Since the economic meltdown in September, I've posted a couple of diaries, with permission, from Prof. Steven Ramirez, professor of law at Loyola University Chicago. In the first diary, he provided an analysis -- from a law professor's point of view -- of the bailout. The second diary outlined his further thoughts on the September financial crisis, along with his analysis of why the Paulson Bailout that the Senate passed was wrong.
In this diary, Prof. Ramirez reviews the current economic climate, based on events since the September meltdown, reviews the lessons learned since then, and provides concrete advice & pragmatic solutions to get us on the road to economic recovery.
Please take time to read Prof. Ramirez's insightful (and very well sourced!) analysis on the uncertain economic times we're in.
President Elect Obama has announced plans for a massive fiscal stimulus package which he hopes he can sign into law shortly after his inauguration. Very soon our government will also take up the task of dealing with our failing auto makers and the possible request from the Bush Administration to access the second part of the $700 billion dollar Wall Street bailout bill that squeezed through Congress in October. This comes shortly on the heels of a recent Bloomberg analysis showing that the US Government (primarily thru the Fed) has already racked up $7.7 trillion in obligations to stem the financial crisis now engulfing the world.
Economist Brad DeLong argues that "old fashioned Keynesian fiscal stimulus" is the only way now to avoid a depression. Nobel laureate Joe Stiglitz suggests a stimulus of up to $1 trillion because "a deep and long downturn" looms. This year’s Nobel laureate, Paul Krugman, says "I’m getting scared" because of the grim jobs numbers and the possibility that fiscal stimulus will take too long. Krugman now sees a "depressed" global economy until at least 2011. Krugman has posted this grim picture of the job contraction suffered at the hands of the Bush Administration:
McCain adviser, Kenneth Rogoff, sees a "collapse" in consumption that will need to be offset by $1 trillion in economic stimulus, or we could face an economic "disaster."
Thus, this much is clear: we are facing a spiraling economic cataclysm that will require trillions in government expenditures between 2008 and into 2010. Moreover, it appears darker days are yet to come, as the real estate market gets worse and, according to the IMF, bank losses have yet to peak.
The essential problem is this:
The amount of debt in the US relative to GDP simply exploded under trickledown economics starting in 1980. As incomes stagnated and jobs contracted (see chart above) for too many the debt burden could no longer be serviced, and a cascade of defaults starting with subprime mortgages has inexorably led to massive deleveraging. Paul Krugman recognized the dangers of deleveraging late last summer. Deleveraging means: banks reduce lending and hoard capital; consumers cut consumption in order to enhance savings; firms and individuals sell assets liquidate debts; businesses layoff workers to reduce expenses and reduce debt; and, severe risk aversion to conserve capital. Deleveraging thereby leads to deflation, which creates a dangerous psychology whereby purchases are deferred in the belief that prices will continue to fall. "Once started the process is hard to stop."
So now we stand at the brink of the Great Depression II or the Great Deleveraging and our leaders seem clueless about what to do other than stuff billions in the pockets of their pals. The big bailout was a big bust, with inadequate oversight and no assurance that it would lead to enhanced credit flows. The primary reason was that it allowed a massive flow of capital into the insatiable insolvency sponges at the center of our economy, whether called Citigroup, AIG or American Express. These zombie banks who ran off the risky leverage cliff like lemmings will not lend because they know they are insolvent or will be shortly when the next massive waves of losses peak. It seems at least theoretically likely that bank CEOs like everyone else just want to hang onto their jobs as long as possible, even if that means mass layoffs for the rest of the workforce. In fact, Wall Street alone is poised to cut $100 billion in wages.
Bipartisan trickledown bailouts are actually poisonous. There are no real limits right now on the amount the TARP money that can fund dividend payments, acquisitions and bonuses instead of lending. Times are hard and banks "do not trust their own balance sheets" so they are hoarding capital instead of lending. Apparently, the banks are using the TARP money to become too big to fail, so they get more government money insuring their viability.
Lesson learned: trying to recapitalize zombie banks will lead to capital hoarding and will not lead to new loans. It also will not stop layoffs. Zombie banks (PDF) are an economic wrecking crew.
Instead of this failed trickle down approach, the government must now immediately throw a lifeline to the 99% of Americans who have so far seen only pennies of the trillions the government has expended in its rescue efforts. We need immediate direct stimulus from the government on a scale more massive than ever before. Ordinary fiscal stimulus will not work now because people will not spend any tax cut, but will instead dutifully send their tax cut to the insolvency sponges. Monetary stimulus is now impotent because the lending transmission (PDF) belt is off track. Both fiscal and monetary policy are impaired by severe risk aversion and the paradox of thrift; everyone is saving and cutting back to meet the coming economic maelstrom.
So how do we now spend the next trillion?
In short, we must spend to create jobs, reduce unemployment and achieve the greatest economic benefit per dollar spent as possible. Along the way, we as a society should accept that prior debt levels were too dangerous, and we should therefore strive for an orderly adjustment in our debt load. There are, after all, two ways to lessen our debt burden and to deleverage: we can reduce debt or maximize growth. Either way, debt relative to GDP goes down. The major problem right now is the prospect of a disorderly reduction in consumption leading to deflationary psychology.
For example, one way to facilitate an orderly reduction in debt while helping growth is to allow taxpayers to bail themselves out of this mess, by allowing them to temporarily access their own retirement funds to invest in their own homes, tax free. The money could be repaid (or taxed) upon the sale of the home, or withdrawal of equity. This would create incentives to reduce mortgage indebtedness, to refinance into lower cost mortgages or to buy a home. The effect would be to directly stimulate the housing market, reduce losses to the financial sector from further loan defaults (and therefore reduce the risks of further home lending), and assist strapped consumers in deleveraging. I first started to advocate this idea to Obama’s staff in late 2007; Obama subsequently discussed a more modest version (his plan allowed expanded hardship withdrawals) of this plan on the campaign trail. This use of consumer wealth to help bailout consumers must now be expanded. So long as taxpayers use the funds to secure their own home, this plan would also assist in securing a sound retirement notwithstanding this financial crisis. This concept would help the most needy—those willing to invade their retirement funds—and cost the government little or nothing in the long run.
The government must also become the employer of last resort and the investor of last resort right now. Delay will add to the costs exponentially as unemployment snowballs, and financial losses cascade. This can be done expeditiously, if properly conceived and if our Congress acts right now.
Consider student loans and grants. Students are definitely beginning to feel the credit crunch and next academic year may be worse, as families begin to cut back, jobs are lost, and assets plunge. Any US citizen who wants to attend trade school, college or graduate school must have access to sufficient guaranteed loans to assure that human capital formation proceeds undisrupted by the current crisis. This will allow thousands of students to continue their education and shift millions off the unemployment rolls and into the accumulation of skills. Grants should be available for those willing to serve their country, in a wide array of capacities. Over the long term these programs pay, they do not cost, because a more educated workforce will contribute to corporate productivity and inexorably lead to greater long term tax revenues. This program should be modeled upon the very generous GI Bill of World War II vintage which paid up to $12 of economic benefits for each dollar expended.
Second, we must now invest in real anti-terrorist measures. A Homeland Security Force must be formed immediately, by this Congress. The force could be modeled after the Civilian Conservation Corps. That New Deal program created 4.5 million new jobs. Young unemployed workers could be trained to guard important infrastructure, patrol our transportation system, inspect incoming container ships holding imported goods, and secure our borders. Given the economic risks of terrorist attacks it is amazing this force has not already been formed. With huge pools of unemployed now available to staff this force (including many Iraq and Afghanistan vetswith real expertise in security against terrorism), this is an economic no-brainer. Just imagine if another 9/11 attack occurred today at the moment of our greatest economic vulnerability. It is inexcusable that the Bush Administration has really done nothing to substantially enhance our domestic security shield. This too, would divert millions from the unemployment rolls into highly productive uses. President Obama campaigned on securing critical infrastructure and he should now do so.
Third, the government must immediately start strategically purchasing real estate, while it is very cheap. This pool of real estate could then be the foundation of major public works. We need a high speed rail network and there are already projects ready to go. Studies show these projects may yield returns of up to three times their cost. (PDF) We should have the best highway system in the world. We should build the best university system in the world, based upon true merit, not legacy status, fame or wealth, like our current system. The US has fallen in college completion rate, and we cannot expect to enjoy a high standard of living with an ill-educated workforce. Why not build a University of the United States with regional branches? Now is the time for the equivalent of an educational moon shot. We also need a massive investment in energy infrastructure and we should have the best mass transit system in the world. All of these projects will require real estate. An announcement of government purchases of real estate would immediately put a floor on prices.
Essentially I simply propose doing capitalism right. Invest in our future at a time when such investments are very cheap, the government’s cost of capital is very low, and the projects are sorely needed for the economy. This program will form the foundation for long term growth. We are facing historically high risk aversion; my program relies primarily on the government to act, and act in a way that should reduce risk aversion by keeping Americans working and off unemployment.
No program will return our economy back to 2006 or 2005. We are in the midst of a painful adjustment. The goal is to keep workers employed and achieve an orderly adjustment while building a durable foundation for future growth.
As such, any program should reassure those investing in the US that their capital is productively employed. Simply put, we must get the maximum stimulus at the lowest cost, with the greatest long term economic benefits.
Continuing to waste money by subsidizing inept bankers will undercut confidence in our system and lead to a loss of confidence in the dollar. The last $350 billion from the TARP bailout should fund real investments.
So, what about the auto bailout? Well for just $15 billion we should view it as a temporary jobs program. A major bankruptcy in the auto sector probably would lead to tremendous economic pain, and enhanced risk aversion. If the auto industry fails to get bailed out it will be because they lack the political muscle that Citigroup and Wall Street has particularly within the GOP.
It is very silly to risk a depression over $15 billion and poor political connections.
For further reading & viewing:
Fear and Social Capitalism: The Law and Macroeconomics of Investor Confidence (PDF) by Steven Ramirez
The Housing Time Bomb - Jim Rogers: The Zombie Banks Must Fail
Questions? Contact SRAMIR3@LUC.EDU
