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Wednesday, January 23, 2008

Robert Reich on the credit crisis 

Robert Reich doesn't think that Fed rate cutting will resolve the credit crunch, a view I happen to agree with.

The problem is, people have different views about what's going wrong. Wall Street sees it as a credit crisis -- a mess that seems never to reach bottom because nobody on Wall Street has any idea how many bad loans are out there. Therefore, nobody knows how big the losses are likely to be when the bottom is finally reached. And precisely because nobody knows, nobody wants to lend any more money. A rate cut won't change this. It's like offering a 10-pound lobster to someone so constipated he can't take in another mouthful.
I couldn't have said it better myself. More:

Main Street sees it as a housing crisis. Homes are the biggest assets Americans own -- their golden geese for retirement and their piggy banks for home equity loans and refinancing. But home prices have been dropping quickly. It's the first time this has happened in many decades -- beyond the memories of most Americans, which is why they never expected it to happen, why they bought houses so readily when credit was so easily available, and why so many people bought two or more of them, speculating and fixing up and then flipping. But now several million Americans may lose their homes, and tens of millions more have only their credit cards to live on and are reaching the outer limits of what they can spend. As consumer spending shrinks, companies will reduce production and cut payrolls. That has already begun to happen. It's called recession.
What about the proposed stimulus package?
Even if a stimulus package were precisely targeted to consumers most likely to spend any money they received, the housing slump could overwhelm it. According to a recent estimate by Merrill-Lynch, the slump will hit consumer spending to the tune of $360 billion this year and next. That's more than double the size of the stimulus package President Bush or any leading Democrat is now talking about. And the Merrill-Lynch estimate is conservative.
Well then Mr. Doom and Gloom, what do you think the answer is?

As a practical matter, our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad -- some major U.S. financial firms have already gotten key cash infusions from foreign governments buying stakes in them -- combined with export earnings as the dollar continues to weaken. But this is something no politician wants to admit, especially in an election year. So we're going to go through weeks of posturing about stimulus packages of one sort or another, and then see enacted the big fat bonanza of a temporary tax break that will likely have little effect. That, perhaps along with a few more rate cuts by the Fed. The presidential candidates will be asked what should be done about the worsening economy, and they'll give vague answers. None will likely admit the truth: We're going to need the rest of the world to bail us out.
I guess another option is to take our lumps, but I guess that's probably not a winner on Super Tuesday.

Hat tip: Life After the Oil Crash

9 Comments:

By Anonymous Anonymous, at Wed Jan 23, 06:55:00 PM:

Taking our lumps is, as you say, the best long-term medicine. Given that we're in the midst of an election year, though, I also agree it'll never be allowed to happen. So working from the presumption the Feds are really so eager to spend tax revenues that they're willing to rapidly do something, anything (!) I'd say two things need to happen:

1) the so-called Bush tax cuts need to be extended. Taxpayer behavior is now or will shortly become focused on that coming enormous tax increase (and please spare me the specious speculation that the looming future tax increase will encourage consumption today- just the opposite is true)

2) mortgage-owning investors need an encouragement to renegotiate loans voluntarily. In those instances where investors voluntarily renegotiate an existing variable rate loan to a low fixed rate, they're going to take a hit of the present value of the new-loan cash flows, as compared to the value of the old-loan cash flows. This loss will be one of the old-fashioned (pre-derivative) kinds of losses too, a real one, given the matched book those investors have probably built. Offering mortgage portfolio owners a tax deduction for the loss they'll have to absorb if a loan is renegotiated isn't giving them anything at all- they already would get that deduction- and so I would expand that to a credit, significantly expanding the value of renegotiating a bad loan to an investor who also has taxable income. I would go further: I would administratively have the SEC allow public companies to write the present value of the resulting losses off ratably over the stated life of the new loan (regardless of actual life), effectively diminishing the financial reporting cost to a very low number annually, while allowing them to take the benefit of the tax credit fully into net income in the year of incurrence. Quality of earnings doesn't decline at all, it actually improves since the cash impact of the renegotiation is reported on a mark-to-market basis right away.

If tax dollars are to be spent, this is the place to do it.

The deal doesn't offer any cheap political tricks, like sending a bunch of people who don't contribute any tax dollars to the upkeep of the country an $800 check as Congress wants to do. But it will immediately give mortgage investors a real alternative to foreclosure (without ending foreclosures entirely) offering a very decent economic return. It will increase demand for mortgages, and thereby stabilize the mortgage market. It will stabilize personal incomes by fixing the cost of mortgages, offering benefits way beyond a one-time check. It guarantees all the money goes right to the source of the national credit liquidity problem, while simultaneously benefiting the poorest, least able Americans (ie, those dumb enough to have taken on a 100% loan-to-value mortgage with no income checks and an interest rate that triples after the first year).

Heck, in order to gather in the tax credits hedge funds and banks will start competing to own these bad mortgages!

We can all then go back to worrying about how we'll be able to buy health care once Hillary gets elected and makes it illegal to privately buy care.

Andrew  

By Anonymous Anonymous, at Wed Jan 23, 09:14:00 PM:

I'm stewing over this tax rebate business. I am "rich" in the eyes of Congress, because my wife & I both work full time & therefore make enough money to afford to send our kids to college without federal aid (well, public college...) But we paid over 50 grand in taxes last year, & now the government wants to send the money I paid to people who paid relatively little, or even nothing.

This is bald faced income redistribution, & I've about had it. It's enough to drive a man to Ron Paul.  

By Anonymous Anonymous, at Wed Jan 23, 10:45:00 PM:

The U.S. needs another 1/2 percent Fed cut next week, a program to save Ambac, MBIA and other like companies plus a rebate to families ASAP.  

By Anonymous Anonymous, at Thu Jan 24, 01:12:00 AM:

Seems like I remember a time when there was no cap on the deductibility of home mortgage interest, and even credit card interest was deductible....

Back then, I even carried credit card balances from month to month sometimes -- I didn't make much, and occasionally it helped to be able to pay over time. Of course, I haven't done that for years.  

By Anonymous Anonymous, at Thu Jan 24, 01:05:00 PM:

I am fully on board with Punditius. All of the headlines say "taxpayers would get checks under stimulus plan". This is a farce. I am a taxpayer, yet I will get nothing because my family works a little to hard and is a bit too successful. In contrast the folks who earned more than $3000 and paid NO TAX get a check. I guess the thought is I might save my check, while the money will burn a hole in the pocket of the desrving "taxpayer" I am funding with my tax payments.  

By Blogger jj mollo, at Thu Jan 24, 03:09:00 PM:

Robert Reich has been around long enough to understand the potential human cost of economic turmoil. I don't think that now is the time to be complaining about unfairness. It's more important to do the right thing economically. We stand to gain a lot more from a plan that provides us with economic stability and the prospects of long-term growth than we could conceivably lose in an unfair tax distribution. We're all in this thing together.

The big question is how to fix the broken economy. Everybody has a theory. Personally, I like the theory that we should take our lumps. I want to see the people who caused this mess suffer the consequences. But the problem is that we don't know where the bottom is. It could be a long way down. We need to prevent a meltdown at all costs. The one thing we don't need are politicians imposing plans that sound good and make everybody happy but don't really work. Economics is more of a science than it used to be. Maybe we should listen to the economists.  

By Anonymous Anonymous, at Thu Jan 24, 03:54:00 PM:

The unfair tax distribution is simply a band-aid to placate the maximum number of voters. It is unfairly applied because high income earners simply don't have the political clout to matter. Some of us are "in it" more than others in that I fully expect to have my taxes raised even more so the less affluent can by a flat screen and kick-start the economy, or to bail them out of home mortgages they couldn't affort in the first place. Apparently once you get your foot in the door on the "american dream" the government owes it to you to make sure you can continue to afford it.  

By Anonymous Anonymous, at Thu Jan 24, 08:50:00 PM:

First anonymous.

Think again.

Cost of house $500,000
Value now $380, 000.

Value next year Maybe $320,000.
Cash deposit - - Zero, to $50,000.

Equity NOW $330,000.
Loan outstanding$430,000.

You really think they'll re-negotiate?

Keys in the post.
Jingle Mail.

Bank owns property now valued at $330,000
Loss of Bank asset base NOW $170,000.
Marked to market = probably in a forced sale loss will be $210,000.

That's the real world.
Blood on the balance sheet.
Eventual blood on the street.

Banks are tightening lending criterior.
Housing stock now 11 months +/-
Commercial real estate in same mess.
Job losses coming, - big time.
Monolines just about had it.

Sov. wealth funds only way to rebuild balance sheets. Not a liquidity problem.
A solvency problem. Fractional lending in reverse.
Punters still may not want to borrow. Pushing a string.

$500 Trllion in toxic paper globally.
Even if only one % goes bad....
All it needs is a bad counter party.  

By Blogger jj mollo, at Fri Jan 25, 04:55:00 PM:

Here's a suggestion. US could match college scholarship money in an effort to encourage borderline big league schools to match Harvard's new initiative. Scholarship money gets spent right away. This could be an indirect way of freeing up endowment money in order to fuel the credit supply. There're a lot of kids who would go to college that might not otherwise have gone. I suspect that college kids tend to spend more money than those who stay at home. Plus, there would be a longterm educational benefit to society. We would be encouraging investment in intellectual capital. (This assumes, of course, that there is a net benefit from college education which some of you might dispute.) Does this make sense at all?  

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