Another Dip in the Road?

Since the economy torpedoed in 2007, the U.S., along with much of the world, has been suffering under the worst recession since 1930’s.  Unemployment is hovering around 10% and “real” unemployment exceeds 15%.  The recovery has been limited and the future is uncertain.

While predicting the future is a risky endeavor (I typically fare better when I make predictions after the fact), following is a marginally informed guess on our economic future for the next few years.


Part 1. Things we should have learned in school but weren’t paying attention.


The 2008 stimulus package helped avert a new Great Depression.  When, in 2007, the credit markets froze, business activity slowed to a crawl.  Without capital to fund business cash flow, purchases of inventory and business investment; financial activity around the world started grinding to a halt, causing a cascade of lay-offs and bankruptcies, which in turn, led to less credit, more lay-offs, more bankruptcies, in an downward spiral that wouldn’t have stopped for a long time.  We would likely have had 20% or 30% unemployment.  In fact, the only thing stopping a complete economic collapse was the steady infusion of money from government to pay for safety net programs, health care, public workers, etc.


So, the government’s actions – such as flooding banks with cash, taking over GM, creating stimulus programs – while unpopular, kept things from getting much, much worse.  And it’s clear that, if we want to return to full employment, further government stimulus will be necessary.  While, reducing the deficit at this point in time would send the economy further down.

And, no, the government is NOT like a family sitting around the table at night balancing the budget.  That’s a nice sound bite; maybe it’s a good vote getter; but it’s not true.

In the mid 1930’s, after President Roosevelt implemented stimulus programs, the economy started to grow again.  However, just as now, deficit hawks urged government cutbacks and . . . the economy quickly went downhill.

We did emerge from the Depression finally when the government pulled out all the stops and embarked on the biggest stimulus program in our history.  In the late 1930's, government stopped relying on the private sector to fix the economy and, instead, fully embraced . . . Socialism!   Government hired millions of unemployed people and spent billions buying lots of new clothing, food, vehicles, ships, etc.  We went hog-wild with the biggest deficit spending spree in history.  Our current deficit is 60% of the gross domestic product; but in the 1940’s, it soared to 150% of our GDP!  Even worse, our "robber" government increased taxes on the middle class and rich to unheard of levels.  Marginal tax rates for the very wealthy soared over 90%.

And, of course, the pundits' dire predictions came true.  The profligate spending of the 1940’s saddled the next generation and their children with crushing debt, from which they never recovered.  Government domination of the economy and high taxes completely destroyed private initiative and wrecked the economy.  By 1950, the country lay in utter ruin, people barely had clothes, lived in hovels and scoured the countryside for food.  It was the end of the great American experiment.

Well, not exactly.

Not even remotely.

Government went on its spending spree, increased taxes on the wealthy and we went from 17% to 5% unemployed in twelve months!  The Great Depression?  Fixed, solved and banished for two entire generations.  And after 1945, there was no collapse; in fact, the economy took flight for the longest period of continuous growth in our country’s history.

And the crushing deficit debt?  It faded away under a rapidly expanding economy – an economy, by the way, where the highest tax rates remained above 90%.

That profligate stimulus spending was, of course, World War II.  It appears that we can’t act in our own best economic interest unless it involves a really big war.  It’s politically just fine to deficit spend and increase taxes on the wealthy if we’re fighting a war.  But, otherwise, we can’t bring ourselves to do the things that would help us.

Oddly, an enormous, ongoing increase in stimulus funding could not only get the economy back on its feet; but could actually prepare us for a new round of growth and expansion.  Deficit spending used to improve our transportation system, advance our educational programs, and wean us off oil, could create a higher functioning, more efficient economy – a good thing, by all accounts.


Still not convinced?  Well, don’t tell China because that’s exactly what they are doing.  When the world economy took a dive in 2007-2008, China took a hit too.  But China learned from our experience in the Great Depression and embarked on an enormous, Keynesian, stimulus-spending program by building transportation, improving schools and migrating to alternative energy.  Guess who is going to come out ahead in this debate?


Part 2.  When the music’s over  . . .
~ Jim Morrison

Unfortunately, we don’t seem to be heeding the lessons of the Great Depression and, instead, are going down a very different path. Here’s what’s coming up in the near future and the impact it will have on us:

First, stimulus funding is OVER.  The old Congress had a difficult time passing bills.  The next Congress will do even less.  And incoming Congress members are clear that they will not support any new stimulus spending.

The 2008 stimulus funding, which kept local government and the economy alive, is winding down.  State budgets are in sharp decline and Legislatures are cutting billions in spending.  Some argue that’s a good thing; after all, what could be better than getting rid of bureaucrats?   Bureaucrats do not make up the bulk of state and local government workers.  These are mostly teachers, college employees, fireman, law enforcement, etc.  So states will be eliminating lots of those jobs, which will affect classroom sizes, the number of police on the beat, etc.  Cuts to Medicaid will affect hospitals, doctors, nursing homes and other medical providers.

Sick of all those road construction projects that are going on right now?  Well, not to worry, as federal stimulus funds dry up, we can say goodbye to those as well.  And while we’re at it, say goodbye to all those jobs that kept the construction industry on life support after the housing market collapsed.
Well, maybe we can live without a few teachers or construction workers.  But keep in mind, those newly unemployed people will stop spending as much money at the local Safeway and other stores.  As their numbers climb, business activity will decline.  If the cuts are severe, it could throttle the weak recovery.

Contrary to what the pundits say, we do not live in a “we’re all on our own, pull yourselves up by your bootstraps” world.  We are profoundly and intimately connected to and interconnected with each other.  When many of us suffer, we all suffer.  When most of us thrive, we all thrive.  This is not socialism; this is our reality.  And nothing demonstrates this interconnectedness more than the housing market.


Part 3. And I’ll huff and I’ll puff and I’ll blow your house down.
~ B.B. Wolf

It was the popping of the housing bubble in 2007 that led to the great financial collapse.  After being driven sky high by Wall Street’s funny money derivatives, the whole edifice collapsed in 2007 and millions lost their homes, millions more lost decades of savings and, of course, the world economy nearly collapsed.
Well, at least that part is behind us, right?

Right?

Well, not exactly.  In fact, not at all.

You see, there is a cloud on the horizon. It’s not exactly a secret; in fact, you can find mention of it inside the WSJ and NY Times.


Remember all of those toxic, subprime loans?  These were the loans given to borrowers who would never be able to pay them off.  These bad loans have mostly worked their way through the financial system.  People lost their homes, a lucky few were able to refinance, and most of these loans have been accounted for.

Unfortunately, the innovators on Wall Street didn’t stop with subprime loans.  In the mid-2000’s, they started promoting “Alt-A” and “Option ARM” loans.  These loans often had “teaser” rates.  Borrowers would pay low amounts – for example, interest payments only – for the first few years of their mortgage.  After 3-5 years, they would start paying interest and principle and their payments would increase . . . a lot.  Say, 30%, 50% or more.  Lenders assured borrowers that perhaps they would earn more income in a few years; or perhaps they could refinance in a few years.

A good plan, except that incomes have not gone up and you can’t refinance your home if you owe more than your house is worth.  And that’s what is happening now in a big way.  In fact, there is over $1 trillion in such loans that are coming due in 2011 and 2012.  As these loans “recast”, a few million people will be unable to pay their mortgages and many will foreclose.  More foreclosures means more banks need to sell more homes, and the glut of housing should drive overall housing prices down.  This will create a downward spiral where more and more people will find themselves “under water” – owing more on their houses than they are worth.  And, once again, as people lose their homes and their accumulated wealth, the effects will percolate through the economy dragging it down further.

This is an awful scenario, but there’s more to come.

It was not enough for Wall Street to sink the housing market and torpedo the economy; there was still more mischief to be done.  After making enormous profits on home mortgage loans and derivatives, they moved on to the commercial real estate market, introducing similar “innovations” there.  As a result, there is about $1 Trillion in commercial real estate loans that are at risk of defaulting in 2013 and 2014.

So, we appear to have a triple whammy:

1. The one thing to revive the economy would be stimulus funding; but this appears unlikely to happen. The existing stimulus funds are winding down.  As they peter out, state and local governments will make dramatic cuts to education, health and construction programs, further depressing the economy.
   
2. More toxic mortgage loans are about to come due, which will increase foreclosures, drive down home prices and roil the credit markets and economy.
   
3. Commercial real estate loans will go through similar turbulence in 2013 and 2014.  This will further disrupt the financial markets and lending will diminish, subjecting the credit markets to a slow freeze.

We can therefore expect a possible second dip to the recession with unemployment rising again.  If Congress cuts domestic spending as some predict, this will further weaken the economy.

It’s a sorry picture – one that implies long-term unemployment for millions, job insecurity for many, and considerable (and unnecessary) suffering.


However, it won’t be bad news for everyone.  Over the last 40 years, the very wealthy have gotten . . . well . . . very, very wealthy.  More wealth is concentrated in fewer people’s hands than ever before.  And those few people sitting on enormous amounts of cash will be able to clean up.

As housing prices plummet, you’d think that ordinary people would be able to buy those homes at really low prices.  However, this would not be the case.  Because, at the same time, the instability in the financial markets will make lenders scared or unable to lend.  The only people able to take full advantage of rock bottom prices will be those sitting on mounds of cash.  As they sweep up cheap homes and commercial real estate, two things will happen: 1) a growing percentage of Americans will become renters and 2) the accumulated wealth of much of the middle class will have been captured by the wealthiest sliver of society.


In other words, the rich will get richer.

The lights are dimming . . .

Another wonderful column from Frank Rich.  The last 4 decades have resulted in a steady hollowing out of the middle class. And lest anyone think this trend has abated, all signs point to it getting much, much worse in the coming years.  Here's why:
1)  The only real solution to the recession is for more stimulus funding.  Yes, I know that the pundits shriek about the dangers of the deficit; but they are flat out wrong - at least for the short term.  As we should have learned from the Great Depression, a national budget is NOT like a household budget.  Shrinking the deficit in the short-term will simply cause the economy to contract - a real disaster.  The only thing that ended the Great Depression was the largest deficit spending stimulus program in U.S. history - namely World War 2.  There's no technical reason we couldn't do another stimulus that strengthens our infrastructure instead of going to war.  But, sadly, the new elected Congress plans to cut funding.

2) The current ARRA stimulus spending is winding down; and states are starting to lay off workers, teachers, police, etc.  This will increase unemployment and have a further dampening effect on the economy.

3) Last, the media has barely mentioned this . . . but we are on the verge of a new foreclosure tsunami.  There is about $1.5 TRILLION in toxic loans (so-called Option ARMS and Alt-A loans) that will reset in 2011 and 2012.  As people's monthly payment suddenly increase, more homes will foreclose.  And, as banks try to sell off these properties at the same time, housing prices will drop again.  This will feed a vicious cycle where more people go underwater and walk from their mortgages.

Even worse, a 3rd sucker punch will occur when toxic Commercial property loans come due in 2013 and 2014. This will further roil the real estate industry and the economy at large.

The above factors will further destabilize the economy, leading to a second dip in the recession.  Unemployment will increase and this time, there will be fewer safety net programs (thanks to the new Congress) than in 2008-2009.  For example, workers will not be able to receive extended unemployment benefits.

But there will be a few winners.  Hedge funds and the top .1% superrich will sweep in and buy property at bargain prices - primarily because they will be the only ones with available cash.  (With so many people underwater, getting a mortgage will be even more difficult than it is today.)  In other words, those who destroyed the economy in 2008 will be the beneficiaries of the next economic dip and, in the process, will transfer what remains of middle class wealth directly to their own pockets.

In addition to the toll in human suffering, this situation will challenge the survival of this country's democratic institutions.  A citizenry with no hope for help from a non-responsive government will turn to more authoritarian figures to "fix" their problems.

There is a slight, but ever-dimming, chance that President Obama and Congress would take action to avert this situation.  It would require 1) enabling homeowners to refinance their mortgages to lower fixed rate loans to stabilize housing; and 2) passing a new stimulus package focused on strengthening our infrastructure and educational systems.  In other words, real investments in our future.  We already have the example of China which successfully avoided the recession by taking this second step.

Not likely to happen . . . but consider the alternative.

Nearer my God to Thee

Earlier this week, President Obama was asked about the huge bonuses for the heads of Goldman Sachs and CitiGroup.  His response was astounding and revealing:  "Well, look, first of all, I know both those guys. They're very savvy businessmen. And I, like most of the American people, don't begrudge people success or wealth. That's part of the free market system."  The President went on to compare the Wall Street bonuses to the extraordinary salaries of baseball players don't perform well.

His solution?  Give shareholders a chance to ". . . scrutinize what CEOs are getting paid. And I think that serves as a restraint and helps align performance with pay."

Hello?  Did Goldman Sachs earn its wealth and success?  Is torpedoing the economy no more serious than a ballplayer who had a bad season?  And last, does anyone really believe that "scrutinizing" CEO pay will somehow stop Wall Street bankers from awarding themselves obscene bonuses?

I wish this were only a matter of tone deafness, as Frank Rich suggested in this week's column.  Would it were so.  Sadly, after one year of this administration, there is no escaping the conclusion that, despite the soaring rhetoric, President Obama is continuing many of the practices of the previous administration:

• The election was barely over when he hired several of the architects of the global economic meltdown, from Larry Summers, who dismantled Glass-Steagall protections, to Tim Geithner who presided over the meltdown from his perch at the NY Federal Reserve.  Mr. Geithner's instincts are always to protect the interests of the monied elite.  He cleared every obstacle that might have stopped Goldman Sachs from receiving $20 billion in taxpayers' funds from a bankrupt AIG.  Goldman then had the astonishing chutzpah to grant those same billions as bonuses while claiming to be doing "God's work", as Lloyd Blankfein put it.

• This administration's affinity to Wall Street  is reflected in its foreclosure policies.  "Protect the bankers at any cost (to the taxpayer)" seems to be White House policy.  The administration's efforts to avert foreclosures have been a sad failure.  Banks have lowered payments for a few months for a few customers.  And, only 7% of that select group have had their mortgages permanently lowered.  Meanwhile the pace of foreclosures is quickening - nearly $1.5 trillion in mortgage loans are scheduled to recast in the next two years.  Soon the wave will become a tsunami unless aggressive action is taken.  The Fed must require banks to re-value their real estate portfolios to current prices and then require them to adjust the principal owed to reflect the new, lower value.   This would reduce the volume of foreclosures and investors would have greater confidence in valuations.

Regardless of intent, policy has tended to support powerful, corporate elites, while the rest of America continues to struggle.

After the Massachusetts Massacre

As always, Frank Rich's enlightened commentary is right on the mark.  President Obama has been handed a very full and difficult plate; but there have been some serious missteps.


Merely days after the 2008 election, he hired an economic team comprised of people who played a key role in wrecking the economy.  In 1999, Chief Economic Advisor Larry Summers teamed up with Sen. Phil "Americans-are-whiners" Gramm to repeal the Glass-Steagall Act.  And under Tim Geithner, Treasury became a principle employer of former Goldman-Sachs executives.  This team blocked any kind of real help for people struggling to avoid foreclosures and successfully funneled billions to the unrepentant bankers who now use the taxpayers' billions to lobby Congress and the Administration to make sure they never get regulated.


Most Americans recognize the blatant injustice of it all.  We see that Wall Street is populated by pirates whose rash actions hurt us all and who control our government and write the rules with impunity.


What would an alternative course of action look like?  A few ideas:

1. Remove the Wall Street insiders - they are too enmeshed with the power-brokers to get it.  Left to their own devices, they will tend to favor their brethren . . . at the expense of the rest of us.
    
2. Replace them with credible, skilled people like Simon Johnson, Volker, Reich, Stiglitz and Krugman.
   
   
3. Tax the Wall Street pirates.  Their reckless risk-taking won't stop until their wings are clipped.  And the simplest way to stop them would be to impose confiscatory taxes - say 75% tax rate after the first $50,000 in bonuses.  This single action would remove some of the incentive to over-leverage, would reduce the deficit and would let Americans know whose side the administration is on.  And, if they threaten to run away to work elsewhere . . . well, is that really a bad thing?  Again, their actions endanger all of us.  (Incidentally, the administration's proposal to tax the banks which pay excessive bonuses would be worse than doing nothing - the bankers will simply increase the fees they charge customers to pay the tax.  No, they have to tax the bankers' bonuses.)
   
   
4. The media is only now beginning to shed light on the new foreclosure tsunami.  A new round of foreclosures is ramping up as a new wave of toxic loans come due.  The Obama Administration - or a revitalized economic team - can simply stop homes from entering foreclosure unless there has been good-faith mediation between borrower and lender.  The administration can also simply stop loans from resetting so families that can afford their current monthly payments would remain in their homes.
   

These are the kinds of steps that would match meaningful action to the soaring rhetoric.  We are all waiting . . . 

A nation of diabetics?

I am waiting to board a flight to Europe with my family. As we wait, my adult son, Adam, whispers to me, “I can pretty much tell who is an American here and who comes from other countries. At first I wasn't sure how I could tell the difference; but then I realized . . . Americans are really fat.”


And so we are. We are really, really fat. And while other nations are starting to catch up to us, when we travel abroad, we cant help but notice how we stand out in comparison. Jowls and dewlaps dangle from our chins; our stomachs bulge over our belts; we waddle, not walk. And the food we eat? An endless stream of burgers, fries, doughnuts, nuggets are required to make us a nation of Sumi wrestler wannabees – without the athletic ability.


During the current round of health care reform debate, much has been made of “personal responsibility” in the rising cost of health care. After all, if only Americans would eat less and exercise more, fewer would get heart disease or diabetes – diseases that drive up the cost of care for everyone.


In fact, while obesity is a very serious and costly issue, it is a smaller contributer to soaring heath costs than factors like the enormous administrative waste, or our fee-for-service payment system which encourages lots of unnecessary (and sometimes harmful) care.


But, for the purpose of this discussion, let's put aside the cost issue and explore why Americans are so obese and what can be done about it.


Obesity – a problem of individual responsibility or a public health issue?


If we are we are serious about addressing the obesity epidemic, we had best treat it as a public health issue. As satisfying as it may feel to blame others for their personal bad choices, that is not an effective strategy to get people to change their eating habits or get more exercise. (Besides, do you ever notice how some of the people who shout the loudest about taking personal responsibility are themselves 50-100 pounds overweight?)


Having set aside the blame game for the moment, we can consider obesity as a public health problem. Treating obesity as a problem to be examined and solved – just as we do epidemics or spreading infections – allows us to identify the causes of this epidemic and find solutions.


Our weighty history.


A hundred years ago; even 50 years ago, Americans were not unusually fat. But starting in the 1950's and accelerating steadily through the subsequent decades, we began to balloon. What changed to make this happen?


Essentially, two things changed about America. First, in the post-WWII era, how we travelled was transformed. In 1945, Americans travelled over 90 billion miles on rail. By 2000, this figure had declined by over 80%, even as the U.S. population more than doubled. Even more dramatic was the sharp decline in the availability of urban public transportation. People who once depended on mass transit to shop and get to work, now relied on automobiles for the same activities.


My own family's story nicely demonstrates the shift:

In the 1940's, my family lived in an apartment in Chicago near the two stores my father owned and managed. But raising three kids in a brownstone apartment and shlepping them (and strollers, toys, etc.) up and down three flights of stairs every day was not at all easy. As the business grew and my parents had more disposable income, they, along with millions of other Americans of that era, decided to move to suburbs. The first house they moved to in 1950 was five blocks from a transit stop and my father walked to the platform every morning and took the train to his store. It required a couple of transfers but he could usually get there in 45 minutes. My mother, meanwhile, had the family car.


But, after World War II, U.S. transit was in the midst of a death spiral. Ridership fell as people purchased cars (and as General Motors purchased urban rail systems and tore up the tracks). As ridership fell, transit systems went out of business, which made it more difficult for the remaining riders to get around. Not surprisingly, in the early 1950's, the transit system my father took to work went bankrupt. There was another railroad company in the same area; but it was not within walking distance. So for the next several years, my mother drove my father every morning in the family car to the station where he boarded the train. But, without all of the connecting routes, he had to take a taxi from the train station to his stores.


Finally, in 1960, the famous interstate highway system envisioned by President Eisenhower came to Chicago. Our family could now do the unthinkable – buy a second car - and my father could drive to work every day. No trains, no waiting on platforms, no transfers, door-to-door service. What could be more convenient?


Only it wasn't. A ride that previously took 45 minutes on the “El”, now took 35 minutes . . . or 45 minutes . . . or an hour and a half, depending on traffic. The expressways that accelerated the death of mass transit encouraged more and more Americans to move to distant suburbs, which meant more people used the freeways, which led the cities to build even more freeways, which led to . . . well, you get the idea. It sounded like a good idea; but once implemented created new problems to solve.


But there was another, more subtle outcome from these transportation changes. Remember, how my family got a second car in the 1960s? My father, who previously walked a quarter mile to the station each day and then another quarter mile to his stores, now only had to walk 25 feet to his car for the long drive to the city. Similarly, millions of other Americans lost their walks that had been previously built into their daily routines.


And remember how my mother schlepped 3 kids and strollers down three flights of stairs and then walked to the park eight blocks away? Even in her final years, she complained about how horrible that experience was and how grateful she was when they moved to the suburbs where she could pop the kids in the car (without seat belts in those days) to go anywhere she liked. That was an enormous and desirable shift which, along with washing machines and dish washers, improved the quality of her life.


But something got lost in the process. And that something, was physical movement and exercise built into the daily routine. Before 1960, very few people (except the very wealthy) worked out at athletic clubs, in part because their days were full of movement and exercise. They may have viewed all this movement as time-consuming drudgery; but it had the effect of burning calories and toning muscles.


This process of removing physical activity from people's lives has continued unabated. I grew up in the 1960's where it was a given that I walked or rode a bicycle to school. Because we lived in an old, pre-Interstate highways suburb, I could ride my bike to the town center to shop, take music lessons, and visit the library. But, if I were to live in a remote suburb where all the stores were located in a distant mall, that would not be an option. I would have to drive (or be driven) to the mall to do the same kinds of activities.


Today, fewer children routinely walk to school. Often, the lack of sidewalks and pedestrian-friendly intersections make that nearly impossible. So they are driven to school, losing the source of daily movement that was simply part of life in previous generations. Today, over 30% of school age children are overweight or obese and many are now saddled with diabetes – a serious, lifelong chronic disease that shortens lifespans and increases the risk of heart disease, blindness and loss of limb. No child should have to deal with such things.


Corporations make you fat.


There is a second chapter to this story of how we became so obese.


In the late 1950's, my father heard about a brand new restaurant in Des Plaines, Illinois. This amazing diner had brought the industrial revolution to dining. Food was prepared with minimal human interference – allowing a faster, safer and cheaper product to be made.


We went to the diner and we were both entranced. A Ford-like assembly line took a pre-made patty of beef on a conveyor belt, through a grill and out the other side. French fries (my favorite) were fried in large vats following a fixed process. The results, while satisfying to us, would be unrecognizable to today's patrons: a 4-inch patty on a small bun and a paper sack containing about 10 fries.


This exciting culinary experience happened at one of the first MacDonald restaurants. While full of fat and cholesterol, this meal was:

1. A rare, one-time event; and
2. The portions were tiny by today's standards.

In this pre-supersize era, fast food was unlikely to make anyone very fat . . . unless they ate amounts that were enormous by the standards of the period.


Much has been written about the industrialization of the food industry, the enormous subsidies for corn and soybeans and the absurd – and dangerous – products that came out of this system. Suffice to say, we now subsidize a food industry that puts out vast amounts of processed food laden with fats, sugars and salt In other words, our food system is designed to kill Americans – quite slowly perhaps – but kill us nonetheless. With both parents working full time, feeding the family on the run may be a necessity – but a necessity that transforms us into a nation of diabetics and cardiac patients.


So, reliance on the car and subsequent suburbanization and loss of daily movement, PLUS the availability of cheap, fattening food have unintentionally created the obesity epidemic.


What to do?


We can and do lecture ourselves and fellow Americans about the need to take personal responsibility by exercising more and eating less. But, by now most people know that they need to eat better and exercise more . . . they just don't. If we want to solve the problem, we need a better plan. In other words, we need public policy and public actions that will undo the conditions that created the problem. A hundred years ago, public health cleaned up our city sewers and taught personal hygiene. Today, we have a more challenging task: we must re-introduce physical activity into our daily routine and we must change the food we eat.


Difficult to do? Not really. The action steps are easy to come by; but the politics are daunting indeed.


But first the easy part – the prescription:


Fewer cars. A few – very few – people have the discipline (or obsessive-compulsive disorder) to exercise daily at a gym and eat only green leafy vegetables. But the vast majority of us just aren't there. And lecturing us about how we should and ought to be there is nice, but not especially helpful. The vast majority of us don't have that kind of discipline and never will. So, if we want to get skinny, we are going to have to change how we live. We'll need to undo urban sprawl, reduce or eliminate freeways, build out mass transit and disperse shopping to neighborhoods. We have to structure where we live so it's easier to walk, bike and take transit than get in the car and drive to the mall. Is this intrusive? Perhaps. But there probably isn't any other way to get us moving again. One added benefit . . . these same changes will also reduce carbon emissions and global warming.


Fewer calories. Does anyone (other than Cargill, ADM or Monsanto) still think we should be stuffing ourselves with fat, sugar and salt as if our actual purpose in life is to emulate a Christmas goose and produce human foie de gras? At a minimum, we must stop subsidizing the production of vast quantities corn syrup, cooking fats, etc. One of the reasons fast food is so cheap is that we, the taxpayers, pay billions in farm subsidies. For those who fear creeping socialism, let me be clear: we already have a government-directed food policy. Only our policy is to spend our tax dollars on the foods that sicken us. At a minimum, we should stop putting fast food on welfare; and at best we should consider taxing the fats and sugars because they cost us our health and economic well-being. If we must subsidize anything, shouldn't it be fresh vegetables and whole grains?

The long and winding road . . .

Previous postings focused on the 2008 economic meltdown. Here, I'll point to some trends in the housing sector that make me think that the end is not in sight for the current "Great Recession".

We've all heard about the rash of foreclosures from subprime loans. Sadly, foreclosures are not likely to end anytime soon. Figure 1 shows a graph from Credit Suisse (click on the figures to enlarge them) giving us a window into the near term:

1. The dark blue bars show subprime loans which dominated loan resets prior to spring, 2009. The chart shows how these loans are done resetting and relatively few will be at risk for foreclosure from now on. However, not satisfied with the damage from subprime loans, the Wall Street wizards created new and improved instruments of economic destruction.
   
   
2. The green bars show Alt A loans and the yellow bars depict Option ARM loans. These new toxic loans offered low "teaser rates" which reset after a period of time. Figure 1 shows that resets will peak in summer, 2010; then decline until March, 2011, only to peak again in the summer and fall of 2011. The number of resetting loans won't recede until September 2012. Since, it takes several months for homeowners to fall behind in their payments and several more months for their homes to foreclose, expect no end of foreclosures until spring, 2013.
   
   
3. The cumulative value of reset loans is about $1.8 trillion. While not all of these loans will foreclose, even a percentage (e.g. 30%, 40%, or more) of these loans foreclosing would represent an enormous loss of accumulated wealth.
   

Can't Congress do anything about this crisis?

Yes, they can . . . but don't bet on it happening anytime soon. The banking industry has successfully lobbied against any measures that might reduce foreclosures. For example, until 2005, bankruptcy law permitted courts to modify the terms of mortgages in bankruptcy proceedings. In 2005, Congress bowed to the demands of banks to pass legislation limiting the ability of courts to modify loan terms. Congress recently considered restoring this ability; but the bill did not move due to vigorous opposition from the financial sector. (Note that these banks used taxpayer bailout monies to "persuade" Congress of their position. Undoubtedly, some of the taxpayer dollars enriched a few campaign funds - a perfect example of a "green" recycling system!)

What does this mean for homeowners?

Housing prices have already declined substantially; in some areas, by more than 40%. If mortgages continue to reset as described in Figure 1, the market will be flooded with foreclosed homes and home prices will likely decline further. This deleveraging process will drive prices down far lower than might normally be the case in the collapse of a bubble. Ironically, the financial institutions that oppose efforts to prevent foreclosures would themselves suffer as they try to unload foreclosed properties in a glutted market. If this scenario comes to pass, we can expect the banks to come crawling to the taxpayers for . . . yes . . . yet more infusions of capital to keep afloat.

Commercial Loans: unfortunately, the practice of offering toxic loans also extended to the commercial sector. Figure 2 parallels Figure 1 by showing how commercial loans will reset in the next few years. Many of these are "toxic" loans which are likely to default, peaking in 2014 and subsiding in 2015. Their total exposure is about $1.5 trillion. If businesses start defaulting on these loans, many will shut down, leading to further job losses.

Figure 2. Leveraged Commercial Loan Resets


If left unchecked, these trends lower the prospects for economic recovery until 2015.


Federal Interventions

Stimulus Funding: during major recessions, government stimulus money can help prevent further decline. The social safety net of unemployment benefits, health coverage, etc. can play a critical role in stabilizing consumer spending and preventing a deflationary spiral such as happened in the 1930's. So, Congress passed the American Recovery and Reinvestment Act which directed funds to states to help stimulate the economy. ARRA should help stabilize the economy.

The downside, however, is that the substantial increase in public debt will be a burden for future taxpayers and, over time, could lead to a drop in the value of the dollar.

Money Supply: In addition to stimulus funding, the Fed has greatly expanded the supply of money. Figure 3 provides a historical perspective of the monetary supply, showing change in supply from the previous year. Over time, the change in supply tends to fluctuate between 0 and $100 billion. The last few months, however, have seen an unprecedented expansion to nearly $1 trillion. Flooding the market with money has been a key tool in keeping many banks afloat and has, perhaps, helped the country avoid a deflationary spiral.

On the other hand, such an enormous expansion in money supply greatly increases the risk of the dollar dropping in value and sparking an inflationary cycle. As the value of the dollar declines, imports and commodities become more expensive to American consumers. More alarming, however, is the impact on foreign investment. The U.S. is a "debtor" nation today, with much of our debt owned by foreign interests and especially China. A significant decline in the dollar could prompt these investors to sell their holdings to invest in more stable currencies. This would be akin to a slow-motion run on the American "bank". Should this occur, the U.S. economy would run the risk of higher inflation and a declining standard of living.

Figure 3. Change in Money Supply over Previous Year











Summing up: If the above indicators correctly capture key trends, we can expect:

1. Rolling waves of housing foreclosures, with continued decline in housing values. Homelessness and associated social ills may also increase.
   
   
2. Similar defaults in the commercial sector affecting small to medium businesses leading to renewed job losses and increased unemployment.
   
   
3. Despite the efforts of Treasury and the Fed to protect large financial institutions from losses, these trends - in the absence of Congressional intervention - will push more financial institutions toward bankruptcy. After investing trillions in taxpayer funds and more than doubling the supply of money, it will be difficult for the Federal government to do more if these institutions become unstable.
   
   
4. The above trends also put the country at risk for inflation and a decline in standard of living.

Oh those silly, silly taxpayers . . .

One of the great untold scandals in the current meltdown is Wall Street's ability to "recycle" taxpayer funds into campaign contributions. Congress, despite its recent scolding of the financial wizards ("We're shocked, shocked!), was their active accomplice in de-regulating the banking industry. And why not, when Wall Street filled their campaign coffers with contributions? And for Wall Street, it's simply a good investment - donate lots of money and Congress will look the other way while you loot the economy. How else to explain Congress, and notably Senator Chuck Schumer, enabling billionaire hedge fund operators to pay a maximum of 15% in taxes?! But I guess that's not a problem in a Washington D.C. where most cabinet appointees don't pay their own taxes. We in the hinterland are fast learning that paying taxes is for "little" people. You know. . . the suckers outside the beltway.

So here's a key question: why are we spending our money to bail out the financial wizards who wrecked the economy, who will then use some of that money to make campaign contributions so Congress will (wink, wink, nod, nod) let them continue to run amuck? If Congress is serious about fixing this mess, they must ban any entity receiving bailout funds, as well as their senior executives, from making campaign contributions for any political purposes. This ban should remain in effect as long as they owe the taxpayers any money and for a period of five year after that.

Would this abridge their freedom of speech? Not at all. Acceptance of taxpayer money should be contingent on their not using our money to influence policymakers.

It seems pretty obvious, right? But if you think Congress will act accordingly . . . well, I have this lovely bridge in Brooklyn I'd like to sell you. Or how about a really sweet financial derivative?

The Economic Crisis - Why it won't end . . .

While the Obama Administration has done much to be commended, the people they hired to fix this mess are sadly some of the same who got us there. Their actions reek of hubris and continued self-interest. Consider:

1. Tim Geithner was the chairman of the NY Fed and an active participant in the fumbled, lurching responses of the Bush administration. Similarly, Larry Summers, although he says he is outraged by the meltdown, was a principle architect of the deregulation fest that got us here.
   
2. Geithner's initial hires are dominated by investment bankers and especially recent employees of Goldman Sachs, the alma mater of Secretary Paulson. Goldman played a pivotal role in promoting credit default swaps and other sketchy derivatives (although they were nimble enough to sell early and avoid the worst of the tsunami). GS has not only taken billions directly from taxpayers; but they are a primary beneficiary of the billions of taxpayers' dollars given by AIG to its "secret" counterparties. (Unbelievably, the taxpayers own 80% of AIG, yet even Congress was denied information on who is getting billions of dollars.) In other words, Geithner and his team of Goldman alumni are donating billions of our dollars to former colleagues and employers under a cloak of secrecy.
   
3. The administration has been unwilling to even consider forceful and timely action, such as nationalizing the most disabled banks. The delays in action only prolong the recession while the steady drip, drip of taxpayer funds continue to bail out the wealthiest of the wealthy. And the reason given for inaction is disturbing - they don't want to hurt the shareholders. Well what about the taxpayers?
   
4. And perhaps the most disturbing thing is that these "masters of our universe" have no sense of the outrage they are perpetrating. Instead, they take it for granted that they are entitled to be bailed out ad infinitum and keep getting their swollen bonuses. Their outrage at anyone questioning their entitlement is evidenced by the absurd statement, "we need to pay huge bonuses to retain the most talented individuals". Never mind that these "most talented" have brought down our economy and thrust ordinary Americans and the rest of the world into the worst hardship since the Great Depression. They are so completely out of touch, that they actually believe their own self-serving nonsense and argue that they deserve the billions they continue to pillage.

Alas, don't count on Congress to take any meaningful action. They are reluctant to bite the hands of their masters - the ones who gave and continue to give millions (of our money) to their campaign funds. Hedge fund managers, who contributed heartily to our economic collapse, continue to be taxed at 15% maximum. The rest of us pay full freight (unless we are a candidate for a senior cabinet post); but the wealthiest billionaires among us continue to pay the lowest possible rate. How is this possible? When Congress considered taxing hedge funds at a higher rate, Senator Chuck Schumer (D-NY) used his considerable clout to protect the hedge fund managers by blocking any legislation. As I said, don't expect Congress to take action anytime soon.

The picture is complete and it's quite clear. The greed-obsessed and heedless crowd who wrecked the economy continue to wield considerable power and not only duck punishment, but get rewarded with billions of dollars in taxpayer funds. While their actions in our deregulated world may be technically "legal", these people are criminals in the classic sense of the word - i.e., they knowingly endanger others with their actions and are incapable of remorse.


The officials hired to fix this situation are too enmeshed in this cozy world of corporate socialists and are unlikely to anything that might harm their former colleagues. And last, our elected officials are compromised by the corrupting influence of campaign donations and will do little, other than spouting platitudes, to challenge the status quo.

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Friday, October 31, 2008

The emerging mortgage bailout plan

Yesterday, the NY Times ran an article titled, "Mortgage Plan May Aid Many and Irk Others". The story described the federal proposal to assist homeowners who are at risk of foreclosure. It's great that the Feds are finally turning to the problem underpinning the crisis; however, it's unfortunate that the Bush administration continues its focus on keeping lenders whole as opposed to helping borrowers. To that end, their plan tries to assess whether it benefits the lender to let a home foreclose versus negotiate easier terms with the borrower. And, of course, if the bank chooses to work out the loan, then the federal government will guarantee it. Unfortunately, this approach, which is far more bank-friendly than consumer-friendly, raises a number of questions:

• Will banks work in good faith with consumers? To date, they haven’t. As Joe Nocera observed in a recent article, even after the Fed invested billions in them, banks have shown greater interest in new mergers than using the funds for their intended purpose - making loans
  
  
• The loan servicers tend to operate on auto-pilot when it comes to the foreclosure process. Can we trust the loan servicers to really help borrowers? Here's a clue - most of the loan servicing in the country is conducted by three banks: Chase, Bank of American and Wells Fargo. These are, of course, the three largest institutions who have capitalized on the financial crisis to grow even larger.
  
  
• Millions of loans are in jeopardy now. The federal proposal entails considering each loan separately which promises to be an enormously time-consuming process. Will this approach address the crisis quickly enough to make a difference to at risk homeowners?
  
  
• To qualify for the program, it appears that borrowers have to miss several monthly payments. As your article notes, this will incentivize many borrowers to stop making monthly payments. Others will feel they are being punished for their continuing to make payments.
  
  
• Last, the proposal ignores borrowers who were illegally or unethically prompted to refinance their homes and will continue to face foreclosure. Consider the elderly individuals who owned their homes outright but were "persuaded" to take on a subprime loan.
  

If this or the future administration can leave ideology behind (isn't it past time to do so?), there are other simpler, broad-stroke approaches to resolving this crisis. Several have been discussed in the Times, such as the proposal to refinance all residential mortgages on primary residences into 30-year fixed-rate mortgages at 5.25 percent and place those mortgages with Fannie Mae and Freddie Mac. At a minimum, the government could institute a foreclosure moratorium and then lock in payments at a lower rate and then permit them to rise (or fall) very slowly over several years. This would stabilize housing prices and permit a softer landing. The real story behind this economic crisis has been the costly triumph of ideology over common sense. The ideologues have been proven wrong and it's time to do what works. To that end, we have to stop feeding the Frankenstein institutions that created this mess and focus on the human beings who are at risk of losing their homes. Failure to prevent them from going into foreclosure will certainly lead to a cascade of declining home values, great human suffering and a longer, deeper recession for all of us.

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Saturday, October 4, 2008

The City on the Hill - A Fairy Tale for Our Times

Once upon a time there was a prosperous city high in the mountains. The reason the city was prosperous was that the surrounding hills had deposits of precious gems and gold. The people of the city were greatly admired from afar for their prosperity and the wisdom of their rulers. Many people would try to venture through the dangerous mountains to live in the city; other cities sought to emulate their advanced ways.

Of course, the wealth of the city resulted, in part, from miners who worked the rich veins of precious metals in the surrounding hills. And ordinary citizens benefited greatly when miners returned home and bought things in local stores and paid taxes. With a steady, reliable stream of wealth flowing through the city, citizens found that they could safely buy on credit, knowing that their prosperity would not abate.

Alas, no good thing lasts forever and that was the case for the city on the hill. Over time, a few of the miners grew ever wealthier and began to buy out small mining outfits. After a few years, there were just a few very large, and very powerful, mining companies left. And these companies came under pressure from their owners to generate ever more profits. Some of these profits were spent locally and so everyone was happy.

However, eventually the veins of gold were exhausted and the companies had to start looking elsewhere.

So imagine their surprise and delight when they discovered rich, untapped veins directly beneath their city. At first, the companies mined the veins on the margins of the city and didn't tell anyone what they were doing. However, inevitably the easy veins were tapped out and they had to probe deeper under the city. It was only a matter of time before citizens became aware of the growing sounds of tapping beneath their feet.

A town meeting was convened and some citizens argued that the mining companies should be prohibited from mining below the city. “They'll destroy the city!”, they argued. Others suggested permitting limited mining that wouldn't endanger the city.

The mining companies had a different perspective. They pointed out to everyone that their employees spent their earnings in the city and that the companies paid taxes* to the city government. If the city restricted their activities, they would have to move their operations . . . and money . . . elsewhere. Besides, didn't everyone know that the mining companies had a great safety record and hadn't had a major accident in nearly 80 years. This was true, but the companies didn't mention, and people had forgotten, that the city council had imposed strict safety standards after that tragic accident.

What do do? The city elders were perplexed. They didn't want citizens to get mad at them (especially with an election coming up); but they certainly didn't want to “kill the goose” that provided so much prosperity. Also, over the years, the mining companies had quietly given city elders a share in their companies and had helped them retain their lofty positions through periodic gifts.

So, the city elders sat the mining company owners down and explained the situation.

“Not to worry!” replied one owner. 'Our engineers are the best and they will make sure that our mining operations won't jeopardize the city.”

“Trust us!”, declared another. “We live here too and we would never do anything to endanger the city we love.” The speaker saluted the city's banner to punctuate his point.

And so the city elders explained to the public that the mining companies could be trusted and that government efforts to limit them would only muck things up and, in fact, might make matters even worse, because everyone knew how incompetent government bureaucrats were. And since no one really wanted the wealth to stop flowing, most everyone decided not to push the issue further.

But an odd thing happened. Over the next year or two, many of the mining company owners sold their holdings and moved far, far away (actually, they purchased some rather large islands in the Caribbean – but that's another story).

Meanwhile, back at the city on the hill, strange cracks showed up in the walls of buildings, floors began to tilt and the sounds of drilling grew ever closer.

And, one day, it happened. A section of the city collapsed into the cavern that had grown beneath it. While most of the city was intact, all mining operations had to be severely restricted. Suddenly, the survivors had to contend with the fact that the money coming into the city had declined precipitously. Making matters even worse, many of the citizens who had bought on credit couldn't pay their bills and several merchants went out of business. The merchants' employees who had lost their jobs stopped spending money and this in turn hurt the remaining merchants. The city's economy steadily spiraled downward. A formerly prosperous people were forced to live in reduced circumstances and over time, the city on the hill looked more and more like a dilapidated slum.

The citizens were furious with their leaders and forced them out of office and elected new leaders – some of whom were the same people who had warned about the dangers of mining under the city. But it was too late. Even thoughtful and competent leaders could only moderate the damage that had been done and the city continued its decline.

And the former city elders? Well, they still had their shares in the mining companies and they weren't forgotten by the mining company owners who provided them with very nice homes in their new island havens.

Epilogue

Not surprisingly, the people in other countries who had admired the city on the hill realized their folly. “That whole city was built on a bed of sand”, they declared. The once beautiful city became a laughingstock and, eventually, a cautionary tale about greed. But eventually, even the cautionary tale was forgotten.


*Actually, the mining companies paid less and less in taxes over time. They successfully persuaded the city elders that taxes reduced their profitability and that they would move elsewhere unless they were lowered.