For more than a year the Treasury and the Fed have been trying to chase down house prices by reflating the housing bubble, creating a market price for housing by feeding the top of the food chain things it cannot digest. It has been a supply side plan with its focus on the toxic loan products, and it has not worked.
A demand side plan to put a floor under house prices began in the Dodd-Frank short refi bill which was included in the omnibus housing legislation two months ago. This is a close cousin of the Home Onwers Loan Corporation of the 1930s which put a floor under house prices then, partly by keeping qualified buyers in their homes.
This is the only way out of the mess, and has to be coupled with the creation of a sound banking structure, not obscenely large megabanks.
The bailout plan, whether $700 billion or $1,200 billion aims to create economic stability by sopping up the toxic paper the financial system pumped out over the past several years. These years of so-called "innovation" produced money for housing out of thin air, or rather out of mathematical models that amounted to modern day alchemy. Promising gold triple AAA, delivering lead junk junk junk.
This may stem the panic in the financial system for a time, but it has unknown and probably dire ramifications even there. It certainly will not solve the housing problem. And we have to have a floor for housing as the base of any solution.
The second reason the bailout won't work is that it doesn't move to rehabilitate the banking and shadow banking system, but simply puts a trillion dollar strut against a collapsing building. The proper remedy is to move as soon as possible to demolish the current system and return the financial sector to its Glass-Steagall form.
Glass-Steagall was the New Deal structure, much of it instituted in the original "first one hundred days," that period of 1933 when Franklin Roosevelt and his brain trust put a floor under the Great Depression. Glass-Steagall created a stable, productive financial system that sponsored American prosperity into the 1970s. It set up the FDIC and separated the activities of financial speculation from those of commercial banking. Over the past twenty-five years it has been dismantled.
The upshot of the opening acts of dismantling was the Savings & Loan crisis of the 1980s, ending with the bailout of the Thrifts through the Resolution Trust Corporation, or RTC, that is the supposed model for the current bailout proposal.
The upshot of the final scenes of dismantling in 2000 were, first, a celebration by Right Wing ideologues because they had finally destroyed this key plank of the New Deal, and second, the callapse we are experiencing right now. Note that the RTC in 1990 was buying bricks and mortar. Paulson's plan this week is to buy pieces of paper of unknown value.
There is no megabank solution, no so-called market consolidation in the banking sector that can survive more than a few months. There is only the return to Glass-Steagall, to a commercial slash consumer banking sector that is separate from the investment slash speculation system. There can be no firm that is too big to fail. Financial innovation and risk diversification have turned out to be smoke and mirrors and risk creation.
Let there be no mistake, the financial nabobs of the present day are practicing the exact same economics and producing similar non-answers as those who knew it all when the system blew up in 1929. The Paulsons and Bernankes and Financial House talking heads have no more clue than the Hoover Administration which watched the stock market collapse into a banking collapse and offered nothing more than market knows best platitudes.
It took the Roosevelt Administration and the original First One Hundred Days. Roosevelt put a floor under the fall and stabilize the financial system with Glass-Steagall, stabilized housing with the Home Owners Loan Corporation and began recovery with the jobs programs of the CCC and WPA.
And be clear, there was no immediate turnaround. It was a slow return to growth. The Obama administration, God willing it comes to pass, will have a similar challenge. But it will have the advantage of the model of the New Deal and the theories of John Maynard Keynes.
In 1933 and throughout the Depression and the Second World War, the best minds of the generation were not in finance, or aeronautical engineering, or computer science, or medical science. The best minds had gravitated to economics. Drawn by the challenge of relieving the climate crisis of that time, the enormous suffering of the collapse of laissez faire. Today we have few great minds in economics. Joseph Stiglitz comes to mind, but most have been driven out by mathematics and the schools sponsored by the entrenched moneyed interests. Economics has returned to the Dark Ages and has to reassert the principles and practices of the demand side enlightenment. We will need to turn back to the economics that worked for the many, not for the few, and so worked for all.
There is no supply side solution. There may be a need to pacify the credit markets so they don't drown us all in their panic, but it should not be considered a solution. There is only the demand side solutions, creating a financial sector and market inside a clear regulatory frame and beginning to form a floor with help to homeowners.
I am not one, obviously, who has suggested that Ben Bernanke was doing a great job, or Henry Paulson was performing as well as anyone could under the circumstances. Perhaps they were doing as well as they could, but that is a pathetic excuse, since they were not doing very well. The crisis has been on us for more than a year. Their strategy was to muddle through. If they had known what they were doing, they could have come up with something better than a massive economy-ikilling socialization of trillions of dollars of bad investment vehicles.
Bernanke is a student of the Great Depression, but Ben has come up with a different answer than those best minds on the ground in 1933. His "answer" has been worse than useless. He has made money very cheap (arguably setting fire to the commodities boom and its attendant inflation) and he has turned the balance sheet of the Fed, the central bank, into a pawn shop. Henry Paulson came from Goldman Sachs. He has offered a series of struts and backstops and smoke and mirrors that have left the financial palaces still teetering.
There are answers. We even have an emergency bigger than World War II to create demand -- and that is the environmental collapse of the planet. How quickly can we clear the rubble from the street? How soon can we return to sound architecture?