I have to tell you the internets were aflame in economic punditry warfare yesterday; so many spins and views in the blogosphere on where the country is heading, what we are doing, the powers of government et al. It's really come to a head with the back to back moves of the Federal Reserve buying US Treasuries (last week) and US Treasury's "we're not calling it nationalization so instead we're going to hand out nearly free money so private investors can make moolah backed by taxpayers" (this week). I'm really incensed about a lot of this, not just what we are doing now but the path that got us here. So many who helped cause this (and profited before the implosion) are going to either directly or indirectly benefit from the plans to "fix it" (and profit from the recovery). If the plans work or don't work, there will still be large profits (just as there were on the path to debauchery in the middle part of the decade)... and now much of the upside will be handed away nearly risk free by many of the same (or similar) players.
Momma have your kid grow up to be a financier; it appears to be a nearly no lose situation. Even the monster called AIG has rallied a few hundred percent the past few weeks - thanks to the taxpayer. I'll be doing a series of posts on this subject (Geithner handout) because frankly it could fill up a month's worth of blog postings, but let it be known that certainly the "speculators" (who drove up the market yesterday) rejoice because its basically a handout, and they will sell it as "look we're going to make major profit but it's in the good of the country - you don't want banks in bad condition do you?" Effectively it's blackmail. They drive up the market on every bailout, every Fed rate cut - etc. It's all bankrolling their actions and ability to make profit - hence this is why we rally each time government comes in and swoops in under the guise of "we're looking out for the small guy". Sorry just my opinion.
This "solution" could be done much cheaper with a temporary nationalization and without subsidizing private investors with the profits. The banks that exist only on taxpayer's dime, should be stripped down, sold off in pieces and any upside should go to the taxpayer. But that's what they do in socialist countries - here we practice "free markets!". Last, I am simply aghast at the unchecked powers of the Federal Reserve - it is scary how they can pretty much do anything they want in times of crisis with no discussion, debate, or real dialogue. If they deem it is necessary - they shall do it. No one can stand up to them ...
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For the first post on this topic I'll focus on James Galbraith who is a descendant of one of the more famous economists there is, John Galbraith. I assume he is considered a "liberal" based on what I have seen of him so far. His father John, much like Ben Bernanke, was an "expert" on the Great Depression and indeed has one of the best selling books on the topic out there: The Great Crash of 1929. Here are a series of videos done on Yahoo's Tech Ticker with Aaron Task and Henry Blodget; I'll state I agree with just about all he is saying in the first two videos but you can listen and decide for yourselves - obviously if you work on Wall Street you will most likely disagree in these assessments since it's to your benefit ;). The third video I don't agree with all the concepts. Again, I think this snake oil job is effectively a cowardly way (or perhaps deviant) to get around what is really nationalization and reward stockholders and "monied folk" with connections with profits backstopped by taxpayers. If there are such great profits to be made, let the US taxpayer who has been milked this whole way enjoy them, strip the banks of the bad assets than sell them off piecemeal to the strong banks who don't need our handouts. But that's just me talking all "socialist". Only in this country is government intervention to enrich the elite few at the top considered "capitalist free market" ideaology: stay out of our business when there are profits to be made (regulation is evil and slows down innovation!), come save us with the money from the "common man" when things go bad. Free markets live!
Before we get to that I'd like to post a link to a quite lengthy piece Galbraith did in Washington Monthly titled "No Return to Normal" - I'm still working my way through it but I've agreed with much of what he wrote. If this is up your alley (it's a bit wonkish) and you have time, it seems like (if nothing else) a provocative read. Some excerpts
- The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it.
- The difference between conservatives and liberals is over whether policy can usefully speed things up. Conservatives say no, liberals say yes, and on this point Obama’s economists lean left.
- Policies are based on models; in a slump, plans for spending depend on a forecast of how deep and long the slump would otherwise be. The program will only be correctly sized if the forecast is accurate. And the forecast depends on the underlying belief. If recovery is not built into the genes of the system, then the forecast will be too optimistic, and the stimulus based on it will be too small.
- To Obama’s economists a "normal" economy is led and guided by private banks. When domestic credit booms are under way, they tend to generate high employment and low inflation; this makes the public budget look good, and spares the president and Congress many hard decisions. For this reason the new team instinctively seeks to return the bankers to their normal position at the top of the economic hill.
- But, is this a realistic hope? Is it even a possibility? The normal mechanics of a credit cycle do involve interludes when asset values crash and credit relations collapse.
On to the videos...
Geithner's Plan is Extremely Dangerous
Tim Geithner has finally revealed his plan to fix the banking system and economy. Paul Krugman, James Galbraith, and others have already trashed it.
[We spoke with noted economist Galbraith this morning. In the accompanying segment, he calls the Treasury Secretary’s plan “extremely dangerous.”]
Why?
In short, because the plan is yet another massive, ineffective gift to banks and Wall Street. Taxpayers, of course, will take the hit
Why does Tim Geithner keep repackaging the same trash-asset-removal plan that he has been trying to get approved since last fall? In our opinion, because Tim Geithner formed his view of this crisis last fall, while sitting across the table from his constituents at the New York Fed: The CEOs of the big Wall Street firms. He views the crisis the same way Wall Street does--as a temporary liquidity problem--and his plans to fix it are designed with the best interests of Wall Street in mind.
If Geithner's plan to fix the banks would also fix the economy, this would be tolerable. But no smart economist we know of thinks that it will.
We think Geithner is suffering from five fundamental misconceptions about what is wrong with the economy. Here they are:
The trouble with the economy is that the banks aren't lending. The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it. As consumers retrench, companies that sell to them are retrenching, thus exacerbating the problem. The banks, meanwhile, are lending. They just aren't lending as much as they used to. Also the shadow banking system (securitization markets), which actually provided more funding to the economy than the banks, has collapsed.
The banks aren't lending because their balance sheets are loaded with "bad assets" that the market has temporarily mispriced. The reality: The banks aren't lending (much) because they have decided to stop making loans to people and companies who can't pay them back. And because the banks are scared that future writedowns on their old loans will lead to future losses that will wipe out their equity.
Bad assets are "bad" because the market doesn't understand how much they are really worth. The reality: The bad assets are bad because they are worth less than the banks say they are. House prices have dropped by nearly 30% nationwide. That has created something in the neighborhood of $5+ trillion of losses in residential real estate alone (off a peak market value of housing about $20+ trillion). The banks don't want to take their share of those losses because doing so will wipe them out. So they, and Geithner, are doing everything they can to pawn the losses off on the taxpayer.
Once we get the "bad assets" off bank balance sheets, the banks will start lending again. The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. So they'll sit there and say they are lending while waiting for the economy to bottom.
Once the banks start lending, the economy will recover. The reality: American consumers still have debt coming out of their ears, and they'll be working it off for years. House prices are still falling. Retirement savings have been crushed. Americans need to increase their savings rate from today's 5% (a vast improvement from the 0% rate of two years ago) to the 10% long-term average. Consumers don't have room to take on more debt, even if the banks are willing to give it to them.
The two charts below from Ned Davis illustrate the real problem: An explosion of debt relative to GDP. The first is Nonfinancial Debt To GDP. The second is Total Debt To GDP.
In Geithner's plan, this debt won't disappear. It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.
Geithner, Obama Kowtowing to "Massively Corrupted" Banks
Like it or not, many people seem to be resigned to the idea there's no alternative to the public-private investment fund scheme Treasury Secretary Geithner detailed this morning. (Click here for part one of our discussion of the plan.)
That's hogwash, says University of Texas professor James Galbraith, author of The Predator State. Of course there's an alternative: FDIC receivership of insolvent banks.
Aside from being legally proscribed, JPM,BAC,USB,WFC,XLF,SKF">the upside of FDIC receivership is the banks are restructured and reorganized for potential sale (either in whole or parts), Galbraith says. Such was the fate in 2008 of, most notably, Washington Mutual and IndyMac.
Crucially, FDIC receivership also means new management teams for insolvent banks; and Galbraith notes new leaders will have no incentive to cover up the fraudulent or predatory lending practices of their predecessors. Given the entire system was "massively corrupted by the subprime debacle," the professor believes criminal prosecutions on par with the aftermath of the S&L crisis - when hundreds of insiders went to jail - is a likely (and necessary) outcome of the current crisis.
But don't expect to see many "perp walks" if Geithner's current plan comes to fruition. That's one reason Galbraith called the plan "extremely dangerous" in part one of our interview.
So why isn't the Obama administration pushing for FDIC receivership? "Political influence of big banks," the economist says.
Happy Talk Won't Solve Crisis
From Obama to Geithner to Bernanke, policymakers are like doctors dealing with a "mildly ill" patient vs. treating one who is "gravely" ill, says James Galbraith, University of Texas professor and author of The Predator State.The economist fears the economy is in terminal condition requiring much more intervention than already prescribed. He believes government "doctors" are engaged in a lot of "happy talk" about recovery based on a "fundamentally flawed model," hinged on the idea the economy is self-healing and only needs a booster shot before it "naturally" returns to trend growth and unemployment in the 5% range.
Galbraith believes that is highly unlikely as Americans grapple with a crushing level of household debt. To help replace consumer spending, massive additional government action is necessary, he says, as discussed in the accompanying video and in this recent Washington Monthly article.
Galbraith's recommendations, which he says will cost $1-$1.2 trillion above plans already enacted, include:
- Higher Social Security benefits: This will aid seniors hurt by the downturn in home prices, financial assets and the dollar's purchasing power.
- More government hiring: Infrastructure spending can help, but major building projects can take years to gear up, and they can, for the most part, provide jobs only for those who have the requisite skills," he writes. "So the federal government should sponsor projects that employ people to do what they do best, including art, letters, drama, dance, music, scientific research, teaching, conservation, and the nonprofit sector, including community organizing - why not?"
- A payroll tax holiday: "This is a particularly potent suggestion, because it is large and immediate," and puts income in the pockets of working families, he says.
- Fix Housing: Put a moratorium on foreclosures and have the government buy homes from those homeowners who have no hope of making their mortgage payments, as detailed in a forthcoming segment.
Galbraith's view is that any or all of these programs "can be scaled back" as growth resumes, but that the government cannot afford to hold back any ammunition in its fight against the deflationary forces of the credit crisis.
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