This has been an interesting week for financial discussions. Some of the comments in this diary and this one and this one and probably others got me thinking about our psychology in how we approach difficult times. Some of us tend to remain irrationally over-optimistic that things will get better, while others more despair that things are so bad we really don't have any good options left. And simply agreeing on the diagnosis of what's wrong, let alone what to do about it, can be more difficult than it may first appear.
I want to offer some ideas of potential actions, including some pretty extreme ones, that could be taken to show (or perhaps reassure) that things are not so bad that we are backed into a corner with no room to maneuver. We're a wealthy country and have a host of options. The question, I argue, is still more what do we want to do and less what are circumstances forcing us to do.
Personally, I believe that at a conceptual level, economics and finance and business should be accessible to most people, and in general, I think people have a good understanding of the basics of how things work. The gut feeling that our system was breaking down seems to have registered on Main Street before DC or Wall Street. To me, the fact that it took business and political leaders so long to react, that they are reacting mostly rather than taking proactive steps to prevent problems in the future, and that there isn't a lot of effort to place incidents in a larger context, suggests that we should be particularly critical of the specifics of solutions that are proposed to the problems in the housing and financial markets.
This is especially true when we're the ones who end up footing the bill through the assumption of risk, extension of loans, and other goodies private actors wouldn't offer in the current marketplace.
So what are these more far-fetched options? Interestingly, they depend on exactly what one believes to be the problem.
If the problem is a short-term liquidity/credit crunch, where the main problem is that financial entities won't lend money to each other because there is uncertainty about how much their assets are worth (the various derivatives and securitized/collateralized debts and other financial products), but the fundamental value of the assets remain, the big worry is about a sudden lack of lending leading to a collapse of one of the remaining investment banks because it simply didn't have cash to cover its obligations, which would lead to a collapse of the financial sector, which would undermine the broader economy, etc. We could:
- Make loans from the government, but instead of accepting these uncertain financial products, demand stock as collateral. That should make management pay attention if the government may become their boss, make shareholders more active, and give taxpayers an upside as well as a downside, all while assuring markets that the short-term cash flow needs of the company are not in doubt.
- Nationalize the firm directly. Management needs to be fired, and with the backing of the federal government, there's no worry about short-term cash flow problems. The ship can righted, so to speak, and then privatized after markets settle down.
- Or perhaps the whole concept of investment banking should be done by the government right now. Nationalize all the major firms. Make political leaders directly accountable for that part of the financial services industry until the uncertainty of how to price these assets, and even what exactly they are, gets settled.
- Create a trust that would have to make loans accepting these kinds of products as collateral. The trust would be funded by the cash on corporate balance sheets, though, not by taxpayers. That would solve the immediate liquidity problem while engaging actors who have a newly-energized stake in ensuring a return to a more stable environment and responsible management.
- Do nothing; just let the firm file for bankruptcy. We could always trust markets to sift through the mess and gamble that turmoil in financial markets wouldn't translate to the larger economy.
- Lend taxpayer money through the Fed to financial companies and let them use these assets they can't sell as collateral (what the Fed has been doing since March, and plans to offer through January).
There could be another problem, though, that leads to some different approaches. The short-term liquidity problems might pop up because the fundamental value of the underlying assets is substantially less than the prices at which they were originally bought. This would require both short-term and long-term solutions.
Short-term:
- Perhaps the most obvious concept is simply to let the system crash. It needs to crash. If assets are way overvalued, the only way to stabilize the market is to drastically reduce their value.
- A second option would be a massive redistribution of wealth. "Somebody" made money when all these assets were appreciating. Unlike in a war or asteroid impact, there was no destruction of the 'actual' economy. The problem with going directly after the winners is that they are very dispersed, from the mortgage broker who made money pushing a predatory loan to the speculator who flipped a house for a 100% profit in two years to the investment banks that sliced and diced all along the way taking their cut to the credit rating agencies that claimed streams of payments from people who can't afford to make the payment are somehow safe investments. So the more practical option is to take money from people who have it and give money to people who have less. A temporary 'financial crisis' tax on high net worth individuals could fund the writing of sizeable checks. That would stabilize the system as people who would have defaulted on payments now can send in the check, rendering the assets backed by those payments valuable again.
- Taxpayers can bail out the losses. This should be an extreme example, but my guess is, this is the 'conventional wisdom' among the people who have influence in DC and what will end up happening.
- We can change the rules on ownership of properties like houses to make companies refinance mortgages to terms people can afford. That would bring down asset values somewhat, but still create a floor below which they wouldn't fall, the value of those renegotiated payments. Dean Baker writes about every other week, for example, about entitling homeowners to remain in the home as a renter.
- We can institute price floors and/or simply shut down trading for 60 or 90 days or however long it takes to make traders act rational.
Long-term:
- As we stabilize the immediate crunch, we could put in place policies to address why people can't afford things like houses and healthcare. This is your whole range of policies from single payer health insurance to substantial increases in the minimum wage to better protections for union membership to clearer credit card fees and charges that either increase wages or decrease expenses for most working families.
- We can re-regulate financial services. This perspective acknowledges that deregulation simply has failed, plain and simple.
- We could do nothing. Maybe an economy that lets a few people get rich leaving everybody else holding the bag is a more exciting one to live in.
I write all this because decision-making is best when there is time to examine the options and formulate policy based upon open discourse. In contrast, the operating procedure of the past year, from the economic stimulus to Bear Stearns to the housing bill, seems to be the opposite. Take action for the sake of taking action, and defend anything questionable by saying trust us, it's a crisis. This list certainly isn't exhaustive, it's just to get people in the mindset that there are possibilities for action instead of thinking in terms of the limitations on action.
If you've read all this, my personal guess is that the reason markets have been seizing up is more due to a decline in the underlying value of the assets than uncertainty in the short-term about how to price them. I think the fact that the term 'credit crunch' rather than 'wage crunch' has entered our lexicon is very revealing about how the problem, and hence potential solutions, are being framed. The problem isn't lack of credit, it's the fact that there are people working full-time who can't afford a house even if they have great credit. Corporations have been sitting on a hoard of cash for a few years now. I think the finance majors at the big investment banks know exactly how worthless some of those asset-backed securities really are. And I believe that these events show that capital and labor, at the end of the day, have cooperative as well as conflicting interests; depression of wages ultimately undermines the value of investments that are dependent upon income streams from those wage earners, and shareholders lose out when companies can't find compelling new ideas in which to invest their earnings.
With the right framing, I think the Democratic party could really win some votes among people seeking a larger narrative for the particular financial struggle with which they're dealing. On the other hand, I think there's a danger that too much appearance of being beholden to corporate interests could make people blame Democrats and Republicans equally, even if the latter is far more responsible for the bulk of the mess. I don't think things will come crashing down next year, but I'd sure like to hedge in the event financial markets completely overwhelm the start of the Obama Administration. I hope he's getting advice from as broad a range of advisers as possible about how to handle potential situations come early next year.