The U.S. Economy After the Bailout 33 comments
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The bailout reminds me of a Hail Mary pass thrown to the 5th wide receiver who is being covered by three defenders and is currently on the 5-yard line, whilst the team's future hall of famer is standing wide open in the middle of the end zone. Sure, the 5th wide receiver may catch the ball and yes, it would set you up for the field goal that could send the game into OT, but throwing the ball to a triple covered 5th WR instead of your wide open hall of famer is a recipe for disaster.
Ignoring my football analogy for a moment, perhaps the biggest problem with the bailout (aside from my usual gripes) is that the plan's proponents are setting improper expectations around the plan's benefits, by assigning benefits to it that the plan simply isn't capable of delivering. The problem with this is twofold: It suggests that the framers of the plan haven't a bloody clue as to the true dynamics of the economic malaise affecting the country, and it could potentially set the nation up for an even greater confidence crisis when the plan fails to deliver.
In order to illustrate this point further, let's take a look at some of the plan's alleged benefits:
Housing Prices: The housing boom was caused by bad lending standards, hyper-expectations and overspending. Remove these bad policies / actions / habits from the system and the housing market is going through a necessary (and proper) correction - a correction that won't be complete until inventories are back to historical levels, and the historical ratio of median income of housing prices is restored.
Nothing short of a Federal agency that demolishes unsold houses and/or gives people money to buy houses that are above their income range can halt the correction, unless (of course) we return to the bad habits of old, but look at where that got us. The claims that the bailout bill can halt the slide in housing prices are fatuous at best, and indicative of the level of ignorance pervasive throughout Washington as to the true causes of the housing crisis. The idea that stabilizing the market for mortgage securities can positively impact housing prices when illiquid mortgage securities have nothing to do with housing prices, is like attempting to wag the dog via his whiskers.
Perhaps the bigger issue here is that people are refusing to accept that the housing market is going through a very necessary adjustment after a period of hyperinflation, and are looking for something, anything to re-inflate the housing market even if it brings dire consequences down the road.
Foreclosures: The spike in foreclosures isn't so much a function of "bad loan terms" as it is a function of people in homes they can't afford, and people struggling to make ends meet due to job loss, general economic pressures, etc. To understand the former all you have to do is read an advertisement for an ARM loan from the housing boom era (and even now to a lesser extent). These and other exotic loan products were advertised as a way for an individual to buy "more house" than they could afford with a conventional loan, with the obvious implication that they can only afford the teaser rate.
The government's ability to modify loans at will aside, how exactly can you "modify" someone out of a situation they could never afford in the first place?
Consumer Spending: Up until last year consumer spending was a product of credit abuse and the housing boom. Remove those factors from the mix and add in escalating prices for food, gas, healthcare, etc, and you get a protracted decline in consumer spending. While the bailout "may" get the credit markets moving again, it's not exactly going to do much to put more cash in the pockets of the average citizen.
I suppose you could argue that easier access to credit will make it easier for consumers to borrow the money they need, however that's not exactly a viable solution over the medium term, let alone the long-term. Furthermore aren't we in this mess because the entire nation (government, consumers, corporations, et al) spent more than they earned and lived above their means?
Consumer Lending: A lot has been made about tightening credit standards and the impact on the consumer, however it's important to put this discussion into the proper context by asking the question: Are standards tighter by historical standards or in comparison to the housing boom era? While this is something that is hard to quantify precisely, I'm of the opinion that the answer leans more towards the latter, and that people's expectations are still inflated after years of easy credit.
That means: Even if the credit markets are magically healthy tomorrow, it's not realistic (or sensible even) to expect the banks to return to the lending standards of old. After all, isn't that what got us into this mess in the first place?
Tighter lending standards are here to stay (at least if the banks have any sense) and are a necessary part of having a stable banking system over the long-term, so people are going to have to adjust their expectations around the availability of consumer credit and consumer spending strength on a go forward basis.
The Dollar: Perhaps the thing that confounds me the most about the bailout plan are the expectations (by some) that the plan will help to strengthen the dollar, an expectation that seems (to me) to be so out of touch with reality that it's not even funny. A nation cannot flood the markets with $700 billion dollars that it has to borrow from overseas and expect that its currency will rise in value at the same time. While the dollar may rise over the very short term due to increased confidence in the U.S. economy, the medium to long-term impact will be currency deflation.
Commodities: While not cited as a benefit of the bailout plan, it's worth mentioning that due to the currency deflating effects of the plan, it stands to reason we're going to see sharp spikes in the prices for oil and other commodities.
It appears that one of the key goals of the plan is to inject a heavy dose of confidence into the markets. What happens to that confidence when many of the same problems remain and a crop of new ones appear? Will the markets take a deep breath, accept reality and start thinking in terms of long-term solutions, or will we see the very consequences the bailout plan is touted as being able to prevent?
Only time will tell.
I suppose when it comes to this bailout we're all waiting to see if the 5th WR catches the ball and manages to get out of bounds in time to stop the clock for the field goal attempt, or if the defenders either intercept it or bat it away.
It goes without saying that in my view even if the 5th WR catches the ball he won't make it out of bounds in time, and even if the best case scenario (the field goal) comes to pass, I think this team is still going to lose the game in OT.
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This article has 33 comments:
Bush is going to turn this 700B into the biggest slush fund in the history of the world. What do you bet he can spend the whole thing before he leaves office? And what do you bet he manages to funnel ALL of it to his pals and cronies? 4 cents on the dollar to us, 96 cents on the dollar to them. Such a deal.
October 2, 2008 10:39 am EST
Originially published at the Washington Times ...
Just one week ago, Treasury Secretary Henry Paulson was demanding that Congress grant him unprecedented, unreviewable authority to spend $700 billion or more to bail-out Wall Street. But in a major rebuke to the administration and to both the Republican and Democratic congressional leadership, the House voted down the 110-page plan that emerged from last weekend´s frenzied — if not unseemly — effort by Mr. Paulson to salvage a bailout deal.
The Dow dropped some 10 percentage points in reaction to the House vote and, while that was less than a third of the massive percentage drop it suffered in 1987, it shouldn´t surprise anyone that Wall Street was upset at being denied at least $700 billion of taxpayer´s money to practice more of what got it into trouble in the first place — buying up over-valued mortgage-based securities. A majority of members of Congress correctly concluded that the leadership-backed bailout bill was, to put it mildly, bad and that the closed-door sessions that spawned it were deeply flawed as well.
Perhaps at long last, some basic understanding of economics is seeping into the Capitol. Dare we hope that some members now understand the fact that Congress can only redistribute, not eliminate, the pain of an economic downturn? At a minimum now, as a result of the House “no” vote, Congress has time to seriously consider alternative strategies and it needs to press its advantage.
The starting point should be private market adjustment. With the knowledge that an easy government bailout is no longer around the corner, the markets can get serious about working through the mountain of bad debt that imperils homeowners, banks and companies alike.
Unfortunately, artificial booms inevitably lead to painful busts, but these can be productively addressed. Today, this means a mix of bankruptcies, company workouts, and takeovers as we are seeing in the banking sector and outside investors buying large pieces of companies, such as Warren Buffett´s $5 billion investment in Goldman Sachs. This process will reward more responsible firms and encourage them to move early to correct past mistakes.
Many companies also will have to sell mortgage-backed securities. Obviously, companies holding over-valued mortgage-based securities (MBS) prefer to dump bad securities on the government than sell them in a down market. But there is a market even though asset values are uncertain. Merrill Lynch liquidated its MBSs in July.
Bailout advocates simultaneously tell us that these assets are “toxic” and are destroying firms, but which magically at the same time are possessed of value that will ultimately make money for the government if it is allowed to buy them with taxpayer funds. However, good business leaders know that private investors are better able than government officials to dig out that hidden value. Private buyers, too, could participate in reverse auctions and hire asset managers on their dime, not the taxpayer´s. This adjustment process should be carried out in the marketplace — not behind closed doors in Washington.
Both Congress and the administration should focus on cleaning up the mess, not making it potentially far worse. Federal and state authorities need to begin to aggressively prosecute fraud in private markets; fraud that has resulted in trillions of dollars of grossly and deliberately, if not criminally negligently, overvalued mortgage paper. The goal is not to create scapegoats, but to keep markets clean. At the same time, we need a thorough investigation of the misbehavior of public officials in spurring Fannie Mae and Freddie Mac, for instance, to engage in reckless lending. Many of the politicians leading the attack on Wall Street for its failures worked overtime to create the subprime lending debacle.
Congress should rein in the Federal Reserve System. Over the last decade the Fed has followed an easy money policy designed to spur economic growth. But this encouraged irresponsible lending and inflated property values. Increasing the money supply is a bit like mainlining heroin — it´s pleasant while you´re doing it, but it´s extremely painful when you finally stop. Yet as currently configured, the Fed is neither transparent nor accountable.
Congress must say never again with Fannie Mae and Freddie Mac, which lowered mortgage standards and pushed people into new or larger homes than they could afford. These government-sponsored enterprises must be privatized; there must be no more implicit or explicit public guarantees for mortgage lending.
Congress needs to repeal the Community Reinvestment Act. The CRA effectively forces banks to lend to poorer communities irrespective of the creditworthiness of borrowers. Many of the same legislators who demanded increased bank lending in the inner-city now criticize banks for making “predatory loans.” Agencies such as the Securities and Exchange Commission need to suspend the mark-to-market accounting standard and reconsider its application. The rule makes sense for trading assets, especially where values are well established; however, the standard has a perverse impact when applied to long-term income-producing assets in a volatile market. A single major, bad sale can force a major corporate write-down, artificially crippling an otherwise creditworthy firm.
We need better, more streamlined regulation, not more regulation. There are a multitude of government financial regulators, leaving us with expensive controls, but without the transparency most needed by customers and investors.
Finally, we must control federal spending. Where is the $700 billion or more for a bailout supposed to come from, in a government already drowning in deficit spending and a spiraling national debt? Who will bail-out the federal government when investors at home and abroad refuse to buy its paper Instead of attempting to ram through a new version of this bad bill, the president and congressional leaders should announce that a government bailout is off the table. Companies and institutions must focus on systematically working through their problems, in a transparent, focused effort, utilizing the tools in the government´s already-massive quiver of tools.
We must learn from today´s economic disaster lest, to paraphrase George Santayana, we repeat this painful experience in the years ahead.
Bob Barr, a former Republican congressman from Georgia, is the official candidate for president of the Libertarian Party.
I have issued the warning as early as June of 2005 (Bloomberg -Mark Gilbert) and on September18,2007 (Bloomberg TV -Brian Sullivan).
At this juncture the problems have been identified and are being addressed.
The 700 billion dollars "aid" will provide almost 5 trillion dollars of the stimulous and will liquify the system.
It had taken few years to create the current nightmare .
It may take few months to see the major impact of the "stability plan " on the economy.
Article after article on this platform spews economic garbage full of criticism and no logical and constructive ideas.
This is a great program aimed at helping Main Street -and it will.
The real punishment is being inflicted on Wall Street /financial institutions which will be forced to sell certain assets at the fraction of the face value but are likely to appreciate to the face value -incredible return for the taxpayers.
The SEC should extend the moratorium on the short selling to all of the stocks for three months in order to enhance the effectivness of the "aid" package.
"Accounting rules and their application can change balance sheet and income statement ‘cosmetics’, but they do not change the ultimate valuation fundamental which is ‘how much cash does a company have in its coffers to operate its business day to day, and will its prospective cash flow sustain the business and result in appropriate after-tax free cash flow returns on invested capital’."
www.stockresearchporta.../
2) US Political System needs to fully understand the ramifications of this statement. Right now, they don't. 20% overcapacity existed in our entire economy/economic model by 2007. That overcapacity has been coming off rapidly. Reliquifying the failed economic model only worsens the pain later just like delaying the deep and long recession from the tech bubble/911 has now caused much more pain. 20% coming off our economy over a duration is a Depression. Yes, we have advantages this time versus the 1930's. This could help decrease the pain but not avoid it and pass the baton to the next political economic mental dwarf and the citizenship at large as we have been doing.
3) What worked to fix our economy in the Great Depression was job creation. The USA cranked up it's GDP toward defense spending, 75% in WWII. The key is that technology used in WWII that was created was later commercialized. Jet propulsion increased the commercial airline business. Building the ENIAC created the mainframe computer industry, etc. etc. etc. So the millions of jobs created in WWII stuck. This time around, the solution is energy. I do not know how much as a nation we would need to crank up our overall percentage of GDP to create the millions of jobs that would stick. I do know abundant energy lowers the cost of everything while increasing upward mobility for the entire economy. Finance focus alone cannot fix Main St. All of us seem to be in agreement that housing must bottom to have a recovery. But point #1 must be acknowledged. The other fix is skilled job creation. The Save and Invest economy we are now returning to runs contrary to the 'globalized' economy/Efficient Market where the loser is Main St and flat wages or failling global wages. The profits are at the top for a weak labor market and it appears those profits have already been taken and either malinvested into finance, or being held as cash for the next big opportunity. That of course is energy. While this 451 page bailoutout bill makes mention of alternative energy, our current efforts (8 B I believe) is a drop in the bucket.
4) It is apparent the USA will turn back to regulations that were lifted to prevent such an economic catastrophe from occuring in the first place. But who is providing oversight now? The same people whom got us here in Washington. The American public has the final say at the end of the road but not the beginning of it which is where we are at. Voter revolution and removing 100-200 members of the House of Representatives that are the most corrupt must and will occur.
Voter revolution is a process that has occured three times in our nations history, all stemmed from corruption in Washington tied into our banking system. This time will be no different but historically it is 4 years. This election cycle will yield much of the same leadership. Pain is now occuring in Washington too. Pain is the catalyst of true change. Pain creates necessity, necessity is the mother of all invention.
TraderBG and CM in MA, excellent discussion of "the way things ought to be".
iThinkBig, you hit the nail on the head. It will take many years, but the way to recovery is through building "things" (rather than financial instruments). These "things" include infrastructure and domestic energy production facilities that can support domestic production of manufactured goods again. As the future unfolds, labor costs of production will become smaller in relation to the facilities, materials and energy costs. We are in a position to become world leaders in reducing and/or controlling future facilities, materials and energy costs, benefitting American labor. I believe this position is temporary and, if not taken advantage of in the next ten years, will be lost.
Are we finally learning that we can not become wealthy by selling houses to each other and borrowing our way to prosperity? Wealth is accumulated by building physical items at ever lowering production costs and providing services essential for living and for supporting the production of "things".
The best analogy I can come up with is giving somebody another drink after a binge and pointing to a six pack as the best solution for his hangover.
I was hoping that, because the election is barely a month away, Congress would use this as an opportunity to get to the bottom of the problem and then construct a really good bill and pass it.
TARP is yet another request by the executive branch for a rubber stamp approval by Congress.
The Japanese are still digging out of their credit contraction, some twenty years later.
We are in for a similar decline, I fear.
Hahaha, brilliant! Again "Gabe", you are a source of incredible humor which brightens my day. Wall street being forced to sell their assets at a fraction of face value. That's humor. Hahaha!
Have we not learned from the Iraq fiasco?
Let it happen! Lassie faire! Everybody suffers; but it is positively the only way to achieve near balance. The economy will be returned to 'production' where we started from and created the finest economy ever. Can this be disputed?
Unfortunately, our good behavior is being overlooked because of the mistakes of others, and not only am I ready for a depression I welcome it!
Perhaps the illegals will leave, freeing up those whom are too "prideful" to work a shovel and then the real heart of the matter can start to rebuild. Get Main Street off the entitlement programs.
Our infrastructure is in a state of shambles and these projects would most likely not be funded directly by the private sector. Thus, we would be much better served spending the $700,000,000,000 on fixing roads, bridges, etc. even though the return on such investment is even harder to measure than return on financial paper of currently unknown value. Better roads, for example, would contribute to better mileage, less breakdowns, and faster delivery times.
The bill does not address the root causes of the problem. Government has fundamentally contributed to this mess with the Community Reinvestment Act and the GSEs (Fannie and Freddie). The CRA needs to be repealed or modified so that traditional lending standards can be applied to all extensions of credit, including low and moderate income borrowers. The GSEs need to be downsized and their function needs to be placed entirely in the private sector without a government guarantee.
Turning the US Treasury into a distressed debt hedge fund is a bad idea. The US Treasury does not have the skills to manage these assets. Outside managers should be retained to manage the assets. PIMCO said it would do it for free, simply covering their costs. 100% of the profits must be returned to the US Treasury.
The price discovery process for the purchase of assets must be thoroughly vetted and be made available to taxpayers. And, yes, if done correctly, there could be a meaningful profit for the UST. (My confidence level here is not high.)
Transparency with the flow of funds, including purchases, sales, expenses and gains and losses, must be made available to taxpayers. In other words, follow the money. Sunlight is the only way of keeping behavior on responsible terms.
Regarding housing prices, the demand curve shifted to the right because people used new mortgage products to buy more house then they could afford and because loans were made to unqualified, low income borrowers under CRA mandates and GSE assistance. Now demand, supply and home prices are returning to a normalized level and this will take time. This bill will not stabilize home prices nor stop foreclosures.
Mark-to-market accounting needs to be changed to valuation based upon expected cash flows. This is being addressed in some fashion. Mark-to-market accounting has contributed to volatility in the prices of illiquid assets, misrepresented the prices of securities and adversely impacted the capital ratios of banks thereby contributing to the contraction of credit.
While I object, this bill is loaded with pork. The idiots in Congress cannot grasp moral hazard issues. No one would lend the Big Three auto makers money, but Congress gave them $25 billion. Can you say corporate "subprime" loans? Have we learned anything? I don't think so. (As an aside, the ACORN provision in a draft of the defeated bill was a complete affront to any thinking person.)
The TEMPORARY increase in FDIC coverage should help stop the "run-on-the-bank" driven failure (although the threshold of $250,000 is too low to address institutional money which moves faster than retail deposits), save the FDIC from needless bank failures and allow for a more orderly price discovery process on impaired assets.
The plan does not ensure that banks will resume lending. This cannot be legislated nor should it be. But this is a major assumption and risk in the proposed plan. My view is that credit has permanently contracted in part because of tighter lending standards and in part because consolidation among banks reduces capacity (e.g. Citi lends $50 million and Wachovia lends $50 million, but after the merger the new Citi will only lend $65 million). The cost of credit will be higher for the foreseeable future. This will impact valuations and demand across the entire spectrum.
The bill will not save us from a recession and there are many other excesses that will need to be worked off. No economy has ever expanded during a period of contracting credit.
Perhaps it is time to address America's inflated lifestyle. Stepping back and evaluating what is and what is not within our means of living, then scaling back accordingly, should be where we start.
Read "The Limits of Power" by Bracevich for a global view. America, we need to "get out house in order" and quit avoiding the pain we deserve.
na justt kiddin... lol
i just wanted to sound smart for a minute. haha
On Oct 02 11:49 AM jlounsbury59 wrote:
> Markham, very good article. I intend no insult, but some of the comments
> are even better. Specifically:
>
> TraderBG and CM in MA, excellent discussion of "the way things ought
> to be".
>
> iThinkBig, you hit the nail on the head. It will take many years,
> but the way to recovery is through building "things" (rather than
> financial instruments). These "things" include infrastructure and
> domestic energy production facilities that can support domestic production
> of manufactured goods again. As the future unfolds, labor costs of
> production will become smaller in relation to the facilities, materials
> and energy costs. We are in a position to become world leaders in
> reducing and/or controlling future facilities, materials and energy
> costs, benefitting American labor. I believe this position is temporary
> and, if not taken advantage of in the next ten years, will be lost.
>
>
> Are we finally learning that we can not become wealthy by selling
> houses to each other and borrowing our way to prosperity? Wealth
> is accumulated by building physical items at ever lowering production
> costs and providing services essential for living and for supporting
> the production of "things".
I don't care what the Bush administration wants, whether it is an extreme libertarian proposal to do nothing or a far left wing proposal to install the dictatorship of the proletariat.
I want congress to advise and consent and I want congress to represent the people instead of monopoly corporate America and, in this case, Wall Street.
Is that too much to ask for?
I like IThinkBig and CM's ideas. Thanks for the fodder for a fledgling economist's mind. Keep them coming.
Regards,
We get alot of bad publicity about not being hard workers, and being cowards and turncoats to our country's freedom for not enlisting enmasse to fight gree wars in Iraq, but our reasons our justified. It's hard to fight for hypocrasy.
I'll tell you this though. We would be alot more excited about getting down to the brass tacks and working our humps off on creating something new, when compared with today's prospects of shuffling papers around trying to "look busy" in cubicles, and cash registers around the country.