Sunday, September 21, 2008

The Current Financial Situation, and Some Solutions

By Ed Smallwood

Yesterday I was watching CNN. Connecticut Democratic Senator Chris Dodd was being interviewed, I can’t remember who it was that was asking the questions. What stuck out in the interview was what he said about a closed-door briefing the Senate got from Federal Reserve Chairman Ben Bernanke. He wouldn’t comment on the exact content, after all it wouldn’t be terribly useful to keep the information in a closed-door briefing if it was all going to become public immediately afterward. What Senator Dodd said was that after Mr. Bernanke was done talking, there was stunned silence for 10-15 seconds in the room.

That’s significant. It’s also very frightening, either way you look at it.
I have known for some time that things were going very wrong with the economy. I remember an interview last March with Paul Krugman in Fortune magazine where he said that he thought we would hit 6-7 Trillion Dollars in capital losses in the housing industry this year, a 25% reduction in equity throughout the United States. That is what we are just beginning to see right now. Congress is talking about an 800 Billion Dollar bailout. You can see that what Congress is talking about is roughly an order of magnitude too small to cover what Paul Krugman was talking about. In short, 88% of the losses aren’t being addressed by Congress.

Now, we also have to take into account that the International Monetary Fund is estimating our GDP at roughly 13 Trillion Dollars. The losses we are talking about are more than half of the Gross Domestic Product of the entire United States. Nobody alive has ever faced a financial disaster of this magnitude.

Is that what Chairman Ben Bernanke was telling the Senators in that closed-door briefing? Numbers so large that it stunned veteran Senators into silence? I think that’s exactly what happened.

Here’s the real problem: The simple answer to this problem was to avoid deregulating the banking industry in the first place. Don’t let this debacle happen. Unfortunately several years ago the “Regulation is Bad for the Economy” branch of the Republican party got it’s way, with Senator John McCain cheering it on. The easy and simple answers to this problem are all gone now. There is no choice but to see our economy slide downward. It’s simply too late to prevent that.

So, what do we do now?

We’re going to have to bail out Wall Street. We don’t have a choice about this. That’s what Congress is doing to some extent now. The problem with how they are doing it is that they are diluting the shares that investors have by taking majority stakes of the companies they are bailing out and putting it under Government control. They are allowing the investors a chance to keep some of the value, but not most of it. This is unlikely to work in the long term. People’s retirement savings are going to suffer, even though it isn’t as much as they could. In short, the government is bailing out the executives of the companies more than the investors.

The landscape for homeowners is even bleaker. Nothing whatsoever has been done to address their concerns. Foreclosures are happening at an even greater pace than before. More properties are going “upside down” in value than they were before, and the Santa Clara County Association of REALTORS is estimating that this will be the case until at least 2010. Some estimates I have been reading put it at 2012 or later.

Now, with it harder than ever to declare bankruptcy (thank you Republicans,) and savings evaporating, the backbone of the American Economy, the Consumer, has almost no money to buy anything. We can see this through the fact that spending is decreasing while savings are simultaneously decreasing. Until something is done to address the concerns of the average person on the street, the economy can do nothing but spiral downward at an ever increasing rate.

This is where we stand now.

What are we going to have to do?

We are going to have to make peace with the fact that our economy is going to crash first of all. We can’t prevent it. Next, we have to do what we can to prevent it from crashing so bad that it can’t recover. This is a real possibility. There is nothing magical about the economy of the United States. Other countries in a similar state that did nothing saw their economies die outright. Most of them are third-world countries now, or failed states. That’s the danger.

We have to bring back the regulations that prevented this problem from happening decades ago. This is an absolute must. Doing any less than this means that nobody will trust banks enough to loan them money to make loans. That’s how the system works. Without that key part the system collapses and doesn’t recover.

We have to protect the money of the average person as much as possible right now. We can’t expect someone to pay back a bad mortgage at an ever increasing rate for the rest of their lives, tying up their spending power in servicing bad debt just because some company got greedy. If these homeowners decide to allow the banks to foreclose, they will find it harder to buy another home later. The inventory of foreclosed homes will increase, because there will be fewer qualified buyers (you can’t have a foreclosure in at least the last 2 years to qualify for a home loan). This is dangerous in several ways. First, unoccupied homes bring down property values. Second, they are fire dangers. Houses are fuel. If you have enough of them you can end up with a wildfire in the middle of a city. Oakland can tell you why this is bad.

This means we have to do at least one of two things, probably both: we will have to forgive at least part of the bad debt to keep people in their homes, or we will have to allow people with foreclosures on their record to get credit anyway. The former is preferable, and while the FHA is doing this to a small extent, the program needs to be massively expanded. The latter solution will probably have to be put into effect as well. Why should we do this? Why not let the people who took out these loans just hang? If we allow our spite to get ahead of our pity (or self interest), making sure these people pay back their loans, our economy suffers from having too little money left over to buy the things that we sell. All of us suffer if we make any one segment of the population suffer too much.

In addition, we really need to start working on our infrastructure, and I don’t mean just roads, bridges, ports, electricity grid, and communications grid. I mean the workforce as well. For most of my life we have seen a growing battle against the workforce. McCain’t has been talking a big game over how strong our workforce is, but the reality is he has actively been working on weakening it.

The big secret that allows the American economy to be so strong has been our educational system. Public education was invented here. We have expanded it ever sense the Brotherhood of Friends (often referred to as “The Quakers”) introduced the concept. All of my life the Republican Party has been trying to weaken it. Vouchers. Increasing tuition in Universities. Destruction of vocational schools. Even “No Child Left Behind” which is decreasing Federal funding to elementary schools. Recently when Democrats tried to bring back full tuition for all Iraq War Veterans, McCain’t voted against it. He said it would reduce the incentive for our Servicepeople to reenlist. This attitude is going to prevent our economy from recovering.

We need a top of the line communications grid to allow educated people to build products using electricity that will be shipped to the consumer through working ports and over working roads and bridges. If any one of those things isn’t working, our economy dies and stays that way.

Why wouldn’t our economy recover? Really, why would it? People with money are under no obligation to invest it in our country. If our economy is wrecked, they would be dumb to put good money after bad. They’ll invest it elsewhere, in economies that are booming. China is a good example. With no money being invested in our country, no educated people to design new products or services, a 20th century communications grid expected to help them design them, no energy to build them, and deteriorating ports, roads, and bridges to ship them our economy will stay sunk.

What we really need to get us through this crisis is a leader that believes in our future, not one that is trying to bring us back to a failed past, namely the “Roaring ‘20s.” Let’s all make sure we work toward our country’s future.


Fortune Magazine interview with Paul Krugman: March 17th, 2008 by Jia Lynn Yang

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