Just Survive …

Posted: October 12, 2008 | Author: | Filed under: U.S. Economy | Tags: , , , | 2 Comments

I’ve really wanted to talk about the financial crisis more.  It’s been hard to write about because things on the ground are changing so quickly. The deal right now is just to survive the entire thing. Times are odd and the odd are getting odder.

The oddest of the the odds is that there are more than just one economic positions being borrowed from Hillary’s plan by BOTH the surviving presidential contenders.  Both of these guys are completely clueless on the economy and it’s really showing. They are like little boys in a class room cheating off that one little girl with glasses that has all the answers.

This week,  Senator McCain became the liberal by suggesting a plan similar to Hillary’s suggestion of some kind of HOLC like the one that bought up bad mortgages during the depression.    Everything he’s been suggesting is so populist that I keep pinching myself to see if I’m actually awake. The Sunday morning talk shows were filled up with democratic talking heads trying to explain that buying folks’ homes at their underwater positions and renegotiating them is going to help banks more than the home owner.  This program is basically a re-tooled Roosevelt New Deal idea that is geared specifically to folks living in their homes, not the speculators. If you were all for the banks, the agency would bail out ALL mortgages, not just firsts for home owners. As a progressive, I have to say, for Democrats to be taking a stand against this position JUST because McCain introduced  into the debate and Obama just says no, is a little, well, odd, to me.

Another odder than odd policy suggestion is Obama’s idea to let judges work out families’ mortgage problems in bankruptcy court.  This is probably a good long term solution, but wouldn’t it be nice to stop these families from showing up in the bankruptcy court?  I’m actually wondering if prevention of a problem is something a lawyer can even wrap their brains around.  I mean, they make money from exacerbating problems once they’ve gotten huge in a court case, not from problem prevention so is this why he’s stumping for this at a time when short term solutions are required?  Even my first year economic students couldn’t figure out why you’d want to let the bankruptcy court work the foreclosures out.  Why not try to prevent the foreclosures? 

The next thing is the Pelosi hint at yet another stimulus package.  Just about any one ought to realize now that the first one really didn’t do much but hold the recession off a few months and make folks think of other things.  While it’s a nice thing to get $600 in the mail, the government can’t control what that money gets spent on.  It’s one thing if you take the money and buy something American, but most folks either use it to pay down debt which is not the least bit stimulatory or they go buy something that stimulates the Chinese economy. Unless you create a no buying at Walmart rule, this is nothing but another make them feel better while we figure out what to do plan.

 Economists have shown empirically with both the Ford and Bush rebates, that rebates are not the way to stimulate the economy because they don’t have the desired results.  They usually just exacerbate the debt and make folks feel a little better.  They are not game changers.  You need underlying changes to the tax codes to do that or you need the government doing spending on something that might have a chance at creating jobs–like building roads.  This is another Obama suggestion. The problem with infrastructure spending at this point is that it takes a long time to get through the system.  It is needed, but how long will it take to get the program going?  Infrastructure improvements are an important part of both short run economic stimulus and long run economic growth, but it’s a little late to start suggesting these things now that we’re in a full blown financial crisis and down turn in the real economy.  They’d have to be coming OUT of the hopper right now to do any real good; not going into the hopper some time ‘soon’.  Again, this is a preventative type of action once you see things are slowing down.  It wouldn’t be soon enough at this point.  This again leads me to believe that Obama doesn’t seem to grok the concept of preventative and when it’s useful. I was suggesting this a YEAR ago as a way of preventing a recession and slowing job loss when it does happen.  It’s a little futile now.  Hillary was suggesting this a year ago too.  That and her green jobs initiative were great suggestions for the situation at that time.

Which brings me to another odder than odd.  Senator Obama is now wanting some kind of tax credit to home owners for higher energy costs.  What I’m waiting to hear is how this is different from just giving every one a tax holiday from gas taxes except you have to wait until the beginning of the year to file for it.  Again, every time you talk about a one time deal, even if it is a tax thing, every one knows it’s a one time deal and it doesn’t really change their behavior.  Any stimulus that comes from it tends to be very short-lived.  Plus, by the time any tax credits would take effect it will be the spring.  Not one economist will probably stick their head out to say what kind of things will be needed by then.  It doesn’t make sense to try to do that now.

Right now, Henry Paulson is the most important man in Washington.  It’s not the President and it’s not these two candidates.  The second most important man is Ben Bernanke.  Again, odder than odd because neither of these men are elected and both of these men may have very short tenures at the helm. However, I’m just hoping Dubya takes some time off at the ranch.  I know I can’t wish that one for every one up for election right now, but I really would like it.   It is in the hands of Paulson and Bernanke until January.  I’m okay with that because Paulson, btw, is not what the Republicans or the Democrats spin would make him to be. 

Paulson has always been odd for both a Wall Street and Washington insider.  Paulson is a man that grew up on a farm in Illinois and got into Dartmouth the old fashioned way–good grades.  He wasn’t a legacy of any one unlike our current crop of candidates AND the president.  His nickname is “the Hammer” because he’s seen as relentless.  He is also a devout Christian Scientist who does not drink or smoke and goes back to Illinois on the weekends. He did this even when he was on Wall Street.  He lacks ideology and has been criticized by the right of being selling out free-market principles  and on the left for bailing out his Wall Street buddies.  I always consider being criticized by both sides a good thing in a public servant, but then that’s me.

Now we seen a joint effort from G-7 countries to contain the contagion.  Almost all of these plans have to do some with some kind of nationalization of banks.   This includes McCain’s suggestion to get the taxpayer ownership which oddly enough was snuck into the bailout package, unknown to many.  I’m wondering where THAT came from.  Perhaps we’ll find some one taking the credit for that soon, but it seems it might actually be some one like Republican Senator Arlen Specter.  Again, odd, odd and odder.

Meanwhile, my strategy and tactics are just to survive with my job and my loans paid down. I’m also trying to put a little money aside in the bank.   I’m trying not to look at my 401k plan because it’s telling me that I will die at the podium at this point.  I haven’t changed anything about it except all my new contributions are going into bonds.  That’s my suggestion to every one right now, don’t panic, we’ve been here before, we just don’t know how long it’s going to last.  I actually do have faith in Paulson and Bernanke but not so much in ANYONE running for election right now.  Right now,  McCain is sounding like the Roosevelt liberal right now and Obama is sounding very moderate so turning to politics for economics signals right now just has me checking my hands to determine which is left and which is right.  I still know which way up and down are and that we’re in for more downs than ups for awhile.  Other than that, I have NO idea what to say other than it’s an odd time right now and the odd are just getting odder.

Bottom line:  Just try to survive.

Crisis Strategy: Getting it Right the first time

Posted: September 28, 2008 | Author: | Filed under: Uncategorized | Tags: , , | 8 Comments

(Cross-posted at The Confluence)

There are very little details out in the public concerning the supposedly ironed-out terms that will solve the current financial crisis.   Almost every one is worried that the terms of the rescue will involve taxpayers bailing out Wall Street High Rollers and their bonus-loving CEOs.  If you review Financial Economics literature, you will discover that there are several findings in the studies done by economists that can provide guidance to every one on the best way to approach the bail-out.  One of the most recent studies comes from the International Money Fund.  It is by Luc Laeven and Fabian Valencia and was posted this month at the IMF research website.

If you’re not familiar with regression analysis which is the analytical method of choice here, stay away from the last half of this paper.  However, you may find some interesting things in the first section because it includes a huge database that looks at all systematically important financial crises between 1970 and 2007.  This means the database has 42 crises in 37 countries. It looks at steps taken by government to solve these crises and the length and depth of the crisis.

Here’s the link:  http://www.imf.org/external/pubs/ft/wp/2008/wp08224.pdf

Another good source of information for suggestions is the Brit Magazine The Economist.  Many of its articles are also available on line and are not technical in nature.

If you’re not up to looking at the details, let me try to explain some of the things that Financial Economists have learned since the Great Depression.  You should look for some of these dos and don’ts when we finally get to see the details of the plan. Sixty years of study and growing theories has shown us that the tactical approaches–which mostly involve containing the crisis–are very expensive and don’t work too well.  Usually, containment approaches happen while the crisis is unfolding.  As an example of this, I will point to the bail-outs of individual banks and financial institutions that have happened to date.  We’ve seen this containment tactic most of this year.

Governments can respond to these kinds of crises in many ways.  In a lot of cases, we see reallocation of wealth from taxpayers to Banks and other institutions that hold debt. When wealth transfers like this happen, many problems happen in the general economy.  The existing research done in this area shows that providing assistance to banks and their borrowers can actually increase loan losses to banks and in many cases lead to laxes in regulation that can be abused. Study-after-study shows that individual bank bail-out is usually not a good approach.  Other costly and not that efficient tactical steps can include accomodative policies like direct government guarantees of bank liabilities or injecting ‘liquidity’ into the bank itself by lending money to the bank.  The literature shows that none of these steps necessarily lead to a speedier recovery.

So what strategies can our country adopt to staunch the current crisis?  Proposals vary, but a good example of something that worked would be the comprehensive plan we had back under the first Bush administration during the S&L meltdown.  The RTC (Resolution Trust Corporation) was set up in 1989 to deal with the many, many S&L bankruptcies.  The purpose of the RTC was to dispose of failed S&L assets in a way that didn’t drive prices on the properties and assets down.  It put a bottom price on things like farm land or houses that were the underlying assets held by the thrifts.  In the case of situation now, a new ‘agency’ would buy troubled mortgage-backed securities from the market and hold them until there was a turn around in their value.

This new agency could also serve another purpose similar to a depression-era institution called the Home Owner’s Loan Corporation.  Hillary has suggested this type of agency whose purpose would be to buy and restructure existing mortgages.  This would basically keep many folks in their homes with mortgages they could handle.  For this to work, it has to be geared towards folks that can actually follow-through and make their payments.  It could not be a social largess program because that would only create more loan losses in the long run.  It’s purpose would be to keep folks in their homes as well as put faith back into house prices and the mortgage market.  It would also alleviate the downward pressure on home prices.  A new agency would be allowed to hold the loans and troubled securities until the market function agains and the assets once again become valuable.  Many of the assets in some of these securities are fine now and could just be repackaged.  The profits need to be returned to the taxpayer and used to pay down the debt.  We should ensure that the proceeds do not go to any politician’s pet project.

At the same time, we need to look for better oversight of derivatives markets.  The big issue that can be layed squarely at the feet of the Bush Administration and Greenspan is their inability to see the need for regulation of these markets.  The existance of this market (which serves a similiar function to insurance) injected more ‘moral hazard’ into the banking community.  This means if you think you’ve got something insured, you’re more likely to act haphazardly.  We already had banks being encouraged to loosen their underwriting standards for certain borrowers by Fannie and Freddie.  With the invention of these innovations, banks were covered, or so they thought, even if they did practice lax lending standards.  These derivatives were an attempt to manage credit risk.  However, as we have seen, actually placing accurate vales on this contracts just created more uncertainty.  The implied consent and guarantee of the government via Fannie and Freddie exacerbated the misvaluation in a market with no oversight.  We need to re-visit the regulatory responsibilities of the SEC and the FED and update them so that they reflect the existence of these extremely sophisticated and difficult to understand markets.  Also, something has to be done about Fannie and Freddie and how their role to feed loans to creditworthy middle class Americans warped into some social engineering plan that began the lax lending standards and provided opportunities for exploitation.

So, do we need a bail-out?  Yes.  Unfortunately, financial contagions do act as a disease and can create economic downturns that impact everyone.  All you have to do is crack a book on the Great Depression to see how problems in banks and stock markets eventually transfer over to Main Street.  What is needed is the least expensive and most prudent approach.  The literature tells us that it must be systematic and not just tactical.  You need to strengthen the market, not just select players.  I’ve outlined a few things that financial economists have learned about past crises.  I’d hope we get the details out pretty soon so you can look and see if the bailout is consistent with these principles.

Newer Entries →