Will Government Spending Work?

Yesterday Secretary Geithner unveiled plans to stabilize the banking system (and hopefully the housing market). These all involved the government spending money. Estimates are running as high as $1.5T or more (some of it private). Then too there is the stimulus plan. For this the government is spending approx. another $1T. This all seems a little like haphazard spending. Will it do any good?

In the short term I think you would have to say the answer is yes. The stimulus plan, however misaimed it may be in many ways, will go a long way toward arresting the downward spiral we have gotten into. Its overall effect may not totally stop job losses, but it is almost assuredly going to slow them down. The Treasury proposed programs will go a long way toward restoring the credit markets. This will allow more businesses to survive the short term problems this recession has created.

For instance, do you really want every company that is suddenly selling 50% less of its goods to cut 50% of its staff due to short term market fluctuations? This would only lead us further into a downward spiral of job losses. Most of these temporarily hit companies will recover as the economy recovers. It will cost them more to fire excessively now. Then they will have the added expensive of retraining workers 6-12 months from now as we start to come out of the recession.

In the case of technology companies, excessive firings now would also slow down technical innovations. It would delay projects. It would make U.S. businesses less able to compete on a worldwide basis. This would have a long term negative impact on the U.S. economy. It is simply better to allow some of these companies to borrow short term to avoid these losses in time, in innovation, in human capital, and even in overall real money.

One might then ask, won't all this excess spending lead to inflation, and isn't that bad? The answer would seem to be that it will lead to inflation eventually. Is that bad? In the short term it is definitely not bad. We are currently in a deflationary state in which housing prices all over the country are going down. A lot of people's net worth is wrapped up in their houses. A lot of banks are dependent on the same houses retaining their value to maintain their viability. If we can stop the housing prices from going down, that is a good thing. The banks won't be able to survive if we do not achieve this goal. The U.S. economy cannot survive without the banking industry. Stimulating inflation is an effective way to combat deflation. The houses become worth less compared to other items, such as food. However, they retain their book value, which allows the banks to survive. The individual owner effectively loses money in this process, as his equity has gone down in real dollar terms.

However, this inflation preserves the book value of the home. It preserves the margin of equity. The owner still has the freedom to sell the home, if the owner desires to move. This situation is highly preferable to people being stuck in homes paying for mortgages that are underwater. It is preferable to the banks having to absorb losses due to foreclosed homes that are underwater. It is preferable to no one being able to buy a home because the banks are gun shy of having to absorb more bad real estate loans. Eventually the Fed will step in to stop inflation by raising rates, etc. The government can control inflation to a large degree. It doesn't have to let it go on wildly forever.

Then you ask, what about bonds? Doesn't this destroy the value I have in my bonds? Won't the eventual higher interest rates destroy the value in the bonds I buy now? The answer is obviously yes. However, this may not be a completely bad thing. U.S. citizens own some of this debt, but we have been a debtor nation for decades now. The Chinese own a lot of the bonds, as do the people of other countries. If inflation of the U.S. currency occurs, it means we owe them less, so this is not a completely bad thing. The bad part is obviously that they will be unwilling to buy more of our debt if they see it as a completely losing proposition.

However, in the same way people re-invest in the stock market after it has fallen, people come back to the bond market too. Losses of investors in the U.S. bond markets will likely only be temporary as long as the U.S. economy is reasonably healthy. Ultimately the real question then becomes what steps we are taking longer term to make sure that the U.S. economy is healthy in the future.

I don't have all of the answers to this. We do need to get rid of the trade deficit though. We have been ignoring it too long. We knew in the 1980s that we had to do something about the trade deficit. The deficit was the hot topic as the markets crashed in 1987. Somehow we never did anything about it. We have managed to ignore it until now. Now we have emerging economies that are putting pressure on the price of all raw materials, especially oil. If we try to persist in being a debtor country in this environment, we will do nothing but spiral downward. The emerging growth countries will choke us with their new appetites (increased demand means increased price) for the materials we used to have exclusive access to. The U.S. economy will simply wither and die.

That is why the energy initiatives are so important. That is why we must produce more ourselves. That is why initiatives to recycle raw materials effectively are important not just ecologically, but economically too. President Obama needs to bring a halt to the current downward spiral. Then he needs to remember to keep the "pedal to the metal". He needs to follow through on not just a short term recovery, but a long term plan for economic growth for the future. It is crazy for U.S. companies to offshore many of their jobs for marginal if any more profit. Often there are many hidden costs involved in this.

Broadcom (BRCM) probably has a more reasonable compromise model. It is crazy to perpetually import high tech workers, when many very qualified U.S. citizens need jobs. A large proportion of these workers eventually make the U.S. their home. However, a more important minority return to their original homelands to start their own competitor companies using technology they have essentially stolen from U.S. companies. Does it make sense to sponsor this on a widespread basis longer term? Does it make more sense to make sure we have children here with the technical skills to fill these jobs?

From what I see, we are now cutting back on education dollars. Is this going to help us have the ability to fill the highly skilled jobs of the future? Are we instead just getting farther from our ideal? I hear Bill Gates lobby perpetually for more H-1B visa workers. I never hear him lobby for more education for our children. One need is for immediate gratification. The other is for a long term strategic plan. We all know which need is more likely to be served. Is Bill Gates the oracle we should be listening to? Is he just advocating immediate gratification over long term success? Obviously some combination of these two needs to be put in place. President Obama needs to recognize this as a major goal. I hope he will.

In terms of the markets, there seems to have been a negative reaction to Secretary Geithner's plan (or lack of a detailed plan). The SPY has now fallen back below the $85 breakout point of a few days ago to its current $83. We can keep falling from here, or the markets can recover. We will have to see what tomorrow brings (or perhaps just later today). The Nasdaq did break solidly above its 50-day moving average. Not surprisingly it is the index that fell the least yesterday. Perhaps a quick approval of the stimulus package will help the market to stabilize. Short term anything can happen. Longer term we need to do well.

I hope the powers that be in Washington are keeping their eyes on the future as well as the present. We need to become a net exporter again. That should be their clear longer term goal. It should be a high priority. We need to become a country that educates so well, other countries want to import our young men and women to help them, not the other way around. That needs to be a priority. Spending less on our children (and importing more highly educated young men and women) is a losing strategy for the U.S. That has to change. Bill Gates's easy tech people strategy has clearly decreased our perceived "need" to educate our own children. That needs to change.

Comments

[Vox Rationalis:]

One clear idea missing in the inflation discussion is the long-term impact on the cost of all dollar-denominated borrowing should the U.S. try to inflate out of this. If the market sees an increased risk of the U.S. inflating its currency (which it obviously would if we did this), higher rates will be demanded not just in Treasury securities, but in all U.S. public and private debt instruments. The long term cost, in terms of slower economic growth, would be very high.

As for the rest, the import/export discussion, in general the market is quite efficient in allocating resources. There should be no surprise that many well-educated Indians want to come here, where salaries are so much higher. There should be no surprise that businesses want to hire qualified labor at the lowest possible cost. Regarding the visa program (if I remember correctly), the visa holders are sponsored by their employers, which causes significant distortions in the wages of these and comparable workers. This deserves some thoughtful attention.

But regarding the vast majority of the trade deficit - this is simply the free market at work. Persistent trade deficits are not inherently problematic.

Feb 11 08:54 AM

[kelm:]

For a plan to be valid it needs to show closure - that is, how do I get to the end state and the end state in this case is all operating banks are solvent. Geithner's plan does nothing other than keep the banking system on life support He is doing exactly what Japan did and what we told Japan not to do. He needs to fail the institutions that are insolvent - quickly and only hep those institutions that are strong.

Your arguments seem to resolve around - make it so no one suffers any pain at home and well, if we default on our bonds that's ok because foreigners own them. Business is based on credit worthiness and the credibility of the counterparty. A nation's ability to maintain a strong currency is based on its credit worthiness and fiscal credibility in the eyes of others. Thinking that it is somehow justifiable to devalue because half of our bonds are held by foreigners is a sure fire way to ensure that this economic crisis turns into a catastrophe that keeps America in an economic wasteland for decades.

Feb 11 09:16 AM

[Ferdinand E...:]

I believe that I heard Mr Geithner on one of those congressional quiz gigs, and got the impression that he was a windbag. I was wrong. He is just of kind of man that they need in the US government. Let me make a suggestion, the president should dump or think about dumping Mr Bernanke and his (so-called) energy team, and if he can't figure out some way to get rid of them, simply ignore them and their advice.

Feb 11 09:23 AM

[axelrod608:]

>> "The U.S. economy cannot survive without the banking industry." >>

Yes and no. Every economy however big or small needs a banking function, but the banking industry the US brought into the 21st century was and is unsustainable. It was a humongous dinosaur, feeding on the lush ocean of easy, cheap credit pumped into the system by Alan "Bubbles" Greenspan.

The bubble burst. The idea that the bubble can be reinflated enough to continue to feed the dinosaurs is silly. Nonetheless, the reigning political opinion is that job one is to put a solid foundation under the very same banks - and bankers - that created the problem that is now plagueing us.

Easy, cheap, unlimited credit created the mess we're in. It is absolutely NOT the solution.

Feb 11 09:24 AM

[FreeMktFailure:]

prudentinvestor, you remark that when you see the rapid advancements in countries that changed to capitalism, you know the answer as to which is preferable. Clearly that is not applicable to the predicament of the United States because... we were never socialist to begin with!

The free-market argument seems to completely and hypcritically ignore the fact that if we had really let the free-market work this whole mess out, from Bear to Lehman to AIG to Merrill to Citi to BofA to GE, GM, etc., there would not be 15% unemployment, there would be 50% unemployment. It is a load of bull. Almost everybody agrees that a paramount catalyst for the spiral we've gotten into was "letting Lehman fail." "How could we possibly let Lehman fail?" the hypocrits ask.

We need to use our damn brains and not stick to dogmas and ideologies. Capitalist ideas where and when capitalism is necessary, socialist ones when and where socialism is necessary. Of course there is a counter-point to every one of this articles comments, as there are counter-points to all of your comments. Every point has a counter-point. Things ebb and they flow. Just because capitalism worked for you, you likely had less to do with itthan you think. It is all based on the circumstances of where and when, randomness. So recognize today's circumstances and realize, they aren't what they were at any point in recent history.

Feb 11 09:24 AM

[Jake Berzon:]

The debate on what to do and whether it will "work" is more philosophical and political than it is economic. The Government has a duty to prevent its monetary Ponzi scheme from collapsing and can hopefully continue to do so. Anything it does beyond that may cause more harm than good.

I am glad that Geithner and company are taking it slow and setting expectations low - better to be prepared than disappointed.

Feb 11 09:54 AM

[1,000,000 S...:]

Ending the subsidies, or government spending (read running the federal deficit by another 800 Billion with the earlier 700 Billion) why not tap another resource of money to help in the mortgage/banking crisis or the funding the Federal Deficit, US citizen ship and Immigration.

The problem with the Federal Deficit of throwing more "fiat" money and the housing market is not enough more money (read Federal funding without taxes) or enough buyers (with money to fill the homes and pay taxes due to declining consumer spending). As a modest proposal, Offer a special route to US Citizenship (via visa's that vest after 10 years for American Citizenship). Imagine if a million individuals already in line to contribute to the American Experience are allowed to "buy in" to the US? With a 1,000,000 providing a check for a $1,000,000 each generating a trillion injection (not increase taxes, not rolling printing presses since it is our money overseas) of would provide not just an immediate injection that would dwarf the 700+800 Billion debt, but would provide real cash and real people to go filling up the empty homes and condo's across the country. It would sweep substantially away many of the empty or under forclosure home too and generate further spending by those families.

The fact of the matter is America is the "ultimate gated global community" in terms of people trying to get in. These individuals are talented, skilled, innovators and risk takes. These affluent "global citizens" would be repatriating dollars that are being funneled out of the country either through oil transfers to the middle east or through the Wal-mart effect on industry offshoing jobs. Trillions are sitting in the sidelines in Asia (China & India) or the Middle East and even in Russia (the recent oil boom and gas shipments to EU).

The problem is finding the dollars to fund the spending, and it can be more debt (Federal) or more printing (Fed Reserve) or "citizenship vouchers" as part of immigration. Fill the empty homes, refund the banks and financial institutions, and get the economy back on track through high income, high talented, risk taking, willing supporters of American values who want to the US. Give the 1,000,000 Squared plan a chance to work.

Feb 11 10:31 AM

[David White:]

To those of you who were offended by my comments about owing less to others due to inflation, I apologize. I was just trying to look at the possible positive side. I also did not mean to say I thought it was okay not to pay debts. I was over simplifying.

The fact is that many countries are going through what we are going through, for many reasons. Some currencies are being hit much harder than the US currency. We are losing value in a lot of those countries. I was rather trying to point out that inflationary actions, when we are in a deflationary spiral may not be such a bad thing.

Feb 11 10:39 AM

[derryl:]

Oil imports cause about 1/2 of the total US trade deficit. Governments since Nixon have been trying to develop a realistic American energy policy but it has proven to be too politically difficult to accomplish. So America spends hundreds of billions of dollars every year importing oil.

The Arabian root of OPEC is building a new Arabian currency and banking system with all the US dollars they earned by selling oil to America (and to the rest of the importing world). Oil is changing the balance of world financial power and this change is NOT in America's favor. A few more decades of this and Wall St will be relocated to Saudi Arabia or Dubai. Or there will be oil and money wars. Gulf Wars I and II to protect Kuwaiti/Iraqi oil, and future pipelines across Afghanistan, show the oil wars have already begun.

Money is the information exchange or 'nervous system' of an economy but energy is the physical lifeblood. Being dependent on imported blood to keep your economy moving leaves you in a precarious position at the mercy of your oil suppliers.

If there is a single 'stimulus' that could produce both short term and long term benefits to the US it is in developing alternatives to imported oil, beginning by upgrading the electrical grid to prepare for an electric car future. It was (arguably) the additional $200-300/month cost of filling up with $4/gallon gas to get to work that triggered mortgage defaults that started this whole financial meltdown (i.e. if after making all your monthly payments you only had $100 surplus, and if the cost of driving increased by $200-300/month, then you have to choose between buying gas to go to work or paying your other bills, so you buy the gas and default on your mtg payment).

I live in Alberta, home of the tarsands and a major supplier of US oil and natural gas. Our economy booms when oil prices spike, but even here only about 1 out of 3 Albertans directly benefits from higher oil prices. For everybody else all this means is large scale worker immigration with more traffic on the roads and higher demand and prices for everything including housing. Unless you're part of the 1/3 who directly benefits from high oil, all you get is the congestion and higher prices and your same old income so your standard of living actually declines.

This especially hurts people who are poor or who live on fixed incomes, so even though Alberta is the capitalist mecca within a quite socialist country we get all kinds of socialist pressures to 'redistribute' when our economy is in oil-fueled booms. And the socialist measures remain even after the oil booms end.

On the flip side, now that oil is down the 2/3 whose income isn't directly linked to oil prices enjoy income stability instead of reduced profits and massive business pain and layoffs. I am in construction and industrial real estate so I am part of the 1/3 whose businesses and incomes are highly sensitive to oil prices, though I've learned to insulate myself to some extent. But Alberta's is a classic commodity dependent boom-bust economy.

My point is that oil price gyrations hurt everybody. The gyrations and the pain are caused by the fact that too many countries are too dependent on oil exports or imports. Oil is the lifeblood of modern economies so you can't just do without it. To reduce import dependence you have to either ramp up domestic production or develop alternatives. A US energy policy should try to do both.

American money and know-how developed Alberta's oil resources at a time when the central Canadian banking establishment was of the opinion our oil was financially unviable and unworthy of investment. So Albertans like me often feel a greater kinship with our American trading partners than we feel with the country that sees us as a taxable cash cow.

Canada is an export economy and 30-33% of Canada's entire GDP comes from Canada-US trade. We enjoy the largest 2 way trading relationship on Earth. Our supply chains in many industries (like autos) are joined at the hip and Canada is America's largest single supplier of energy. What's good for America is good for Canada (which doesn't stop Cdn nationalists-socialist... from gloating over any US pain even if their jobs depends on trade with America, but nobody is accusing socialists of being rational).

Alberta in particular and Canada in general wants to be part of a US or North American energy policy, including developing alternatives to oil which is a depleting resource no matter how much you try to pretend it willl flow forever.

Canada currently has a Conservative federal government with a Prime Minister who made his home in Calgary so it's a good time to start discussing a North American energy policy. Like the auto pact and free trade agreement, the benefits of a joint energy policy will flow both ways across our border. I think this is one 'stimulus' proposal that can actually work.

Feb 11 12:07 PM

[richard_nog...:]

First of all. The USG has to lose the idea they can wallpaper over a trust problem by printing new dollars. It causes more problems than it cures and there are trillions of dollars not being invested until trust is addressed. The USG has to lose the idea they can create jobs. That will work for a short time.

The truth is that banking has an entire section of the federal code of regulations (12CFR) they are supposed to adhere to. That means they are already tightly regulated. The Bush administration either winked and nodded when banks did not follow regulation or they were negligent in the duties and responsibilities of a regulator. It was the gross failure of our government to perform its oversight duties that got us here.

Therefore in order to regain investor trust three things have to occur: any bad assets must be assigned fair value, a place to store the bad assets must be provided, and the government needs to profile bank or banks that violated their regulatory boundaries.

A reverse auction is the fastest way to assign fair value and provide a means for treasury to purchase the assets at fair value. Each bank has to value their bad assets and treasury purchases those of lowest value/market segment. During the S and L crisis of the 1980's the federal home banks were used to store bad assets. Since that precedent has been set, they need to be used in that capacity again. When investors see these assets at fair value they should start competing with treasury, so not all bad assets will wind up at auction.

Finally in order to assure the rest of the world that the USG will ensure banks comply with regulation, one or more banks will have to be slapped in public. Again the keys:
force banks to evalutate their bad assets fairly via reverse auction
use federal home loan banks to store some of the bad assets
allow investors to compete once they see fair value is being assigned
ensure public is aware that bankers are being punished for violating regulation.

Feb 11 12:51 PM

[Vox Rationalis:]

The author wrote: "I was rather trying to point out that inflationary actions, when we are in a deflationary spiral may not be such a bad thing."

What seems to be missing is that there is a middle ground. Yes, the Fed's actions in the last year would normally be inflationary. But these are not normal times. The Fed is already fighting deflation with inflation; the result, if done perfectly, is stable prices. Once the economy begins to recover, the Fed can easily undo much of what it has done. If it does this perfectly, the result is stable prices. I'm not saying it will happen, but what the author seemed to miss was the link between deflation and inflation - one can be used to fight the other, and when it's a tie, prices are stable.

Now, another thing about inflation. Several trillion dollars of government bonds are held by the government trust funds. If the government were to rely on inflation to get out of this current problem, it would dramatically accelerate the deterioration of the Social Security and Medicare funding situations. Further evidence that inflation is not an acceptable solution.

Feb 11 01:05 PM

[Gedankonomist:]

They're giving us more of the hair of the dog that bit us.

Feb 11 01:36 PM

[David White:]

BS Detector: Actually I don't think I missed the price stability issue at all. I rather think you have missed the major point of the current inflationary policy. That is to stop the fall in the housing book prices in order to stop the bleeding of the banks and the individuals. This should lead to a more stable banking industry, which is necessary for business to flourish.

The main thesis of the Fed's current action seems to be targeted inflation to counteract the strong defaltionary trend in the housing market. This will then improve the credit markets. Along the way the Fed is also trying to improve the current credit crunch due largely to the already high housing book value losses. This approach then allows for outright inflation in other areas of the economy. That inflation is likely to occur in a variety of areas before the housing prices stabilize. The Fed will likely allow this. It is likely necessary in order for the housing prices to truly stabilize. The Fed will try hard not to let interest rates rise. That is because the mortgage rates are a determining factor in how affordable houses are, since most people get 30-year mortgages. It seems likely to me that the Fed may gauge it policy not so much on the actual inflation that occurs, but on the number of months of market supply of houses for sale. The number of new housing permits and starts will also be a factor. This means that commodity prices are likely to go up significantly from their current values before housing prices have completely stabilized. This is in a way an actual lowering of the housing prices without an actual lowering of the housing book prices. Allowing the housing book prices to drop considerably from their current levels will be bad for the banking industry and bad for the economy as we have already seen.

Feb 11 01:44 PM

[Vox Rationalis:]

The author wrote: "Actually I don't think I missed the price stability issue at all."

Upon re-reading, I did find it, so that one's on me.

"I rather think you have missed the major point of the current inflationary policy. That is to stop the fall in the housing book prices in order to stop the bleeding of the banks and the individuals. "

Nonsense. The major point of the Fed's inflationary policies has been to counteract a massive failure in the credit markets, which has led to a significant reduction in the money supply (broadly defined) and significant deflationary risk. The largest expansions of the Fed's balance sheet have been buying large amounts of foreign currency reserves in support of other central banks, a large expansion of the term auction facility, and the establishment of the commercial paper facility. None of these is targeted at housing. If the "major point" of the Fed's expansionary policy is to inflate housing prices, don't you think it would be taking a more obviously direct path? I mean, as Bernanke has said, the Fed can cause inflation at any time. If inflation is the goal, where is it?

But you hardly mentioned the Fed in your article. Again, if the point is to inflate home prices, don't you think fiscal stimulus is a particularly dull instrument?

"However, this inflation preserves the book value of the home. It preserves the margin of equity. The owner still has the freedom to sell the home, if the owner desires to move. This situation is highly preferable to people being stuck in homes paying for mortgages that are underwater. It is preferable to the banks having to absorb losses due to foreclosed homes that are underwater. It is preferable to no one being able to buy a home because the banks are gun shy of having to absorb more bad real estate loans."

Quite the doomsday scenario. Here, let me try. Let's say we save the small minority of homeowners who are underwater (or will be) by devaluing the currency. Consequently, to reflect the inflation risk premium demanded by investors, real interest rates for dollar-denominated assets increase by 3% permanently (or at least for a long time, until investors are sure we won't deflate again). This makes it much more expensive to buy a home, which leads to another decline in home values across the board. The cost for businesses to invest is permanently higher, which leads to less business investment and slower GDP growth - permanently. Additionally, because the trust funds have been devalued, Medicare runs out of money in 2014 instead of 2018 and Social Security in 2029 instead of 2042.

Now which is preferable?

Feb 11 02:56 PM

[David White:]

BS Detector: First the credit problems have been caused by the housing market problems, especially foreclosures. The Fed response is two pronged in its objectives. One is to provide some immediate relief to the credit markets (get them going again). A second is to provide more long term relief to the credit markets by stabilizing the housing prices. This in turn leads to fewer foreclosures, which leads to fewer bank failures and fewer indiviual bankruptcies. Since the original cause seems to have been the housing market crisis (to a large degree), it seems one has to resolve this crisis to have a prayer of resolving the credit crisis longer term.

I don't think the Fed is trying to necessarily inflate housing prices. I think the Fed is trying to halt the fall of housing prices. They are also trying to keep interest rates low as a means of doing this. As you say that makes houses cheaper to buy. They are using inflationary tools to fight the defaltion in the housing market. Perhaps they will overshoot a little. Inevitably prices of some other goods will go up (inflate) as the Fed and Treasury use inflationary tactics to fight the defaltion in housing. This effectively devalues the price of the housing in real dollar terms while leaving the book price unchanged (good for banks and individuals).

They have to stop the fall of housing prices before banks will feel secure in making home loans (and by extension other loans). Therefore they have to stop the fall of housing prices in order to restore good credit markets. In this sense stopping the housing price decline is their top goal. This is not a small issue of a few home owners. It is a huge issue that is causing a huge number of foreclosures. If this logic was a little esoteric for you, I apologize.

After they get the decline in housing prices stopped, I am sure they will then return to their more normal stance of balancing the fighting of inflation with the stimulation of good economic growth. This is essentially what you have described. Currently they have abandoned the fighting inflation priority for virtual complete focus on economic growth and stopping the housing price decline, which is decimating the banking system currently.

Feb 11 03:39 PM

[David White:]

BS Detector: I should have further pointed out that the bank losses are fueling the stock market losses. They are the primary cause of the destruction of wealth. Admittedly they should not have been allowed to get so high in the first place. However, you now have to solve the problem by the least painful means available. The ideal would be to stop the housing price decreases without spurring inflation too much. Still many of the Fed policies are specifically aimed at keeping interest rates for mortgages low. They have cut the Fed Funds rate to 0-.25%. They have said they will buy US bonds to try to keep those rates low. They are trying to cooperate with BOE to keep the LIBOR rate low. We are now in a death spiral situation. It feeds on itslef. Once they stop its downward progress they can go back to trying to address the issues that you bring up. It is clear that they are trying to stop the declines for the reasons I have stated.

Once they get rid of the huge backlog in unsold homes, they can let up a little. Then they can let the housing market find its own levels by itself. They just have to stop the death spiral. This spiral means death to the banking industry as well as death to personal wealth.

Feb 11 03:53 PM

[David White:]

BS Detector: If you remember, Bernanke's first strategy was to let the people who were responsible for all of this excess take their medicine. That was a short sighted strategy. That allowed the death spiral to start. At this point the Fed and Treasury are just trying to stop a runaway train before it does more and more serious damage to our financial system. Bernanke has realized he has to do this. It sounds like you have not. Bernanke's original stance was very like yours is now. That did not prove effective. He has rethought his stance, and I don't think it was due to political pressure. Perhaps you should rethink yours.

Feb 11 04:01 PM

[Gem Hudson:]

But what was is no longer yours but ours now and my freind, to tax and to spend is to spend more what was yours but our money. We'll spend more than a deficit death. We'll spend into an hyper-inflate.

You see. Inflating to pay up isn't buying much no not even in China. You can pay up the total amount on the excnahge rate and they get less wangs. It's a minus sing in the red from what they loaned out to what they will be really getting in principle. What everbody are buying into is a brake down.

Feb 12 07:27 AM

[Vox Rationalis:]

David White wrote: "I don't think the Fed is trying to necessarily inflate housing prices. I think the Fed is trying to halt the fall of housing prices."

I don't think you can make an argument, nor do I think you have, that the Fed's actions to date (with the exception of very limited purchases of agency securities) has been specifically targeted at firming up home prices. The Fed simply doesn't have the tools to be so targeted.

But I'm not being fair. This article was not about the Fed at all. It also didn't even touch on the programs the government has launched in direct support of the home-ownership industry, such as Hope for Homeowners. Make no mistake, however - the Treasury bailout is targeted at far more than housing. The capital injections are there to firm up the banks so that they are in a better position to make all kinds of loans. The "bad bank" does nothing to specifically support housing prices. The expansion of the TALF does nothing to specifically support housing prices.

But even so, you seem to be trying to make the case that the government is trying for inflation by fiscal methods that have very modest inflationary impacts. Why didn't you just say that the Fed's recent expansion of the monetary base is intended to cause inflation to the point of stabilizing house prices? It's not, but at least the right tools would be identified.

"They are using inflationary tools to fight the defaltion in the housing market."

Only in as much as the housing market is tied in to the overall economy - the Fed's actions are clearly targeting the economy as a whole. Lowering interest rates spurs the entire economy, not just the housing market. Expanding the monetary base replaces lost money supply in the entire economy, not just the housing market. I think Bernanke was fairly clear in his 12/4 remarks: "To the extent that more accommodative monetary policies make credit conditions easier and incomes higher than they otherwise would have been, they support the housing market." This is a very good read about foreclosure mitigation: www.federalreserve.gov....

"Perhaps they will overshoot a little. Inevitably prices of some other goods will go up (inflate) as the Fed and Treasury use inflationary tactics to fight the defaltion in housing."

By your logic, the most apparent indicator that the government is supporting housing prices in this way will be generalized inflation, right? So how much inflation do you think it will take to stabilize home prices? Should I expect my $10.50 orange juice at Costco to go up to $12 or $13 or higher? By the way, a generalized increase in price levels would be a drag on the economy in the short run and would tend to worsen the recession, as aggregate demand would fall due to the reduction in real wages. And then there's the significant drag that the increased uncertainty would cause.

"They have to stop the fall of housing prices before banks will feel secure in making home loans (and by extension other loans)."

What I think you really mean is that banks won't make loans until they are better able to quantify the risk in their loan portfolios, which they would be better able to do if home prices stopped falling. The government is clearly taking other steps in this direction, steps not related to devaluing the currency.

"Therefore they have to stop the fall of housing prices in order to restore good credit markets."

No, they don't. They have to make the banks more willing to lend. They don't need to stop the short-term decline in home values to do this - they could for example provide support for loans such that the bank's potential losses are limited.

"This is not a small issue of a few home owners. It is a huge issue that is causing a huge number of foreclosures."

This is all relative. A hundred thousand homes being foreclosed every month is certainly not a few and is very significant, especially for those families and communities with clusters of foreclosures. But in terms of the percentage of homeowners? There are more than 125 million housing units in America. Even under the worst-case scenarios I've read, we're talking about a couple of percent of homeowners. As I said, a very small minority.

"If this logic was a little esoteric for you, I apologize."

Oh please. Are you sorry for the condescension?

Feb 12 12:25 PM

[Vox Rationalis:]

The author wrote: "I should have further pointed out that the bank losses are fueling the stock market losses. They are the primary cause of the destruction of wealth."

It's pretty clear from a graph of the situation that the stock market was trading at above-average valuations, so while the collapse of real estate was the trigger for the decline in stock values, much of the decline can be explained as reversion to the mean.

"Still many of the Fed policies are specifically aimed at keeping interest rates for mortgages low. They have cut the Fed Funds rate to 0-.25%."

Which is different from normal, expansionary monetary policy how?

"They have said they will buy US bonds to try to keep those rates low."

Which is different from normal, expansionary monetary policy how?

"They are trying to cooperate with BOE to keep the LIBOR rate low."

Which has nothing to do with mortgage rates in the least.

"We are now in a death spiral situation."

Which is much larger than the real estate market. Valuations MUST come down - it happened in Japan, it happened in tech, it will happen here. The government can no more stop this process than it can provide a job to every person in America. What government has to do is help the banks quantify their risk and limit it so that they can function normally again. This is what the bad bank is about. This is what the toxic asset scheme is about. Neither of these things would have a significant direct impact on the decline in housing prices, but both could go a long way to allowing banks to operate normally.

"It is clear that they are trying to stop the declines for the reasons I have stated."

It is quite clear from Bernanke's own words that the Fed's abilities in this area are limited, and while he has spoken at length on a number of occasions about the need for foreclosure mitigation, he has made it clear that those efforts need to come from other government entities.

"Bernanke has realized he has to do this. It sounds like you have not. Bernanke's original stance was very like yours is now. That did not prove effective. He has rethought his stance, and I don't think it was due to political pressure. Perhaps you should rethink yours."

Sigh. Let's see - is it better for the government to take the steps it clearly is taking, that is, directly shoring up the banks, or is it better for it to devalue the currency, with all of the damage that would cause to the broad economy, to shore up the banks and keep 2% of homeowners from being foreclosed upon?

But this whole sidebar started because I pointed out that you discounted or disregarded the Fed's primary role in inflationary policy, and that the Fed has not, and can not, target its actions at the mortgage market. It's not the FDIC. It's not any part of the Treasury. It's not an agency of government that spends money. Bernanke's beliefs and the Fed's capabilities are two entirely separate things.

Good day.

Feb 12 12:52 PM