ECONOMY  
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Obama's Team Signals It's Taking the Taxpayer Ripoff Route to Saving Our Financial System

Obama's team is talking a whole new economic voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.
January 20, 2009  |  
 
 
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Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain the issue, let me describe the position of a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.

Why would the government bail Gotham out? Because it plays a central role in the financial system. When Lehman was allowed to fail, financial markets froze, and for a few weeks the world economy teetered on the edge of collapse. Since we don’t want a repeat performance, Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham’s current shareholders — and it would also encourage excessive risk-taking in the future. Still, the possibility of such a gift is what’s now supporting Gotham’s stock price.

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward a compromise approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, recently tried to describe how this would work: “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent because the alleged $400 billion of toxic waste on its books is actually worth only $200 billion. The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth: “We don’t have really any rational pricing right now for some of these asset categories,” Ms. Bair says. But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make Gotham solvent again?

What I suspect is that policy makers -- possibly without realizing it -- are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word -- nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal -- and that we’re about to get another financial rescue plan that fails to do the job.

© 2008 The New York Times

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Comments are closed-

Yep, The Biggest Ripoff in World History...
Posted by: mmckinl on Jan 20, 2009 12:27 AM   
Current rating: 4    [1 = poor; 5 = excellent]
I have been clamoring for an "FDR Bank Holiday" and now you know why. Without auditing these banks we won't know how much tax payer money they will cost. It's money down a rat hole to save the very scoundrels that caused the mess.

And this is a bigger disgrace for most economists and financial writers than the " Missing of the Housing Bubble". Even Krugman can't bring himself to say : " We Need FDRs Bank Holiday"

If they pull this sham off it will probably cripple our ability to fund Medicare and probably Social Security. Call your Senators and Representative and tell them NO to the "Bad Bank Plan". Tell them we need the accountability of audits through an FDR type Bank Holiday.

Find Your Senators and Representative by Zip Code

Zip Code Link

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» RE:Karl Denninger Posted by: chance garden

Comments are closed-

Congrats Progressives- You've Got A DLC President
Posted by: NoPCZone on Jan 20, 2009 2:34 AM   
Current rating: 4    [1 = poor; 5 = excellent]
Amerika 2.0
Vote for a Republican & get a NeoCon Republican.
Vote for a Democrat and get a regular (DLC/Blue Tick) Republican.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Shareholders rescued, really?
Posted by: beachcomberT on Jan 20, 2009 3:08 AM   
Current rating: Not yet rated    [1 = poor; 5 = excellent]
Re the voodoo, if this smoke & mirrors is supposed to help my Bank of America stock, it's not doing much. Shares have lost nearly 90 percent of their value over the past 2 years. But these bright bulbs at BofA continue buying junk like Countrywide and Merrill Lynch. Why not, if Uncle Sam is paying the bill?

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» RE: Shareholders rescued, really? Posted by: moyshekapoyre

Comments are closed-

It's virtually the same team
Posted by: sicntired on Jan 20, 2009 3:12 AM   
Current rating: 4    [1 = poor; 5 = excellent]
From Nazi quoting preachers to Clinton and Kennedy hacks Obama wants to be the new Lincoln.He has a really good start by pissing off just about every supporter that believed the Change you can believe in.Ramstad as drug czar will be the end of any support from progressives.he's disappointed just about everyone that worked so hard to get this kind of old fashioned political hack out of Washington.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

just wondering...
Posted by: aislinnluv on Jan 20, 2009 3:53 AM   
Current rating: 3    [1 = poor; 5 = excellent]
how much a jar of vaseline is gonna cost us? bend over, america....

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Pulease
Posted by: mpreb658@earthlink.net on Jan 20, 2009 4:30 AM   
Current rating: 3    [1 = poor; 5 = excellent]
The first one to post sounds like a good fellow. As to the ones following:

The crazies, the cranks, the losers, the soreheads, the Uglies are out in full force. Pulease crawl back in your hole.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» all apologies Posted by: aislinnluv
» Similarities Posted by: ProgressiveManiac

Comments are closed-

CEO Obama
Posted by: socialpsych on Jan 20, 2009 5:52 AM   
Current rating: 3    [1 = poor; 5 = excellent]
Obama sounds just like a typical corporate CEO when he talks down to us and says that times are tough and "we" are facing difficult choices.

The only difficult choices most Americans are facing are: xbox or wii? 46" or 61" hdtv? Cheetos or Doritos?

What we have is disaster political economics in action.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Disaster in the making
Posted by: beandang on Jan 20, 2009 6:17 AM   
Current rating: 5    [1 = poor; 5 = excellent]
Wow, very well put indeed. Really makes you wonder doesnt it? It should!

RT
Privacy Center

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

BHO already made it clear when he flip-flopped on
Posted by: Jennifer Bedingfield on Jan 20, 2009 6:29 AM   
Current rating: 4    [1 = poor; 5 = excellent]
rescinding tax breaks on the wealthy elite by postponing it for a year and giving Wall $treet a bailout at our taxpayer expense. If you all had voted for Nader instead of Obama or Mccain we'd all have something better to look forward to.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

A government of the bankers, by the bankers, and for the bankers...
Posted by: TJColatrella on Jan 20, 2009 8:05 AM   
Current rating: 4    [1 = poor; 5 = excellent]
We're a government of the bankers, by the bankers and for the bankers...

Will President Obama see fit to end this..?

Who knows, perhaps in time he will..?

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

The Federal Reserve Fraud: Learn it. Share it.
Posted by: Fog on Jan 20, 2009 8:33 AM   
Current rating: 5    [1 = poor; 5 = excellent]
In order to come up to speed with the rest of the country in understanding how you've been fooled all this time by the people who own the Federal Reserve, get the background by studying this site:

The Money Masters

.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

This Ceaseless Bitching about the FED is Ridiculous!! They Surely Created Asset Price Bubbles but...
Posted by: yellow on Jan 20, 2009 11:04 AM   
Current rating: 4    [1 = poor; 5 = excellent]
...the real, underlying problem is the chronic stagnation of late capitalism. It is chronic stagnation that first led to the financialization of the US economy. The 1980-82 recession decimated the US and global middle classes creating high average rates of unemployment and low real wages caused by sustained high real interest rates. The concentration of the global economy followed with financialization close behind.

High real interest rates continued despite the dollar devaluation in 1985 and a consequent US export boom allowing modest job market recovery and some sustained GDP growth until the recession of 1990. The jobless recovery of 1991 was accompanied by high real interest rates and slow growth. At this time the US was experiencing capital flight due to slow growth, lack of investment opportunity, low bond yields and a general capital glut. Capital fled the US to Mexico. In September 1994, Greenspan raised interest rates despite 6% unemployment to slow the outflow of capital causing a currency crisis in Mexico as capital returned to the US in response to the rate hike. Clinton argued vigorously with Greenspan to lower interest rates to stimulate the economy.

A reduction in interest rates in 1995 allowed a recovery in the housing and stock market. From 1996 to 2000, the total value of the DJIA quadrupled. Housing stock increased and house prices gradually inflated as real interest rates remained depressed. Greenspan made a modest rate hike in 1999 and quickly reversed it as he saw the housing and stock markets react. A quick succession or rate cuts followed but it was too little too late. The US economy had begun to slow and a recession was in progress.

The problem was not the failure of monetary policy to prevent stock market and housing price bubbles that ultimately proved so dangerous to the US economy. It was exactly these bubbles, and the wealth effect they created, that allowed consumers to borrow against their assets to finance the continued growth of the US economy in the 1990s given low and declining real average wages and salaries. Without consumer borrowing, effective demand would be too low to sustain the US economy. The contradictions of this strategy became obvious; the rapid increase in the debt service ratio constrained further consumer borrowing and spending and hence GDP growth. Currently, US consumer debt is equal to the US GDP!!

In 2002, with a jobless upswing in the business cycle in effect, interest rate cuts and a weak dollar designed failed to spur exports. Thus, a job market recovery was delayed until 2005, but a bubble on the housing and stock markets did develope. Between 2002 and 2006, over $1.6 trillion in foreign capital inflows to the US equities markets sustained US borrowing and depressed interest rates.

Short term borrowing in low interest financial markets like Japan financed long term investment in the US stock and high yield bond market creating a capital glut in the US. The stock market responded to rate cuts but mortgage rates, which are tied to long term treasury bond rates, remained high for a time at just over 7%. Long term rates remained high reflecting inflation fears caused by short term rate cuts thus increasing bond yields which drew still more foreign capital into US bond markets. Much of this money leaked back out into third world sovereign debt which went back to US bonds in an effort to prevent currency appreciation in the third world that would harm exports. A vicious cycle fueled continuing financialization of the global economy.

Global imbalances led to financial innovation and ultimately to loan securitization as a way of financing new consumer spending. Short term rates continued downward. Ultimately, these efforts to sustain economic growth failed. That effort will require redistribution and public investment for full employment.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» Great post. Posted by: GuitarBill
» Sure Bill!! Posted by: yellow
» Okay, that explains recent events Posted by: GuitarBill

Comments are closed-

and don't forget tax cuts for the rich
Posted by: sonofloud2 on Jan 20, 2009 11:21 AM   
Current rating: 1    [1 = poor; 5 = excellent]
and rebates for the rest of us.
deficit be damned!

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Get a life
Posted by: dockboy on Jan 20, 2009 11:30 AM   
Current rating: 2    [1 = poor; 5 = excellent]
Come on, people. I didn't vote for Obama, but he's now my president. I'm behind him 100%. Give him a chance before you do your bitching and moaning.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» RE: Get a life Posted by: VicJuans

Comments are closed-

All part of the plan...for the demise of the System
Posted by: VicJuans on Jan 20, 2009 12:55 PM   
Current rating: Not yet rated    [1 = poor; 5 = excellent]
Indeed

www.politicalaffairs.net/index.php/article/articleview/7648/

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Comments are closed-

The sickness is taking over Europe too
Posted by: Bliss Doubt on Jan 20, 2009 1:17 PM   
Current rating: 3    [1 = poor; 5 = excellent]
I hear it on the news every day, the president of this one, the prime minister of that one, awarding billions to dying banks and businesses, while attacking national pensions, education, health care and other "burdens".

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Robert Rubin
Posted by: JSquercia on Jan 20, 2009 4:16 PM   
Current rating: 5    [1 = poor; 5 = excellent]
I read that the Wall Street Journal today had an article concerning Rubin and that it was none too kind to him , I was surprised to hear of this but from what I have heard of Rubin he s part of the problem being a foe of regulation of Financial Markets(lobbied hard for end to Glass Steagall and opposed regulation of derivatives ). It was his efforts that enabled the merger of Citi Bank and Travelers Insurance under Sandy Weil . He
left government to work for the newly created Coorporation . He spoke of his knowledge of
Company but was as astounded as the rest of us
at its bad investments . These seem to me to be dubious at best qualifications for his role of economic advisor to Obama .
To me there are far too many involved in his economic team who were active contributors to the current mess and who were well paid for their bad advice . THAT is why I worry about the road we are taking . As I understand it we STILL have no idea How many of these toxic item are on the balance sheets of these banks nd there doesn't seem to be anyone to force these worthless pieces of paper into the open

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Comments are closed-

Krugman hit the nail on its head - this is residual fallout from market fundamentalism
Posted by: PaulC on Jan 20, 2009 9:54 PM   
Current rating: 5    [1 = poor; 5 = excellent]
Although market fundamentalism is in tatters, fear of nationalization fed by the same people who brought us that same moronic trickle-down ideology continues to pump billions of taxpayer dollars into the hands of the wealthy elite.

Short term we need to follow Krugman's advice and let the government act as turn-around agent for banks requiring Chapter 11 restructuring. This cuts the corrupt CEO's and managers out of the picture, slashing their golden parachutes, short-circuits their attempts to use taxpayer money to fund things such as acquisitions of other banks, instead serving to break up larger banks into smaller ones, eliminating the "too-big-to-fail" problem.

Long term we need to follow Yellow's advice, returning to actually producing something tangible, creating jobs and living wages, providing banks something tangible to work with.

Obama is very aware of this and has made the transition to the coming green industrial revolution the centerpiece of his plan to revitalize our economy. This is profoundly important on many levels.

Finally, banks need to be separated from financial service houses. Any crossover must be met with increased reserve requirements and/or increased regulatory requirements.

peace,
Paul

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Comments are closed-

“Bush” is a four-letter word, but “nationalization” is not.
Posted by: jimswanson on Jan 22, 2009 2:20 PM   
Current rating: 5    [1 = poor; 5 = excellent]
James A. Swanson, Los Altos, CA
“The Bush League of Nations”
www.bushleagueofnations.com [for FREE download of book]

At the risk of offending religious folk who worship Free Market God, I offer some blasphemy:

There’s a parallel between America’s military and America’s financial system.

Both are too important to be entrusted to private mercenaries.

I suspect there are millions of Americans like me who know “nationalization” is not a four-letter word.

Have we learned nothing from the last three decades, especially the last eight years?

When the GOP and the Republican wing of the Democratic Party talk about reform and use wonderful words like “free enterprise,” “privatization,” and “deregulation,” be sure to count your fingers.

Jim Swanson, Los Altos, CA
“The Bush League of Nations”
www.bushleagueofnations.com [for FREE download of entire book]

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

Alternet Comments:

Comments are closed-

Yep, The Biggest Ripoff in World History...
Posted by: mmckinl on Jan 20, 2009 12:27 AM   
Current rating: 4    [1 = poor; 5 = excellent]
I have been clamoring for an "FDR Bank Holiday" and now you know why. Without auditing these banks we won't know how much tax payer money they will cost. It's money down a rat hole to save the very scoundrels that caused the mess.

And this is a bigger disgrace for most economists and financial writers than the " Missing of the Housing Bubble". Even Krugman can't bring himself to say : " We Need FDRs Bank Holiday"

If they pull this sham off it will probably cripple our ability to fund Medicare and probably Social Security. Call your Senators and Representative and tell them NO to the "Bad Bank Plan". Tell them we need the accountability of audits through an FDR type Bank Holiday.

Find Your Senators and Representative by Zip Code

Zip Code Link

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» RE:Karl Denninger Posted by: chance garden

Comments are closed-

Congrats Progressives- You've Got A DLC President
Posted by: NoPCZone on Jan 20, 2009 2:34 AM   
Current rating: 4    [1 = poor; 5 = excellent]
Amerika 2.0
Vote for a Republican & get a NeoCon Republican.
Vote for a Democrat and get a regular (DLC/Blue Tick) Republican.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Shareholders rescued, really?
Posted by: beachcomberT on Jan 20, 2009 3:08 AM   
Current rating: Not yet rated    [1 = poor; 5 = excellent]
Re the voodoo, if this smoke & mirrors is supposed to help my Bank of America stock, it's not doing much. Shares have lost nearly 90 percent of their value over the past 2 years. But these bright bulbs at BofA continue buying junk like Countrywide and Merrill Lynch. Why not, if Uncle Sam is paying the bill?

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» RE: Shareholders rescued, really? Posted by: moyshekapoyre

Comments are closed-

It's virtually the same team
Posted by: sicntired on Jan 20, 2009 3:12 AM   
Current rating: 4    [1 = poor; 5 = excellent]
From Nazi quoting preachers to Clinton and Kennedy hacks Obama wants to be the new Lincoln.He has a really good start by pissing off just about every supporter that believed the Change you can believe in.Ramstad as drug czar will be the end of any support from progressives.he's disappointed just about everyone that worked so hard to get this kind of old fashioned political hack out of Washington.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

just wondering...
Posted by: aislinnluv on Jan 20, 2009 3:53 AM   
Current rating: 3    [1 = poor; 5 = excellent]
how much a jar of vaseline is gonna cost us? bend over, america....

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Pulease
Posted by: mpreb658@earthlink.net on Jan 20, 2009 4:30 AM   
Current rating: 3    [1 = poor; 5 = excellent]
The first one to post sounds like a good fellow. As to the ones following:

The crazies, the cranks, the losers, the soreheads, the Uglies are out in full force. Pulease crawl back in your hole.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» all apologies Posted by: aislinnluv
» Similarities Posted by: ProgressiveManiac

Comments are closed-

CEO Obama
Posted by: socialpsych on Jan 20, 2009 5:52 AM   
Current rating: 3    [1 = poor; 5 = excellent]
Obama sounds just like a typical corporate CEO when he talks down to us and says that times are tough and "we" are facing difficult choices.

The only difficult choices most Americans are facing are: xbox or wii? 46" or 61" hdtv? Cheetos or Doritos?

What we have is disaster political economics in action.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

Disaster in the making
Posted by: beandang on Jan 20, 2009 6:17 AM   
Current rating: 5    [1 = poor; 5 = excellent]
Wow, very well put indeed. Really makes you wonder doesnt it? It should!

RT
Privacy Center

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

BHO already made it clear when he flip-flopped on
Posted by: Jennifer Bedingfield on Jan 20, 2009 6:29 AM   
Current rating: 4    [1 = poor; 5 = excellent]
rescinding tax breaks on the wealthy elite by postponing it for a year and giving Wall $treet a bailout at our taxpayer expense. If you all had voted for Nader instead of Obama or Mccain we'd all have something better to look forward to.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

A government of the bankers, by the bankers, and for the bankers...
Posted by: TJColatrella on Jan 20, 2009 8:05 AM   
Current rating: 4    [1 = poor; 5 = excellent]
We're a government of the bankers, by the bankers and for the bankers...

Will President Obama see fit to end this..?

Who knows, perhaps in time he will..?

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

The Federal Reserve Fraud: Learn it. Share it.
Posted by: Fog on Jan 20, 2009 8:33 AM   
Current rating: 5    [1 = poor; 5 = excellent]
In order to come up to speed with the rest of the country in understanding how you've been fooled all this time by the people who own the Federal Reserve, get the background by studying this site:

The Money Masters

.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]


Comments are closed-

This Ceaseless Bitching about the FED is Ridiculous!! They Surely Created Asset Price Bubbles but...
Posted by: yellow on Jan 20, 2009 11:04 AM   
Current rating: 4    [1 = poor; 5 = excellent]
...the real, underlying problem is the chronic stagnation of late capitalism. It is chronic stagnation that first led to the financialization of the US economy. The 1980-82 recession decimated the US and global middle classes creating high average rates of unemployment and low real wages caused by sustained high real interest rates. The concentration of the global economy followed with financialization close behind.

High real interest rates continued despite the dollar devaluation in 1985 and a consequent US export boom allowing modest job market recovery and some sustained GDP growth until the recession of 1990. The jobless recovery of 1991 was accompanied by high real interest rates and slow growth. At this time the US was experiencing capital flight due to slow growth, lack of investment opportunity, low bond yields and a general capital glut. Capital fled the US to Mexico. In September 1994, Greenspan raised interest rates despite 6% unemployment to slow the outflow of capital causing a currency crisis in Mexico as capital returned to the US in response to the rate hike. Clinton argued vigorously with Greenspan to lower interest rates to stimulate the economy.

A reduction in interest rates in 1995 allowed a recovery in the housing and stock market. From 1996 to 2000, the total value of the DJIA quadrupled. Housing stock increased and house prices gradually inflated as real interest rates remained depressed. Greenspan made a modest rate hike in 1999 and quickly reversed it as he saw the housing and stock markets react. A quick succession or rate cuts followed but it was too little too late. The US economy had begun to slow and a recession was in progress.

The problem was not the failure of monetary policy to prevent stock market and housing price bubbles that ultimately proved so dangerous to the US economy. It was exactly these bubbles, and the wealth effect they created, that allowed consumers to borrow against their assets to finance the continued growth of the US economy in the 1990s given low and declining real average wages and salaries. Without consumer borrowing, effective demand would be too low to sustain the US economy. The contradictions of this strategy became obvious; the rapid increase in the debt service ratio constrained further consumer borrowing and spending and hence GDP growth. Currently, US consumer debt is equal to the US GDP!!

In 2002, with a jobless upswing in the business cycle in effect, interest rate cuts and a weak dollar designed failed to spur exports. Thus, a job market recovery was delayed until 2005, but a bubble on the housing and stock markets did develope. Between 2002 and 2006, over $1.6 trillion in foreign capital inflows to the US equities markets sustained US borrowing and depressed interest rates.

Short term borrowing in low interest financial markets like Japan financed long term investment in the US stock and high yield bond market creating a capital glut in the US. The stock market responded to rate cuts but mortgage rates, which are tied to long term treasury bond rates, remained high for a time at just over 7%. Long term rates remained high reflecting inflation fears caused by short term rate cuts thus increasing bond yields which drew still more foreign capital into US bond markets. Much of this money leaked back out into third world sovereign debt which went back to US bonds in an effort to prevent currency appreciation in the third world that would harm exports. A vicious cycle fueled continuing financialization of the global economy.

Global imbalances led to financial innovation and ultimately to loan securitization as a way of financing new consumer spending. Short term rates continued downward. Ultimately, these efforts to sustain economic growth failed. That effort will require redistribution and public investment for full employment.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

» Great post. Posted by: GuitarBill
» Sure Bill!! Posted by: yellow
» Okay, that explains recent events Posted by: GuitarBill

Comments are closed-

and don't forget tax cuts for the rich
Posted by: sonofloud2 on Jan 20, 2009 11:21 AM   
Current rating: 1    [1 = poor; 5 = excellent]
and rebates for the rest of us.
deficit be damned!

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Get a life
Posted by: dockboy on Jan 20, 2009 11:30 AM   
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Come on, people. I didn't vote for Obama, but he's now my president. I'm behind him 100%. Give him a chance before you do your bitching and moaning.

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» RE: Get a life Posted by: VicJuans

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All part of the plan...for the demise of the System
Posted by: VicJuans on Jan 20, 2009 12:55 PM   
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Indeed

www.politicalaffairs.net/index.php/article/articleview/7648/

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The sickness is taking over Europe too
Posted by: Bliss Doubt on Jan 20, 2009 1:17 PM   
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I hear it on the news every day, the president of this one, the prime minister of that one, awarding billions to dying banks and businesses, while attacking national pensions, education, health care and other "burdens".

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Robert Rubin
Posted by: JSquercia on Jan 20, 2009 4:16 PM   
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I read that the Wall Street Journal today had an article concerning Rubin and that it was none too kind to him , I was surprised to hear of this but from what I have heard of Rubin he s part of the problem being a foe of regulation of Financial Markets(lobbied hard for end to Glass Steagall and opposed regulation of derivatives ). It was his efforts that enabled the merger of Citi Bank and Travelers Insurance under Sandy Weil . He
left government to work for the newly created Coorporation . He spoke of his knowledge of
Company but was as astounded as the rest of us
at its bad investments . These seem to me to be dubious at best qualifications for his role of economic advisor to Obama .
To me there are far too many involved in his economic team who were active contributors to the current mess and who were well paid for their bad advice . THAT is why I worry about the road we are taking . As I understand it we STILL have no idea How many of these toxic item are on the balance sheets of these banks nd there doesn't seem to be anyone to force these worthless pieces of paper into the open

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Krugman hit the nail on its head - this is residual fallout from market fundamentalism
Posted by: PaulC on Jan 20, 2009 9:54 PM   
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Although market fundamentalism is in tatters, fear of nationalization fed by the same people who brought us that same moronic trickle-down ideology continues to pump billions of taxpayer dollars into the hands of the wealthy elite.

Short term we need to follow Krugman's advice and let the government act as turn-around agent for banks requiring Chapter 11 restructuring. This cuts the corrupt CEO's and managers out of the picture, slashing their golden parachutes, short-circuits their attempts to use taxpayer money to fund things such as acquisitions of other banks, instead serving to break up larger banks into smaller ones, eliminating the "too-big-to-fail" problem.

Long term we need to follow Yellow's advice, returning to actually producing something tangible, creating jobs and living wages, providing banks something tangible to work with.

Obama is very aware of this and has made the transition to the coming green industrial revolution the centerpiece of his plan to revitalize our economy. This is profoundly important on many levels.

Finally, banks need to be separated from financial service houses. Any crossover must be met with increased reserve requirements and/or increased regulatory requirements.

peace,
Paul

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“Bush” is a four-letter word, but “nationalization” is not.
Posted by: jimswanson on Jan 22, 2009 2:20 PM   
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James A. Swanson, Los Altos, CA
“The Bush League of Nations”
www.bushleagueofnations.com [for FREE download of book]

At the risk of offending religious folk who worship Free Market God, I offer some blasphemy:

There’s a parallel between America’s military and America’s financial system.

Both are too important to be entrusted to private mercenaries.

I suspect there are millions of Americans like me who know “nationalization” is not a four-letter word.

Have we learned nothing from the last three decades, especially the last eight years?

When the GOP and the Republican wing of the Democratic Party talk about reform and use wonderful words like “free enterprise,” “privatization,” and “deregulation,” be sure to count your fingers.

Jim Swanson, Los Altos, CA
“The Bush League of Nations”
www.bushleagueofnations.com [for FREE download of entire book]

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