How Economists (and Pundits and Politicians) Helped Steer America Off a Cliff

By Joshua Holland, AlterNet. Posted February 12, 2009.

The reason why that's so important is, if we believe the credit crunch story ... let's, for a moment, imagine that there's all these good credit risks out there who simply can't get credit because banks are holding on, hoarding their money, and they're sending everyone away. OK, so if we believe that, then we have a lot of people who go to the bank to get a mortgage, and they're turned down. Even though they've got a solid credit rating, put down a reasonable deposit and they're paying a reasonable price on a home, the bank's turning them down. So they go to a second mortgage company. They go to a third, a fourth.

So, if we believe the credit crunch story, there's real simple test. There should be a huge rise in the ratio of mortgage applications to mortgage issuances, which correspond roughly to the homes sold. Well, there isn't. There's no perceptible rise at all. I mean, I haven't done the arithmetic, but I could eyeball it. There's no uptick at all. In fact, the mortgage applications index has been trending downward, and it's pretty much been following the rate of house sales. So, there's no evidence at all that people [who are creditworthy] are having difficulty getting mortgages.

Now, there's lots of people who owe $300,000 on a home that today is worth $200,000. They go to the bank and they say, "I want to refinance." They can't get it. No. No bank in its right mind's going to lend someone $300,000 on a home that's worth $200,000. That's not a credit crunch. They'd never do that even if they were stuffed to their gills with capital.

But that really has nothing to do with the strength of the banking and the financial system. Banks, as a general rule -- we had an exception a couple years ago -- don't like to make loans to people they don't think are creditworthy.

JH: Now, this seems to me a crucial question, in terms of policy ramifications, right? I mean, if we have this credit crunch, where banks are not loaning to otherwise-qualified individuals, but showering billions and billions and billions of dollars onto the financial system, makes a certain amount of sense, doesn't it?

But, is there another approach that might seem more obviously effective, if this credit crunch story is not the primary issue, but rather a secondary issue to this massive loss in wealth and the fact that people are sitting in homes that are worth significantly less than their loans?

DB: Well, I think first off, in terms of how we look to boost the economy, it's going to have to be primarily through fiscal policy. We're going to have to spend a lot of money, and we're going to have a big stimulus. I think the one that President Obama worked through with Congress is a good start. It should give the economy a boost, but we'll need more than that.

But the other problem, when we come to the banking sector, we do have to fix it. I mean, you do have a situation where you have a large number of banks that are insolvent -- they're bankrupt.

But the fact that there's not this imminent credit crunch does mean two things: One, we have more time. And two, we could think this through. We could structure this in a way so that we don't just end up giving money to the shareholders who took a bet and lost. In a market economy, if you take a bet and lose, you're out of luck. That's the way it's supposed to be.

So, one, we don't want our money going to the shareholders. And two, perhaps more importantly, we don't want it to go to the bank executives. And, we have the time to sit down and work this out to make sure that what we do doesn't reward the people who got us here.

In any case, we certainly have the time today, and there's absolutely no reason on earth to be designing new plans that are going to end up rewarding the banks, rather than simply sustaining the financial system. Which again, that's what we care about. There's no reason on earth that taxpayers should be coughing up their tax dollars to help out the shareholders and the executives at these banks.

JH: Now, you talk about moving beyond the bubble economy, and you lay out a number of things that you think need to be done. Dean Baker, you're president for life, without a Congress to worry about. You're a dictator. What are you going to do to keep the next bubble from rising?

DB: And I thought we just inaugurated Barack Obama.

JH: Who?

DB: Anyhow. Several things. First off, I'd rein in the financial sector. We have to understand, the financial sector is a drain on the economy. That's not a moral statement; it's an intermediate good. This isn't like recreational activities or health care, goods that make us better off as an end in itself. It's an intermediate good, like trucking.

So, if we suddenly saw that more and more of the economy's resources were being used up by the trucking sector, we'd be inclined to say, well, what's going on there? Why do we have 10 percent of the economy in trucking? Of course, we have about 1 percent, but suppose it jumped to 10 percent. We'd think, "we have a really inefficient trucking sector." And that would be the same way we should look at the financial sector.

We need the financial sector so that we can get the money to buy a house, to start a business, to borrow money to send our kids through school, or so they can borrow it themselves. There's all sorts of reasons that we need, and we want a good, working financial sector.

See more stories tagged with: baker, financial crisis, bubble economy

Joshua Holland is an editor and senior writer at AlterNet.

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