Strategies to End the Crisis

Global stock and commodity prices continue to drop as the threat of a long recession looms.  Fear casts a shadow that threatens the viability of democratic capitalism and threatens a wholesale breakdown of the economy into a depression.

Conventional mortgages and business loans remain scarce, four million homeowners face foreclosure by 2010, and plummeting demand for goods and services throughout the economy is destroying more than 100,000 jobs a month. Construction and manufacturing jobs are disappearing at an alarming pace.

Bank bailout efforts by the Treasury, Federal Reserve and their counterparts abroad are failing because those address symptoms not the systemic ills that caused the credit crisis. While global investors and traders may not articulate their fears in such esoteric terms, failure to address systemic problems are driving down corporate sales and profits and destroying stocks values.

At the banks, the national officials have provided liquidity, injected equity and guaranteed overnight and other short-term borrowing. However, large money center banks simply are not interested in using the massive funds provided them to make sound loans to consumers and businesses on the scale needed to get the economy going. These money center banks are no longer interested in providing liquidity to regional banks by bundling their loans into bonds for sale to insurance companies, pension funds and other fixed income investors that sit on vast pools of capital.

The bonus systems and compensation structures at large banks permit executives to earn much larger sums doing other things—engineering mergers, currency and derivatives trading and the like. Money center banks have become part of larger financial conglomerates over the last 25 years. These are run by executives who believe they should be able earn millions of dollars each year doing deals and creating exotic securities rather than by making loans and helping smaller banks raise needed funds.

The compensation restrictions put in place by Treasury when it injected capital into the largest banks only apply to a few top officers and are easily circumvented. They simply change little in what is wrong with executive incentives at the large money center banks.

Beyond that, demand for goods and services in the United States and Europe are being driven down by the undervalued currencies and massive purchases of dollars and euros by China, oil exporters like Saudi Arabia, and other emerging economies. Their huge trade surpluses translate into trade deficits in the United States and Europe and the need for massive borrowing to keep up demand for goods and services in Western economies. That caused the housing bubble and over borrowing in the first place, and without a policy to realign currencies to redress trade imbalances, we simply can’t get beyond the current credit crisis without ruinous government deficits, reckless consumer borrowing and indenturing our children to foreign creditors.

Congress is talking about another stimulus package but tax rebates would only give the economy a temporary lift. As we saw last spring and summer, those gave consumption a boost that slipped back after a few months. That gave GDP growth a sugar high late in the second quarter and helped growth from slipping too much in the third quarter. Now, flagging construction and retail sales are taking the economy into an abyss.

The best purpose for another stimulus package would be to help get the economy through the first half of next year while the Treasury and Federal Reserve take even more assertive steps to straighten out the banks and address other structural problems such as the trade deficit, energy development and inadequate public facilities.

Infrastructure spending that fired up projects already in the pipeline would leave a more lasting legacy than facilitating a few more restaurant meals and trips to the mall. Such spending would also have a greater multiplier effect on GDP than tax rebates as it would result in fewer imports.

In parallel, we need aggressive programs to straighten out management at money center banks, assertive steps to correct currency misalignments with China and other countries with huge trade surpluses, and efforts to reduce oil imports through reduced gasoline consumptions and investments in both conventional and alternative energy sources and conservation. The latter includes incentives to build more hybrid automobiles quickly, more offshore drilling and onshore natural gas development, investments in nonconventional energy projects, and more energy efficient buildings.

Comments

[OilyGasMiner:]

Peter great post, we continue to employ bandaid solutions while we ignore the real root of our problems. I haven't heard anything on the WAR in Iraq for weeks, and this was the true origination of our problems followed by terrible rating agencies, who would rate the greedy mortgage brokers' bonds as AAA when they weren't worth more than FFF. HAha. Stimulus? Will it work? Question. Has it worked? Temporary solutions mean nothing in the long run.

2008 Oct 23 10:59 AM

[MarvinMBA:]

Of course things always look bad before any turnaround. Actually, I personally believe that there could be some bottoming action coming soon with some of the bigger entities such as MSFT show some inherent strength....MarvinMBA

2008 Oct 23 11:17 AM

[sickofthehype:]

Conventional mortgages scarce?
Not at all - IF you maintain good credit. In fact, you can put as little as 5% down on them, down from 10% down required just a few months ago.

2008 Oct 23 11:30 AM

[Smarty_Pants:]

“Beyond that, demand for goods and services in the United States and Europe are being driven down by the undervalued currencies and massive purchases of dollars and euros by China, oil exporters like Saudi Arabia, and other emerging economies. “

I’m not sure whether this means:

1) Demand for US goods is lower because foreign goods are cheaper; OR
2) Demand for Chinese goods is lower due to undervalued foreign currencies.

The sentence is ambiguous in this respect.

Number 2) doesn’t even make sense as lower foreign currencies translate into more purchasing power for the dollar and hence lower pricing on foreign goods. This would tend to increase demand for foreign goods as any Microeconomics textbook will tell you.

Number 1) at least makes sense from an economic standpoint. With lower prices on imports people will buy those before they buy higher priced US made goods. While that may be bad for US manufacturers, it is good for the consumer. After all, isn’t it better to buy the same item at a 25% savings than to pay the higher price? What the author overlooks is WHY US made goods are more expensive than foreign made goods which need to be shipped half way around the world to compete in the local marketplace.


“[Foreign governments’] huge trade surpluses translate into trade deficits in the United States and Europe and the need for massive borrowing to keep up demand for goods and services in Western economies. That caused the housing bubble and over borrowing in the first place”

This makes absolutely no sense. The reason the foreign countries have surpluses is because Americans buy more of their products. Of course their trade surplus “translates” into our trade deficit. It has to. One party’s surplus is the counter party’s deficit. How that caused a “need for massive borrowing” is beyond me.

What it did was put massive amounts of US currency in the hands of foreigners. They had to do something with it, so they CHOSE to buy US debt when the US offered to borrow it on the market.

Foreign governments could have CHOSEN to buy other things instead and the US would still be borrowing “massive” amounts of money. The borrowing has nothing to do with trade deficits, the deficits only served to provide a means for the foreigners to be able to lend to the US when they asked for a loan.

How either US borrowing or foreign lending led to the housing bubble is beyond me. I thought we borrowed because the gub'mint spent too much.

I would expect better from someone with a PhD in economics.

2008 Oct 23 01:47 PM

[Tony Petroski:]

Peter Morici: Cheer up. My whole life the U.S. has had a trade deficity with the rest of the world and yet.. here we are. We will be OK.

2008 Oct 23 09:35 PM