Brother, Can You Spare $700 Billion
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As the U.S. Congress debates the George W. Bush administration's proposed massive bailout of the nation's precarious financial system, the astringent analysis of economist Dean Baker has enjoyed a high profile in the news, the opinion pages and the blogosphere.
Baker is co-director of the Centre for Economic and Policy Research (CEPR), "an independent, nonpartisan think tank" in Washington ( www.cepr.net). His most recent book is "The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer".
Peter Costantini spoke with Baker by telephone on Sep. 24, 2008. Excerpts from the interview follow.
PC: On TV, Treasury Secretary Hank Paulson comes off as a straight shooter you could sit down and have a beer with. These are qualities we prize in choosing presidents and deciding to go to war. Why shouldn't we just trust him and round up the 700 billion dollars he's asking for to an even trillion?
DB: I don't mean to impugn Paulson's integrity, but the guy was the CEO of Goldman Sachs. The people he's bailing out are his friends, his colleagues. We don't hand anyone a blank cheque, but particularly not someone who comes from his background.
Would we hand a former head of the United Auto Workers Union a hundred billion dollars for a bailout of the auto industry to spend as he thought best, even if we trusted the guy? When we spend public money, we expect accountability, especially when it's such a huge intervention.
PC: Some take the position that this crisis is all scare tactics, that we should let the market wring out the financial industry.
DB: I'm happy to see the financial industry wrung out. Half the banks could go out of business and we'd be fine. But last week the whole system of payments almost collapsed. I don't want to see people unable to pay their bills or withdraw money from an ATM or buy plane tickets with a credit card.
I don't rule that out that it was engineered -- I wouldn't say it's absolutely above these people to do something like that. But you actually did have a situation where banks didn't trust each other to the point that you couldn't conduct normal business.
PC: China holds an enormous quantity of U.S. bonds. Could we pressure them into helping with this bailout because we're "too big to fail"?
DB: China is holding our bonds at extremely low rates of return, which helps the bailout in a huge way. Frankly, I don't know why they do it. For all I know, we've already negotiated this. Given that, we're not in a position to lean on them to give us more money.
We'd actually be better off in some ways if they didn't help us by holding our Treasuries. The dollar would fall, which would increase our exports and reduce our trade deficit -- one of the forces underlying this crisis.
PC: What kind of effects do you see this crisis having on, say, a coffee farmer in Mexico or a factory worker in Vietnam?
DB: First, assuming the government does this right, we'll be preventing a lot of global financial instability, because a meltdown in the U.S. would cause damage just about everywhere.
But the U.S. economy will be heading into a recession, so that's going to reduce demand for exports from all over the world, and the prices for many of these products will contract. It will affect the coffee farmer and anyone who's been selling things to the U.S. or world market.
Now if that's offset by China and some other developing countries continuing to grow rapidly, then maybe the impact won't be that big.
PC: If China and India and Brazil continue to grow, do you see a shift of economic power away from the U.S. towards these economies?
DB: Well, it's certainly part of the story. The U.S. had already been growing much less rapidly than China. They're not about to pass the U.S., but they're certainly gaining very rapidly. For many countries, particularly in East Asia, the Chinese economy is already more much more important the U.S. economy.
PC: What measures should Congress be considering to help homeowners at risk?
DB: We've been pushing for private lenders to first try to do workouts that reduce mortgage payments so people can continue to make good on their mortgages and stay in their homes. Now that we're the effective lenders of some mortgages or mortgage-backed securities, we should continue to do workouts where that's feasible.
Then if it turns out a write-down of the loan value is too large to be practical and they lose the house, let them pay market rent. Give them the option to stay there as a renter for some long period of time, five or 10 years.
If both of those fail, then clearly they're in over their head and we can't expect the taxpayers to subsidise them.
PC: The Democrats have been talking about modifying the bankruptcy law to allow judges to restructure mortgage payments.
DB: It's just common sense. You'd just be treating mortgage debt like any other debt, credit card debt or car debt. In fact, we did that until 1991. The vast majority of these things don't end up in bankruptcy anyhow, although more would if you changed the law.
PC: To the extent that homeowners are helped, doesn't that make bad debt viable again and reduce the financial burden that the public is picking up?
DB: Yes, it should increase the value of this debt somewhat. That's one of the motivations, absolutely.
But it's never going to be fully viable, because the bottom line is that people owe more than they can pay. So unless you find someone who's not too bright, they're going to pay at best at maybe 50 cents on the dollar.
PC: What about renters whose units are being are being foreclosed? Is there any way to help them?
DB: We should try to ensure that if your landlord loses the house, you would get to stay there at least through the remainder of your lease and some grace period. So they can't say, "OK, the house has been foreclosed. You're out of here today."
Even without a lease, renters should get something like 90 days notice so that they can plan. Because unlike owners, renters may not know if their landlord's not making the mortgage payment.
PC: In the long term, what regulations need to be put in place to fix these markets?
DB: First let's back up a step. The Federal Reserve board allowed the housing bubble to grow. The bubble could have easily been attacked, but [Fed chief] Alan Greenspan made the decision not to. If he had, you wouldn't have had a lot of these problems.
Beyond that, he was totally derelict in enforcing a lot of regulations. Everyone knew that a lot of garbage loans were being made. They could have easily cracked down on that -- that was incredible negligence.
As to the deeper structure of the markets, it makes sense to make sure that the issuers of mortgage-backed securities have a stake in them, so that they don't have an incentive just to issue garbage loans and sell them on the secondary market.
As a practical matter, though, I don't know if the regulators will have to do anything, because I don't think anyone's going to buy mortgages from people who don't have a stake in them. Wall Street might actually want the regulation because they want people to believe that they're selling good assets.