent proposal by Alec Ross of One Economy and NDN, "A Laptop in Every Backpack," is a sound and innovative start. Every worker in America also should have access to training in these technologies. Nearly half of our current workers cannot operate a basic computer, principally those workers with relatively few other skills. We can and should create a federal grant program for the country's 1,200 community colleges to use their existing computer labs and personnel to offer free computer training several nights a week to anyone who walks in and asks for it. Finally, Congress should look at ways to give workers more and better tools to prosper in this more competitive world, such as portable pensions and the passage of the Employee Free Choice Act.

As global competition increases, we also can and should expand public investments in the factors that foster innovation and help all industries grow and become more efficient. The federal government has long supported the nation's infrastructure, basic research and development, and education and training, all of which are essential to creating new business and spreading technological innovation. In recent years, however, our commitments in these areas have contracted sharply. For example, new commuter rail systems in the nation's larger metropolitan areas can not only bring more workers to more jobs, but also help reduce congestion and dependence on fossil fuels and consequent production of greenhouse gases. In addition, greater support for basic R&D in nanotechnologies for energy and health care, and the human genome for health care, can help to develop new business and over time address some of the long-term cost pressures in health care and energy.

Serious commitment to basic health care and energy policy reforms and meaningful new investments in education, training, infrastructure and basic R&D will be costly, especially at the outset. In the meantime, we can finance these necessary investments in many ways. Wasteful spending in other areas, including tax and spending subsidies for some well-connected companies and industries, can be pared back. Recent tax cuts for very high-income individuals, whose incomes have soared as those of average people have stalled, also can be pared back. Given the economy's basic strengths in this period, such steps will not slow down or hamper its growth in any meaningful way.

There are sound reasons to be wary of deficit spending, especially the prospect of sharply-rising federal expenditures for retirement and Medicare benefits as the baby boom begins to retire just a few years from now. These concerns, however, need not preclude our undertaking these commitments and investments. They will create substantial dividends for both the economy and government revenues over time, by bolstering those specific economic areas where the United States either has real advantages or needs real change. In so doing, they should help generate stronger growth and higher incomes, producing the revenues needed to sustain them. In this sense, these commitments and investments will operate like a sound investment that a good business makes, and often borrows to finance.

In addition, globalization itself can reduce some of the traditional costs associated with budget deficits, especially for the United States. As recently as the 1980s and early 1990s, when global capital markets were smaller and less efficient than today, large deficits in a growing economy claimed domestic savings that otherwise would have gone for business investments. As capital markets have gone truly global, the sheer volume and variety of financial assets flowing through the world's economies have blunted those effects because productive American businesses have direct access to the world's savings.

For some time, global capital has been growing faster than world GDP, faster than global trade, and faster than worldwide saving.17 A fair estimate of the global capital pool today is more than $150 trillion, more than three times world GDP and more than three its size less than 15 years ago.18 Moreover, the rate at which dollars, yen and euros move from one country to another (and often one currency to another) is accelerating even faster than their quantities, tripling in just the last 10 years and reaching more $5 trillion a year in 2006.

The fact that global financial assets today are growing faster than global GDP is meaningful. Since these assets are claims on the future, this rapid growth signals that overall, the world's rich people and rich businesses that hold them most of them are bullish about the future - certainly more so than in 1980, when the world's financial assets were growing much more slowly and totaled just 10 percent more than world GDP.

The unprecedented size of both the global capital pool and capital flows from country to country ultimately reflect the new prosperity of much of the developing world, along with the revolution in information technologies. After the last 15 years of massive transfers of Western investment, technologies and expertise to many countries that had stagnated for decade or centuries - China, India, Malaysia, and Mexico, for instance -their businesses and people are amassing large amounts of new saving and wealth. Modern finance exchanges much of this wealth for corporate bonds, bank deposits, stocks and other kinds of financial assets - economists call this process "securitization" - so that much of this new prosperity ends up in local or national capital pools.

Information technologies play a special role in moving these local and national pools of financial assets into the global capital system, because most of these financial assets now exist in the form of the bytes created, stored and transmitted by those technologies. And no sector has more thoroughly globalized itself than banking and finance. These technologies allow banking and financial institutions to not only link up and manage global operations, but turn physical wealth into securities and financial deposits that unlike paper or gold, can move from account to account and country to country in a nanosecond with no shipping costs. So, while there are relatively limited numbers of businesses in Chile or Indonesia - or even China - that can profitably use all the capital they create and save, firms and wealthy people in Santiago, Jakarta and Shanghai can easily and seamlessly invest their profits and savings in companies in Raleigh, North Carolina and San Jose, California, or lend it to the U.S. government.

There is a cost: Our trade and budget deficits require that we tap into global savings to maintain our business investments, and the result is that a growing share of the U.S. economy and its assets are owned by non-Americans. At last count, 12 percent of all U.S. equities, 25 percent of all U.S. corporate bonds, and 44 percent of U.S. government securities. And the large U.S. current account deficit, comprised mainly of our trade deficit, means that every year, we have to borrow hundreds of billions of dollars more from non-Americans. All that borrowing has depressed the value of the dollar, making it more expensive for American and U.S. businesses to invest abroad. It also raises the possibility of an eventual dollar crisis that would drive up U.S. interest rates.

These are all legitimate concerns, and we should take serious steps to increase our domestic savings. With global capital markets continuing to help finance business investment in the United States, these concerns need not delay the public investments and reforms required to better prepare Americans to live and prosper in an economy shaped by globalization and new technologies.

Weekly Kos Poll, GOP Still at 16 Percent, Messaging the Economy

The weekly Kos track has the landscape essentially unchanged this week - Obama strong,Congressional Dems in an improved position, the Congressional GOP at catastrophically low levels. 

The Congessional GOP is at 16 percent approval this week.   Recalling that John McCain received 46 percent of the vote last year, 30 percent of the country is now in a position to have voted for McCain in 2008 and be currently disapproving of the Congressional GOP.   At some point the national media is going to come to terms with how incredibly unpopular, ineffective and intellectually bankrupt the modern GOP is today.  Only a few times in this past century has a poltical party in the United States been so unpopular.  

So Obama has prevailed in this first round.  But a new and very important round of public engagement with Congress and the GOP begins now.  For the next month or so, even while the Administration starts to very publically engage with the rest of the world (G20, Summit of the Americas, Biden and Clinton trips), there will be a very consequential battle over the President's budget.  

The President begins this next round in very good shape.  But my sense is that the Administration will have to do a better job now at distilling down to the essence of what they are asking the country to do - is it recovery? To invest in the future? Get the budget under control? Tame Washington? I think the President's plan needs a name and single message.  Not sure it should be "recovery,"  Do we really believe the country wants to go back to where we were - 81 percent wrong track? No.  Increasingly I get the sense that these economic and fiscal terms - recovery, stimulus, deficits, investment, budget plan - are the wrong words for this next phase.  Feels like it should be more about adopting the President's plan for America; embracing the President's strategy for a strong America in the 21st century; etc.

In reviewing the budget blueprint, it is clear that the President has a far-sighted plan to ensure America prospers in the 21st century.  That is what we are going to debate over the next month - and all components of it are means to the end, and not the end in itself.  What the Obama team must do at all costs is to prevent the GOP from doing what is has done so effectively these past few years and reduce this big conversation on what our economic strategy for the future needs to be into a overly simplistic debate about numbers, deficits and taxes.  All of that is tactical, means to an end - and that end is broad based growth, a strong America, a successful America of the 21st century.  Remember that in the Clinton era we raised taxes on the wealthiest among us and saw extraordinary growth and broad-based prosperity.  In the Bush era we radically cut taxes for the wealthiest and saw the incomes of every day people decline.  Tax rates are only part of the overall strategy our nation uses to create growth, broadly shared, and this old canard that tax cuts automatically create growth has been disproven once and for all.  

Larry Summers began laying out the terms of this next debate in an important speech yesterday.  But I still feel what is missing in the emerging Obama argument is 1) old bad economy vs new better economy - a forward/backward main thrust vs the concept of recovery; 2) we still have not done nearly enough to account for and explain why incomes went down during the years of recovery before this recent recession.  There is a mountain of data that shows that for the American people this period of losing ground was traumatic, that it helped drive the wrong track number to 81 percent, the highest ever recorded, prior to the recession and financial crisis.  For many Americans what this means is that we don't need recovery - a return to a period of declining wages - or growth which excluded them - but we need a different and better type of growth that this time, now, raises all boats and helps them manage this more competitive economy of this new century.  What we need is a new and better economy; an economic strategy for the 21st century; a strong plan for a strong America; a plan to make globalization work for all Americans, etc.  

The idea that we had growth under the GOP that saw a declining standard of living for the typical American family is the strongest rationale for the plan the President is promoting.  In this much more competitive economy of the 21st century America will need to invest more be smarter and try harder to maintain our standard of living.  We will need to equip America to be successful in a very different 21st economy - one that must be more energy effecient, low-carbon at its base, is technology tense, and globally competitive and interconnected.  For America Inc. to propser in that economy we need a new and comprehensive strategy; one that invests in our infrastructure and people; that encourages accelerates innovation and new job creation; that cuts health care costs and encourages better health; that modernizes our electricity network, invests in renewable energy sources and makes a national crusade to make our homes and businesses more energy effecient.  

All of this will take time, years in fact.  But in his desire to be honest with the American people it is critical for the President to continue to emphasize the long term structural changes and investments we are making, and to not let short term metrics like "recovery," "stimulus" or the stock market be the way he defines success.  A tall order all this, but it is one I truly believe the President is up for.  The real question is - is Congress?

The GOP's Early Response to Obama Has Been Catastrophic

The weekly Kos track is out, and the central dynamic of this new political year remains unchanged: Barack Obama has become a towering and popular figure, the Democratic Party retains its relatively strong position, and the already unpopular GOP had paid a heavy price for opposing the President in his efforts to lead America to recovery.  

I've been writing about how one of the central stories of the new Obama era would be how the GOP struggled with the new realities of this new political era. With the rise of Rush, the struggles of Steele, the disapointment of Jindal, the lack of any attractive savior on the horizon and the just plain irresponsibility and awfulness of their Congressional leaders in a time of national crisis the GOP truly appears to be a political party facing a long road back.  

Remember, in this Kos poll Obama is at 69, Boehner 15.  The Congressional Dems are at 45, the Congressional GOP is at 15.  There can be no other conclusion than this early engagement with the President has been catastrophic for the GOP, and that they will need to find a new way to work with the President.  

Rob Shapiro has a great new essay on the inanity of the GOP's emerging economic arguments, and I discussed all this with Norah O'Donnell on MSNBC earlier this week.

10am Update: From a new Newsweek poll getting a lot of attention this morning: 

Despite the tumbling economy, Barack Obama continues to enjoy a honeymoon with the American public in the face of the most trying crisis any newly inaugurated president has encountered since Franklin Delano Roosevelt. The GOP, meanwhile, is viewed by a majority of Americans as the party of "no," without a plan of its own to fix the economy, and even rank-and-file Republicans are concerned about the party's direction, according to the first NEWSWEEK Poll taken since Obama assumed office.

"People give Obama credit for reaching out to Republicans, but they don't see Republicans reciprocating," says pollster Larry Hugick, whose firm conducted the survey. "A surprising number said bipartisanship is more important than getting things done."

Overall, 58 percent of Americans surveyed approve of the job Obama is doing, while 26 percent disapprove and one in six (16 percent) has no opinion. Although his approval ratings are down from levels seen a few weeks ago in other polls, 72 percent of Americans still say they have a favorable opinion of Obama-a higher rating than he received in NEWSWEEK Polls during the presidential campaign last year. The president's rating in this poll is consistent with estimates provided by other national media polls in the last week.

Leonhardt: Story of the Great Recession Not Nearly Written

Across the upper five percent of America, there's some sense that this Great Recession, as NDN's Dr. Robert Shapiro labeled it in December, just isn't really that bad. Sure, stocks are taking a hit and the financial sector is hurting, but we've been there before. In the New York Times, David Leonhardt lays out how bad this Great Recession really is, and who it has hurt the most, to this point.

What does the worst recession in a generation look like?

It is both deep and broad. Every state in the country, with the exception of a band stretching from the Dakotas down to Texas, is now shedding jobs at a rapid pace. And even that band has recently begun to suffer, because of the sharp fall in both oil and crop prices.

Unlike the last two recessions — earlier this decade and in the early 1990s — this one is causing much more job loss among the less educated than among college graduates. Those earlier recessions introduced the country to the concept of mass white-collar layoffs. The brunt of the layoffs in this recession is falling on construction workers, hotel workers, retail workers and others without a four-year degree.

The Great Recession of 2008 (and beyond) is hurting men more than women. It is hurting homeowners and investors more than renters or retirees who rely on Social Security checks. It is hurting Latinos more than any other ethnic group.

Leonhardt tells us that could all soon change:

You often hear that recessions exact the biggest price on the most vulnerable workers. And that’s true about this recession, at least for the moment. But it isn't the whole story. Just look at Wall Street, where a generation-long bubble seems to lose a bit more air every day.

In the long run, this Great Recession may end up afflicting the comfortable more than the afflicted.

He points out that the collapse of the financial sector will hurt the wealthy and ultimately lead to a smaller Wall Street. (The same dynamic will ultimately help young families, allowing them to buy into the financial and housing markets at the bottom.) Government policy will reduce inequality. And, most importantly for expanding the economic pie, the nation's unemployed will turn to education, if they can. Community colleges are already feeling budget crunches across the country, especially in the areas where they’re most needed.

There seems to be, amongst conservatives in Congress and the Rick Santellis of the world, a sense that the Great Recession just isn't that bad. They shout "Moral Hazard" as we try and stabilize the housing market, and they cry about deficits that didn't matter to them when the last Administration launch an optional war and ideological tax cuts. But Leonhardt tells us that they're about to start feeling it.

And, even if they aren't big fans of some of the President's plans, let's hope they can work with him to do the one thing we know will grow the economy for everyone in the long term – build a 21st century education system to create the workforce for the next great expansion.

Two Questions Central to the Emerging Economic Debate

You can see them gaining currency in thank tanks, op-ed pages and tv shows.  2 questions whose answers will drive our policies and dictate the terms of our recovery - is our financial system insolvent? and Will high-levels of consumer debt force American consumers to save rather then spend, and take them out of the game over the next few years?

We've been asking the Spend? Save? question here for a few weeks nowDavid Leonhardt attacked it last week in the Times, and Paul Krugman visits the question today in his column

Last week the Federal Reserve released the results of the latest Survey of Consumer Finances, a triennial report on the assets and liabilities of American households. The bottom line is that there has been basically no wealth creation at all since the turn of the millennium: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001.

At one level this should come as no surprise. For most of the last decade America was a nation of borrowers and spenders, not savers. The personal savings rate dropped from 9 percent in the 1980s to 5 percent in the 1990s, to just 0.6 percent from 2005 to 2007, and household debt grew much faster than personal income. Why should we have expected our net worth to go up?

Yet until very recently Americans believed they were getting richer, because they received statements saying that their houses and stock portfolios were appreciating in value faster than their debts were increasing. And if the belief of many Americans that they could count on capital gains forever sounds naïve, it's worth remembering just how many influential voices - notably in right-leaning publications like The Wall Street Journal, Forbes and National Review - promoted that belief, and ridiculed those who worried about low savings and high levels of debt.

Then reality struck, and it turned out that the worriers had been right all along. The surge in asset values had been an illusion - but the surge in debt had been all too real.

So now we're in trouble - deeper trouble, I think, than most people realize even now. And I'm not just talking about the dwindling band of forecasters who still insist that the economy will snap back any day now.

For this is a broad-based mess. Everyone talks about the problems of the banks, which are indeed in even worse shape than the rest of the system. But the banks aren't the only players with too much debt and too few assets; the same description applies to the private sector as a whole.

The other question, to the solvency of our financial system, was discussed a great deal on the Sunday talk shows yesterday.   Last week Martin Wolf of the FT wrote

Yet hoping for the best is what one sees in the stimulus programme and - so far as I can judge from Tuesday's sketchy announcement by Tim Geithner, Treasury secretary - also in the new plans for fixing the banking system. I commented on the former last week. I would merely add that it is extraordinary that a popular new president, confronting a once-in-80-years' economic crisis, has let Congress shape the outcome.

The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. If this "progeny of the troubled asset relief programme" fails, Mr Obama's credibility will be ruined. Now is the time for action that seems close to certain to resolve the problem; this, however, does not seem to be it.

All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency.

Under the first view, the prices of a defined set of "toxic assets" have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. This was the rationale for the original Tarp and the "super-SIV (special investment vehicle)" proposed by Henry (Hank) Paulson, the previous Treasury secretary, in 2007.

Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad - on sovereign, housing and corporate debt - will surely fall on US institutions, with dire effects.

Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a "no brainer".

The new plan seems to make sense if and only if the principal problem is illiquidity. Offering guarantees and buying some portion of the toxic assets, while limiting new capital injections to less than the $350bn left in the Tarp, cannot deal with the insolvency problem identified by informed observers. Indeed, any toxic asset purchase or guarantee programme must be an ineffective, inefficient and inequitable way to rescue inadequately capitalised financial institutions: ineffective, because the government must buy vast amounts of doubtful assets at excessive prices or provide over-generous guarantees, to render insolvent banks solvent; inefficient, because big capital injections or conversion of debt into equity are better ways to recapitalise banks; and inequitable, because big subsidies would go to failed institutions and private buyers of bad assets.

Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing. Trying to make up for this mistake by imposing pettifogging conditions on assisted institutions is more likely to compound the error than to reduce it.

And the aforementioned Professor Roubini wrote yesterday in the Washington Post:

The U.S. banking system is close to being insolvent, and unless we want to become like Japan in the 1990s -- or the United States in the 1930s -- the only way to save it is to nationalize it.

As free-market economists teaching at a business school in the heart of the world's financial capital, we feel downright blasphemous proposing an all-out government takeover of the banking system. But the U.S. financial system has reached such a dangerous tipping point that little choice remains. And while Treasury Secretary Timothy Geithner's recent plan to save it has many of the right elements, it's basically too late.

The subprime mortgage mess alone does not force our hand; the $1.2 trillion it involves is just the beginning of the problem. Another $7 trillion -- including commercial real estate loans, consumer credit-card debt and high-yield bonds and leveraged loans -- is at risk of losing much of its value. Then there are trillions more in high-grade corporate bonds and loans and jumbo prime mortgages, whose worth will also drop precipitously as the recession deepens and more firms and households default on their loans and mortgages.

Last year we predicted that losses by U.S. financial institutions would hit $1 trillion and possibly go as high as $2 trillion. We were accused of exaggerating. But since then, write-downs by U.S. banks have passed the $1 trillion mark, and now institutions such as the International Monetary Fund and Goldman Sachs predict losses of more than $2 trillion.

But if you think that $2 trillion is high, consider our latest estimates at the financial Web site RGE Monitor: They suggest that total losses on loans made by U.S. banks and the fall in the market value of the assets they are holding will reach about $3.6 trillion. The U.S. banking sector is exposed to half that figure, or $1.8 trillion. Even with the original federal bailout funds from last fall, the capital backing the banks' assets was only $1.4 trillion, leaving the U.S. banking system about $400 billion in the hole.

Two important parts of Geithner's plan are "stress testing" banks by poring over their books to separate viable institutions from bankrupt ones and establishing an investment fund with private and public money to purchase bad assets. These are necessary steps toward a healthy financial sector.

But unfortunately, the plan won't solve our financial woes, because it assumes that the system is solvent. If implemented fairly for current taxpayers (i.e., no more freebies in the form of underpriced equity, preferred shares, loan guarantees or insurance on assets), it will just confirm how bad things really are.

Nationalization is the only option that would permit us to solve the problem of toxic assets in an orderly fashion and finally allow lending to resume. Of course, the economy would still stink, but the death spiral we are in would end.

Both of these essays echo an essay Rob Shapiro wrote within days of the announcement of the original TARP, Back to Basics: Why The Treasury Plan Won't Work.  

I read these articles.  I listen to the commentators.  I and many others in positions of responsibility continue to wake each day to an even greater understanding of the enormity of the problems our nation now faces, of the hole dug by the mismanagement and ignorance of the previous administration.  Clearly, now, we have to conclude these are no ordinary times.   

So my friends watch the debate over the next few weeks and come to your own conclusion - should American consumers spend, or save? And are the banks insolvent?  How we answer these questions in the short term will dictate very much how we approach the next stage of the management of our economic crisis. 

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. 

Christian Science Economics

The Bush administration, long known for faith-based initiatives, has embraced a new form of faith-based economics to address the financial crisis and cascading recession: We’ll call it an economic version of Christian Science, prescribing modest steps to make the patient comfortable while largely leaving us to heal ourselves.

It’s only an analogy, but play along. A succession of debilitating infections has left the American economy in critical condition. The specialists (the Treasury and Fed) have prescribed the application of salves (the bailouts) wherever the infections break through the skin (financial institutions facing bankruptcy), while the actual infections (rising home foreclosures, lax or absent regulation, and the credit freeze) are left to heal themselves. As the patient deteriorates, the family (Congress and the White House) faithfully hang on every word from the specialists; and like everything in modern medicine, the price tag is astronomical. Months into this regimen, the treatments have done little to control the infections, and the patient’s condition is critical.

The current regimen also leaves the economy vulnerable to new shocks to its system, and they’re almost certainly coming. Lucky for everybody, this patient can’t pass away – but the economy could require life support for another year and come out of this with long-term disabilities. This week’s shock came from Bernard Madoff and his accomplices. In normal times, the banks and other institutions that gave Madoff tens of billions of dollars to invest would write down the losses with modest effects on their other activities. Or, if the bailout regimen had included serious measures to stem the housing foreclosures still eroding the value of mortgage-backed securities, the institutions could better absorb the new Madoff losses. But more than half-year into this crisis, the Drs. Bush, Paulson, and Bernanke have still left hundreds of large banks and funds exposed to additional rounds of mortgage-backed-security losses, and thus all the more vulnerable to unexpected losses from sources like Madoff’s schemes. It’s not too late for Congress to address the underlying infection here, with a 90-day moratorium on foreclosures, and a commitment by Fannie Mae, Freddie Mac and the institutions collecting taxpayer bailout money to renegotiate the terms of the distressed mortgages they hold.

The Great Recession we’re all living through will inflict additional, damaging shocks on the economy. For example, the budget deficit is growing at a record pace, fueled by the accelerating decline and stimulus packages that include virtually every idea any member of Congress has considered over the last decade. The new catch is that as the effects of the economic decline spread to the countries which finance most of our deficits, especially China and Japan, the global pool of savings is contracting. On top of that, the recession has taken hold in much of Europe, driving up their deficits. The inevitable result will be intense competition next year for a shrinking global savings pool, which in turn will put upward pressure on our interest rates in the midst of deep recession. And that will further slow the resumption of normal lending – because, once again, the bailout regimen simply applied a salve of taxpayer infusions for financial institutions without addressing their dogged resistance to using those funds to resume normal lending.

The good news in all of this is that the nations that regularly make trouble for the U.S. – Russia, Iran, and Venezuela – all find themselves in terrible straits. The global recession has driven down their oil revenues (and the value of their government bonds) faster than an American 401K. Unfortunately, as Harvard’s Ricardo Hausmann points out, the global crisis also is cutting off foreign capital flows to most developing nations, including stable and friendly places such as Mexico, South Africa, Turkey, Brazil, and Malaysia. President Obama may well find Vladimir Putin and Hugo Chavez much weakened adversaries. But he and Secretary of State Clinton could well also face new problems triggered by economic upheavals in many parts of the developing world. The silver lining for us is that much of the capital that would have gone to developing countries will flow here instead, hopefully moderating the upward pressures on interest rates. In order to take advantage of it, however, Congress will have to go beyond the administration’s salves and attach explicit lending requirements to the next round of bailout funds.

The current regimen of Christian Science economics is working no better in this financial crisis than the medical version would work in a deadly epidemic. The American economy will not get well on its own. Fortunately, however, the architects of this approach will retire in a month, and the country then can turn to more able doctors.

Syndicate content