As a sign that Heaven had turned its face from the Republicans, the economy, long turbocharged with debt,
collapsed in the middle of a presidential election campaign. This resulted in a decisive victory for the Democrats who
then had to deal with the biggest economic catastrophe in 80 years. As his first step, President Barack Obama signed
a $787 billion bailout bill, with a little help from three moderate Republicans who trimmed some of the fat added by some
of the Democrats. Will this somewhat improved bailout restore the economy to glowing health? No. Will it even
stabilize the economy? Maybe, maybe not, probably not. Prompt action may have been indicated, but there is no silver
bullet available, and there is still a whole lot of muddling through that needs to be done. Which is to say, if we want
things to stay the same, changes have got to be made. Changes it will take time to figure out, and more time to put into
effect.
Part 1. The Perps
The bursting of the credit bubble had a lot of different effects. I don’t recall hearing the word “banksters” until very
recently, a coinage perhaps inspired by the golden parachutes some of them got when leaving, after what may fairly be
called sub-prime to catastrophic performances. Yet for a long time those boys were Masters of the Universe, the fittest
of the fit, the smart and aggressive supermen who had figured out how to game the system. Alas, the system was only
part of the larger world, and the system had its limits. Limits? What sort of limits? Most obviously, there was that set of
old, archaic laws imposed after the Great Depression, regulations intended achieve safety by reducing the opportunity
to take risks. Less obviously, for the system to work in the world there had to be the faith that loans made to strangers
would be repaid. Like all great religions Capitalism, supposedly totally secular and economically rational, was faith-
based. What undermined that faith? Not heresy, ala Socialism or Communism, but Capitalism does adapt to the times,
and from an initially fear-based system, which was safe, the market slowly evolved towards a greed-based system,
which was increasingly less safe. In the long bull market, the rational money managers were selected out in favor of the
high-rolling risk takers who made more money. Given all the money involved, economists favoring deregulation, like
Alan Greenspan, got a big lift from the business community. That money was also the wind beneath the wings of
politicians like Senator Phil Gramm who was, perhaps, the point man of the deregulators. (Not to mention Dick Cheney,
who famously said that “Reagan showed that deficits didn’t matter,” and may even have believed it.) In the end, those
old, archaic laws were consigned to the dustbin of history, and the investment banks leveraged themselves at 30 to 1,
acting on the irrational belief that since everyone else was doing it (the sane managers having been let go for refusing
to take enough risks,) it must be all right. Playing the system beyond the limit and without a net they invited failure, and
when it came, that failure took down all those highly leveraged companies run by all those system gamers, even as it
destroyed the faith they had abused. The kindest interpretation of those golden parachutes is that the banksters had
learned something from ancient history. They avoided the fates of their predecessors in 1929 (most of whom died
broke) and in the next cycle the future banksters might (its not the way to bet, but just maybe) even be mindful of the
welfare of their companies and their stockholders. A more accurate interpretation would be complicated theft. What
about their unhappy congregation, the stockholders left holding the bag and the collateral damage to the general
public?
Anecdotal and statistical evidence tend to support the notion that the American consumer (driving 70 percent of
the US economy; the government drives the other 30 percent) may have been shocked out of the belief that taking on
debt (the mantra “Shop until you drop” implies your limits are the weakness of the flesh rather than the weakness of the
finances) is free of sin. Or maybe not, since growing up pickled in the brine of debt just naturally leaves one resistant
to the virtues of thrift. However, there is a much older philosophy, holding that debt is to be avoided if possible, since it
makes a good servant but a bad master. Pain reinforces learning, and enough pain might effect a secular conversion
to that older philosophy for those recently burned by the fires of debt. Especially if borrowing money becomes more
difficult. We are talking about all of those hyper-consumers out there, the ones who had been driving the US economy,
the ones who are currently in hock to an average of 130 percent of their annual incomes. It is optimistic but not totally
unreasonable to expect that most consumers will discard their hyphenated hyper, eschewing the indebtedness that
provides the hot rush of shopping for the cool pleasure of being debt-free, even if it means deferring the joy of owning
new stuff. Even if they never become totally debt-free, they will modify their spending to be less extravagant. By thus
reducing their interest payments they will become more efficient if not richer while the banks and credit card companies
become smaller if not poorer. Say that our consumers reduce the velocity of their spending by 10 percent. They will
still be driving 70 percent of the economy, but it will be a smaller economy, because their spending will amount to 63 (70
– 7) compared to what they used to spend. It is not possible that the government could take up the slack to go back to
the older level. The US government was running a huge deficit at 30 percent of the bubble economy, but is now faced
with falling revenues and rising outlays—bailout related and therefore necessary if not virtuous, thus facing a real
danger of inflation.
With the best will in the world there is no return to the status quo ante. From which it follows that the post bubble
economy is going to be radically different than it was. Working through the economic rubble is going to be slow—a
decade or more, and painful in the sense that hard choices will be the rule rather than the exception. Once the
American consumer has finally worked their collective debt down to manageable levels, they will resume buying the stuff
they need and want, only more slowly than in the good old days. At a guess, such a reduced rate of consumption might
let Dow Jones Industrial Average claw its way back up to some level below where it presently sits (if I knew that number I
could make some money.) In the meantime, while all that debt is getting paid down, a major contraction in the economy
will be unavoidable. For example, if we have the capacity to produce 18 million cars a year (2007), and only 11 million
cars are consumed (2008), it would appear that we could do with fewer makers of cars. Should the government bail out
General Motors and Chrysler when they are redundant? I would answer no. Can they be bailed out? Again, I would
answer no. If we DO bail them out, and they drive Toyota and Honda to the wall, should we then bail out the Japanese
plants in America? Get real! The more general case is that shopping malls, drawing heavily on easy credit, were
overbuilt even for serving the bubble economy. In leaner times they, also, will have to contract. Thus, Circuit City goes
out of business, while its competitor Best Buy struggles but may survive, and Starbucks introduces instant coffee.
Housing? Housing deserves its own separate discussion.
Part 2. The Caper
Begin at the beginning. Making housing affordable to the masses has long been government policy, as shown by
the tax deduction for mortgage interest. To facilitate the issuance of those mortgages, the Federal Housing Authority
was created, and institutions like Fannie Mae and Freddie Mac. However, good intentions sometimes result in bad
legislation, and the best interpretation of the Community Resources Act (CRA) passed in 1977, was that it was intended
to encourage banks to give mortgages to credit-worthy customers living in “red lined areas” otherwise known as poor
and/or black neighborhoods. After being modified by Clinton in 1995, however, it became necessary for banks wishing
to make changes (such as reorganizing or opening a new branch) to meet quotas of CRA approved loans, which
resulted in defining down credit-worthiness as a cost of doing business. As a concession to the banks, which didn’t
wish to hold such inferior paper, the 1995 modification permitted them to commoditize those loans and sell them off.
This was not the invention of Collateralized Debt Obligations (CDOs), since Wall Street was already commoditizing high
quality bonds and commercial paper, but it was the government that put housing into play. It soon became evident that
that there was a ton of money to be made by repackaging all sorts of debt and selling the CDO packages. The result
was that the fee driven sales of CDOs created a huge market for new mortgages, thereby inflating the housing bubble.
Step one, the demand for CDO packages drove up house prices. Step two, with the government providing easy credit
to build the new housing needed to feed the CDO hunger for new mortgages, the supply of housing grew. Since the
supply of housing was now unrelated to any real demand for housing, a bubble was clearly being blown. In hindsight
we can see the housing bubble from which foresight (being unwilling to look up from the trough?) had averted its gaze.
Greenspan, who authorized all that easy credit, argues that seeing a bubble in real time is difficult if not impossible.
Maybe he was right, but what happened when the bubble burst?
Looking around Arlington what I see is a whole lot of new townhouses and condominiums all currently coming on
line as the belated but tangible manifestation of the busted credit bubble. Getting the morning paper I go past a new
(built in 2008) but empty townhouse that (Lee’s beautician says) had been intended as an investment to be turned over
in a rising market rather than a dwelling place. My next-door neighbor’s house (built in 1968) has been on the market
for eight months after he moved into a new and larger house, and even though his old mortgage had been paid off, he
has since told Lee that he regrets the timing of his move. Nationally there are more than a million new houses on the
market, plus a large (5 million in the last three years) and growing (Credit Suisse estimates 9 million in the next four)
number of foreclosed properties, constituting a supply far in excess of demand. The conventional wisdom used to be
“safe as houses,” believing that the price of houses would never go down for any number of historically valid reasons.
When I bought my present house in 1974, the rule of thumb was that a house one could afford should cost about 3 to
3.5 times the net household income with as large a down payment as one could manage. Times change, alas, so that
history no longer serves up valid forecasts. From 2002 to 2007 the housing bubble meant that houses were selling for
a whole lot more than the old rule of thumb, even as down payments dwindled and vanished, along with any income
requirement at all. Consequently, a lot of house buyers (The Washington Post says 9 million.) now find themselves with
negative equity. If house prices continue to fall, two things will happen, first, that negative equity will get even more
negative, and second, that 9 million figure is going to get a bigger.
Will house prices continue to fall? It’s the way to bet, especially when unemployment rises and net household
income falls, as both are expected to do. Time out for a smartass comment: For years if not decades there has been
little or no investment in low cost housing and all of a sudden we have a gross abundance of what is essentially no-cost
housing thrust upon us. We would rejoice, if it didn’t hurt so much. The situation is that the collapse of the credit
bubble has left a lot of people inappropriately indebted, and if they default (as it will be increasingly in their interest to
do,) their banks will be left holding illiquid real estate. Also in the Post we learn that Obama is looking to put $75 billion
into a scheme to prevent foreclosures, which comes to about $83,000 per house. We wish him well, but the plan is an
ad hoc response aimed at treating a symptom and does not address the question of who will need to eat that massive
and growing loss. Note that it would be inequitable to prevent foreclosures only on those improvident or unlucky souls
who have some arbitrary level of negative equity at some arbitrary point in time. All mortgage holders have incurred
losses, and either all of them should be made whole, or none of them.
Probably the best that can be done is to “temporarily” nationalize the banks, a hitherto unthinkable deed, which
Greenspan, a kibitzer rather than a player, now says may be “the least bad alternative.” The purpose of such a bold
stroke would be to renegotiate all the home loans on all the books to give the hapless homeowner a break, in that they
will have their loans reduced to match what their house has become worth. The banks will also get a break in that they
don’t have to absorb that bubble-inflicted loss, because the said loss will be applied to the national debt. This may be a
paper transaction, since that increase in debt will be secured by a lot of overpriced real estate, but this sudden
expansion of the national debt is going to have consequences. The first and most obvious of which will be that the US
will appear less credit worthy, and since appearance influences reality, the US will therefore have to pay more to borrow
from abroad. Which means that money and credit will more expensive, bad for business but not necessarily a bad thing
if we want to discourage inflation and encourage responsible credit use. Our newly nationalized banks can pay more
on their deposits even as they charge more for their loans, which, backed by the full faith and credit of the US
government, those banks (as hand puppets of the Fed) will now be able to make. Will the government have to pay that
debt down? Yes, yes, one thousand times yes, there is no choice but to do so, and under the gun of necessity this
means (if I may mix a metaphor) cutting up our sacred cows for pork chops. Defense spending comes to mind, which
probably should have a whole paragraph to itself, if not an article or maybe even a big, fat book. The long version
would discuss the nuts and bolts of hardware, and the Byzantine procurement process. The short version: If a smaller
budget for our Defense Department means relying more on diplomacy and less on brute force, we may realize the
unlooked for savings of unfought wars, even as we inspire less hostility abroad that needs to be defended against.
Does other ill-considered spending come to mind?
Part 3. The Payoff
Well, there are the Farm Subsidies, increasingly large sums paid out to an increasingly tiny number of farmers.
Again, this should properly have its own article or even book, but a cold-eyed review might rationalize the system to
some advantage, though perhaps less than non-farmers might expect. Farm Subsidies serve to insolate the farmer
against the market, and, since you can’t do only one thing, they might also be considered as Food Subsidies, providing
the American consumer with cheap, abundant, and safe food.
We also need to reconsider the 30-year old “War On Drugs.” To be sure, prohibition seems to be in America’s
DNA, the national prohibition of alcohol requiring one constitutional amendment to get started, and a second to repeal
when it proved unworkable. Sadder but wiser, the bluenoses prohibited drugs by legislation alone, arguing that
banning drugs will prevent drug related crime, and outlawing marijuana to provide make-work for the officers charged
with enforcing prohibition. Eventually the vigorous enforcement of that legislation resulted in the WOD. A war which
has served mainly as a price support for all sorts of illegal drugs, forcing the addicts, for whom demand is inelastic, to
resort to crime to get their fix. It is also an unsymmetrical war, in which the despotic State is opposed by Free
Enterprise in the form of an unending supply of impoverished entrepreneurs seeking to make a profit. Drug dealers we
call them, and as fast as they are eliminated they are replaced, like Kleenex popping up out of the box. Given that
alcohol, nicotine, caffeine and sugar are all legal drugs, the puritanical WOD suffers from a certain inconsistency, and it
has not been waged without serious side effects.
As one side effect, the WOD has enormously enlarged the prison population in the “Land of the Free,” now the
world’s highest, both numerically and as a percent of the population. Currently the US incarcerates 1.0 percent of the
adult population, at a cost of ~$35,000 per inmate per year, plus medical expenses. Which was maybe OK, if not
exactly fine, as long as we could afford it. However, it was always a racist, mean-spirited and ill-considered social
policy. The legalization and/or decriminalization of drugs, so that marijuana could be freely grown and taxed while the
hard stuff would be made freely available at government clinics to those unfortunates who needed it, should at least be
debated. Certainly it would cost less than putting the users in jail, while getting your fix on the dole would serve to
eliminate drug related crime. By making drugs commodities, and agricultural commodities at that, the price of drugs
would fall dramatically, causing the drug cartels of the world to go out of business if not bankrupt.
A second side effect has been the destabilization of drug producing countries by those same drug cartels waging
the drug war for fun and profit, i.e. a share of the American $25 billion drug market. “Drug war” is not a metaphor; in
2008 there were 6,600 drug related deaths in Mexico alone. In Afghanistan the Taliban rely heavily on opium to fund
their jihad, and the list goes on. Mexico and Columbia are not failed states, yet, but the interminable WOD has been
disruptive, corrupting their institutions and wasting the lives of honest men. Even in good times the US should be
reluctant to intervene in Mexico, with greater reluctance in bad times. Meaning that prophylactic measures might get
substantial conservative support. Recalling that after prohibition was repealed there was also a major drop in the crime
rate, we see that ending the WOD in favor of TEDA (Treating the Epidemic of Drug Addiction) might be the way to go.
Getting major social benefits at home and abroad while saving money seems somehow un-American, but if we need to
save money badly enough we might be willing to try it.
Medicare and social security are also on the table, and both should be dealt with in their own fat books. For social
security the short version might be to compensate the neediest cases with public housing using a voucher/subsidy/deal
to put them into some of that government foreclosed housing cluttering up the US market. The short version for
Medicare could be making more preventive care available. Recruit and train more nurses and nurses’ aids, perhaps in
a national medical service—which might help with unemployment, and distribute them where they are needed. Possibly
by setting up Minor-Type Emergency Rooms--there also being a lot of extra commercial real estate on the market that
needs filling. Technology will play a role by letting less skilled people provide better health care. There are new
diagnostic devices coming online, and telecommunication with real doctors, so that MTERs staffed by nurses can
provide needed services without causing harm. Mostly people should be encouraged to take better care of themselves,
because staying healthy saves money for both the individual and the state. The easy availability of prescription drugs
is not necessarily good for the public health, and should be avoided. Handing out drug drugs while discouraging the
consumption of prescription drugs seems like a paradox, but it isn’t the only one. We need to spend more while saving
more to get out of our financial jackpot, and we also need to spend both wisely and fast.
If a silver lining is needed for our cloud, it might be that we humans have evolved to deal with hard times, so that
under stress we act better, eat leaner, exercise more, and generally avoid the currently unaffordable vices of
affluence. We said that the more things change the more they stay the same? The nationalization of the banks until
they can be safely re-privatized will probably require a new cabinet post charged with keeping them honest. The
Attorney General deals with legal issues, so we will need to create the office of Auditor General to keep the business
community on the straight and narrow. When the AdG finds someone’s dubious tax loophole, they will be advised to
cease and desist, with the kicker that when Congress gets around to writing the appropriate law, it will be made
retroactive to the cease and desist letter. Done right, the rich should hate it, but the economy will improve as we dig
(sorry, work) our way out of the hole of debt we are in. We wanted things to remain the same, but returning to the lofty
heights we fell from will take time. Time in which our new office will find itself subverted by the scoundrels it was created
to monitor. Eventually the good old entrepreneurial spirit which made this country great will vigorously reassert itself, as
the office of AdG is first politicized, then emasculated, and finally abolished (de facto if not de jure,) so that once again
we can let the good times roll. When? Figure ten more years to muddle through the current year-old recession, and
seventy more years to forget about it. So, along about 2089, the new whatever-kicks-it-off boom will get under way,
and people, making money hand over fist will breathlessly proclaim: “This time it really IS different!”
The End
