Pushing on Strings Won’t Solve Economic Problems
Democrats now accept the right-wing mantra that government is the problem, not the solution. The Obama Administration has refused to take direct action on the financial crisis, and has instead tried to find some way to use private business to solve it. The results are piling in now, and we see the miserable results you’d expect from pushing on a string.
The housing crisis provides a good example. The problem is that people owe mortgages they can’t afford, either because the interest rates are too high or because they lost their jobs and have substantially less income. At the same time, housing prices have plunged, putting many homeowners underwater. That makes people feel like debt slaves, with all their income going to pay off something that will never be worth what they paid. For many people, that sense of misery is reinforced by the feeling that they are powerless to protect their families and themselves from predatory banking practices.
There are direct solutions. The government could give homeowners the right to cram down the mortgages in Chapter 13 cases, giving them equivalent rights to those enjoyed by their Corporate Person peers. There are a number of solutions even more forceful. But no. The President backed down from his campaign promises on cramdown, and the Democrats in Congress refused to consider any solutions that would require lenders to share in the losses they helped to create. Homeowners were left powerless to negotiate with lenders. We got HAMP and HARP and the foreclosure fraud settlement, all designed to encourage predator lenders to solve the problems they created. Pushing on a string doesn’t work.
The collapse of demand in the consumer economy could be solved with direct action. President Obama’s economic advisers pushed for big tax cuts, which, they said, would be spent in the consumer economy and provide a demand bump. That didn’t happen. People wisely chose to devote all their discretionary money towards debt reduction, including paying for underwater mortgages. Or they saved the money, rightly concerned that their retirement portfolios were damaged and that they would need even more money as both parties claimed that we couldn’t afford to pay for Social Security and Medicare. Giving people a tiny bit of extra money was pushing on a string. It didn’t work.
The money directly spent by government to create demand for labor worked exactly as predicted, and gave a push towards recovery. But conservatives in both parties hate that idea, because it shows that government is valuable. There won’t be more direct spending.
With fiscal policy sidelined by a two-party consensus, the Federal Reserve Board tried quantitative easing, flooding the economy with cash, buying financial assets at a ferocious pace. The idea is that banks will lend all that money to corporations which will spend money and hire more people. More string pushing. We got a staggering increase in the amount of money sloshing around in banks and in the stock market. Gillian Tett reports in the Financial Times:
At a meeting of corporate treasurers Thursday, those wails were echoed again: US groups are now stuffed with cash (more than $2tn at last count), but are finding it harder than ever to find anywhere to invest it.
She reports hearing that Brazilian investors are buying US Treasuries for safety, at negative real interest rates, even though Brazil needs infrastructure investments that would provide much higher long-term returns. In his introduction to our Book Salon with Paul Krugman, George Grantham gave us this chart:
Banks are required to maintain a certain amount of money as reserves. In normal times, they can buy safe investments, treasuries, for example, to hold that money and make a small profit. Now, however, they store the money at the Fed, where it earns a minimal interest rate. That $1.6 trillion at the Fed includes $126 billion in excess of required reserves at those banks. That’s $126 billion more dollars that isn’t in the economy in the form of loans. Banks can’t lend it out, because there isn’t any demand for loans, and why would there be when corporations have $2 trillion in loose money?
Total deposits at institutions insured by the Federal Deposit Insurance Corp. rose to about $10.2 trillion at the end of last year from $8.2 trillion in the third quarter of 2007. In the same period, total loans fell to $7.5 trillion from $7.7 trillion. Securities in bank portfolios rose to $2.9 trillion from $2 trillion, according to FDIC data.
So JPMorgan takes in $360 billion in deposits it can’t lend, and tries to invest it. They have to provide a return higher than treasuries, which means increasing their risk of loss. They have to do something to protect against loss, which means hedging. They are already a huge part of the hedging world, and it was easy to trap them in a bad hedge. The net result was a transfer of money from JPMorgan’s shareholders to the investors in a bunch of hedge funds. It didn’t help the economy, it didn’t solve the demand problem. It just rearranged the holdings of all that money.
The idea behind quantitative easing, and indeed, behind the entire program of salvaging the banks, was that they are this wonderful engine of allocating capital to its highest and best uses. So we flood them with money, and they’ll lend it out and the economy will get going. Pushing on a string. It doesn’t work..
The stupid idea that we can provide incentives to rich people to act in the interests of society has failed and has made things a lot worse.
We need direct government action: direct spending, and direct rejection of economic policies that have never worked anywhere at any time.