The Fight is On

It is no secret that our country is under intense economic pressure. The credit is frozen, GDP is falling, unemployment is rising, bankruptcy is at historical highs, 1 out of every 200 homes will be foreclosed upon, and banks are holding at least $2 trillion in troubled assets. We are in deep shit and have been in a recession longer than the Bush administration wanted to admit. Meanwhile, Obama is telling us that “we can't go back to an economy that's built on a pile of sand.” But that's easier said than done. People's lives hang in the balance with an unemployment rate at 8.5% and growing closer and closer to double digits.



So what have the powers to be been doing to get us back on track? Currently, we have three main tools to fight recession.

The first tool to fighting a recession is to have the Federal Reserve use expansionary monetary policy to increase the money supply. This is accomplished by the Fed purchasing bonds from the open market and by lowering interest rates. More money in the system tends to increase investment and output. Unfortunately, not much economical traction resulted from the Fed slashing interest rates down to 1% and by buying up bonds. Creditors did not lower their interest rates or begin loaning more freely. So at this point. expansionary monetary policy is useless. This comes to a great shame, since credit makes the world go 'round.

The second tool is an economic stimulus package. Many economists believe that a successful stimulus package should be around 4% of the GDP. The current stimulus package is only around 2.5%. Assuming these statistics are correct, two things can be said. One, this current stimulus package won't do enough to stimulate the economy. Two, there's probably going to be another stimulus package within 12-18 months. But we all know that the Republicans will obstruct the process every step of the way. Ironically, 40% of the current stimulus package is in their beloved tax cuts that they themselves helped orchestrate, only to vote against it! Don't forget we're in two wars and we should be RAISING taxes. But I digress. The Obama administration should be focusing their efforts on a proper stimulus package. We cannot forget that the purpose of a stimulus package is to stimulate demand and it's no secret that our infrastructure has been neglected for going on a decade. But that's a story for another day.

The third tool is to bailout the troubled institutions. Also known as Bush's Troubled Asset Relief Program (TARP). Remember that $700 billion bailout that Bush shoved down our throats last year out of nowhere? Congress passed this bailout bill under the pretense that the money was supposed to be used to buy up toxic assets (investments that hemorrhage value and not generate it) and get them off of the banks' books. However, Bush spent almost half the money buying up Wall Street bank's stock, not toxic assets. This is called recapitalization. Basically, this strategy is when the government buys up a bunch of preferred stock with the intention of injecting enough capital into banks so they can unfreeze the credit and begin loaning again. It's fair to say that this approach has indeed worked in the past (USA during WWII, Sweden in the 1990's, Japan in 1998). But even if the entire $700 billion was spent on buying up stocks it still wouldn't be enough because that figure is just too low relative to our GDP (Krugman 2009). That is why I'm saddened to see the Obama administration following in Bush and Paulson's footsteps. Obviously, this approach is just burning money and the fact that credit is still frozen is evidence enough.

Econ 101 teaches us that mismanaged and inefficient companies are supposed to fail so that their assets can be absorbed by more efficient and profitable companies. That's the law of the jungle. Right now, it's like we're giving life support to an antelope that was just mauled by a lion. One day when that antelope can get up and stand it will still just be a weaker version of its former self and an even easier meal. Some of these institutions should indeed be allowed to fail, but certainly not all. I understand that at this point the administration is trying to avoid further lack of consumer confidence in our markets. Many tough decisions need to be made and I agree something needs to be done. However, an underfinanced recapitalization effort is clearly not the way to go. Good thing there's a new plan in the works.

Recently Obama has added a new dimension to his bailout plan that I'm optimistic about. His plan is more or less to attract private investors to buy up around $1 trillion of these mortgage backed (toxic) assets. His plan includes loaning the investors up to 85% of the money to use towards purchasing these assets and matching every investor dollar with up to six dollars of tax payer money. Using private capital to handle these toxic assets will shift much of the burden off of tax payers, even though the government will certainly subsidize the losses (and profits). I don't have all the details on this plan quite yet and I'm sure these figures are subject to change. However, it definitely sounds better than simply buying shares of stock.

It is also probably pretty relevant to discuss our debt here as well, because there's no free lunch. The stimulus packages and TARP funds cost money. Money we don't have. So we need to raise the capital, mostly by selling bonds (creating debt). As of right now, when most people think of U.S. debt, China comes to mind. But you'd probably be pretty surprised to find out who we actually owe the most money to. The answer is: ourselves. As of right now over 50% of the our debt is to different branches of the government and the Federal Reserve (remember the Federal Reserve is as federal as Federal Express). For example, the money that is collected from the Social Security (FICA) tax is, by law, required to be held in government bonds. These bonds account for 23% of our total debt (as of 2006, however the statistic is higher today) and are used to finance much of our current deficit. In fact, as of right now, only between 25-30% of our total debt is owned foreignly. Furthermore, China only owns about 23-24% (Dec 08) of that debt. Or in another words, 6.5% of our total debt. So rest assured that it is virtually a statistical impossibility that China can bankrupt us by calling in our debt. We also have to remember to compare our debt relative to our GDP. Because this is the best measure we have when considering how much of a debt we can accumulate and manage to pay back. When we consider the size of our GDP (also the fact that it increases 1.5-2.5% annually) and the amount of debt we actually owe ourselves, we reach the conclusion that we can still safely borrow trillions without much concern in our ability to make interest payments and eventually pay back the principal (Colander 08). With that said, we also need to keep in mind that deficit spending is absolutely critical right now and the ideology that “government should quit spending” is a detrimental concept. Especially when this notion is backed by “intimidating” figures that do not carry very much weight in proportion to our GDP.





Something else we need to realize is that many of our current problems are due to a lack of regulation or good old fashion deregulation of the financial system. The shady derivative market (the main source of the toxic assets) would have never happened with regulations and the commercial banks would have never acquired these investment risks under Glass-Steagall... I think we're going to regress back into the constant boom and bust business cycles that were dominant prior to the Great Depression, before major financial regulations. It's obvious that since the financial system has been in the process of being deregulated problems have continuously arisen. The Savings and Loan crisis, the dirty accounting of Enron and others, the derivative and subprime market are all fine examples. It's not a coincidence that these sorts of issues didn't happen between the New Deal and Reagan's administration, and that it was only after the Reaganomic trend that all these banking problems surfaced. That's what deregulation does. It's a get rich quick scheme for politicians and bankers, usually at the expense of the tax payers and working Americans.

In the end, citizens and policy makers will have to make some hard decisions. Many of these problems will not correct themselves. Not to mention Republican obstruction will be flagrant every step of the way. But the bottom line is that we can't let everything fail while crossing our fingers and hoping we can restructure after the dust has settled. Hoover's laissez faire approach, balanced budget agenda, and late actions catapulted us into the great depression. So we can imagine what will happen if we do nothing. Economists who were whistle blowing on the housing bubble were marginalized. It's time to start listening to the people who know how markets work, not politicians, lobbyists, bankers, or news commentators. Disagreements will exist and that is normal, especially with problems of this magnitude. However, listening to “socialism” and “anti-government spending” rhetoric right now is just a distraction from the real issues plaguing us. As new plans and suggestions are proposed, we can't just look at the nominal values and say “it's too much money” without comparing the figures to our GDP. A billion dollars sounds like a lot, but it's only .007% of a $13.84 trillion GDP. Yes, that's right, not even a hundredth of a percent. How much of a dent do you think that billion will make? But that doesn't mean the billion should be pissed away. Our economic moves must be planned and concise. Hit and miss right now is bad for business, like an inadequate stimulus and underfinanced recapitalization plans. It's a waste of money if we're not going to do it right. And that's the bottom line.




Works Cited


Andrews, Edmund, and Er. "U.S. Expands Plan to Buy Banks? Troubled Assets." The New York Times - Breaking News, World News & Multimedia. 01 May 2009 .

Andrews, Edmund, Eric Dash, and Graham Bowley. "Toxic Asset Plan Foresees Big Subsidies for Investors." NY Times. 20 Mar. 2009.

"Bureau of Labor Statistics Data." Databases, Tables & Calculators by Subject. 01 May 2009 .

Colander, David. Macroeconomics. 7th ed. New York: McGraw Hill, 2008.

"Foreclosure Statistics." FDIC: Federal Deposit Insurance Corporation. Mortgage Bankers Association. 01 May 2009 .

Krugman, Paul. The Return of Depression Economics and the Crisis of 2008. New York: W.W. Norton and Company Inc., 2009.

"Nobel Prize Krugman says US and EU stimulus packages insufficient MercoPress." MercoPress South Atlantic News Agency. 01 May 2009 .

"Ownership of the Debt." Financial Management Service: A Bureau of the U.S. Department of the Treasury. Dec. 2006. U.S. Department of the Treasury.

"PolitiFact | Columnist Will correct that initial TARP money did not buy toxic assets." St. Petersburg Times Online. 01 May 2009 .

"Stimulus Watch: Government Responses to the Financial & Economic Crisis | US Budget Watch." US Budget Watch | A Project of the Committee for a Responsible Federal Budget. 01 May 2009 .