Politics of an Economic Nightmare

I have to pass along:

The Politics of an Economic Nightmare, Robert Reich, Jan. 22: A possible economic meltdown is worrisome enough, but a possible meltdown in an election year is downright frightening. For months now, Republicans have been pushing the White House to take some action that looked and sounded big enough to give them some cover if and when things got worse. President Bush has now responded with a stimulus package more than twice as large as the one Bill Clinton briefly entertained at the start of 1993 but couldn't get passed.

Not to be outdone, Democrats want to appear at least as bold, which means they'll suspend pay-go rules and throw fiscal responsibility out the window. In other words, hold your noses, because the "bipartisan" stimulus package that's about to be introduced could be a real stinker, including tax cuts for everyone and everything under the sun -- except, perhaps, for the key group of lower-income Americans. …

Meanwhile, Fed chairman Ben Bernanke and Co. have surprised everyone with a rate cut larger and sooner than expected. The three-quarters of a percentage point ("75 basis points" in biz-speak) cut announced Tuesday morning may not sound like much, but it's bigger than any rate cut in decades. The politics here are more subtle because Bernanke and his Federal Reserve governors are supposed to be independent of politics. … Expect lots and lots more Washington activity -- enough seemingly bold strokes to convince voters that our nation's capital is doing whatever is necessary to stop whatever seems to be going wrong with the economy.

The problem is, people have different views about what's going wrong. Wall Street sees it as a credit crisis -- a mess that seems never to reach bottom because nobody on Wall Street has any idea how many bad loans are out there. Therefore, nobody knows how big the losses are likely to be when the bottom is finally reached. And precisely because nobody knows, nobody wants to lend any more money. A rate cut won't change this. It's like offering a 10-pound lobster to someone so constipated he can't take in another mouthful.

Main Street sees it as a housing crisis. As I've noted, homes are the biggest assets Americans own -- their golden geese for retirement and their piggy banks for home equity loans and refinancing. But home prices have been dropping quickly. It's the first time this has happened in many decades -- beyond the memories of most Americans, which is why they never expected it to happen, why they bought houses so readily when credit was so easily available, and why so many people bought two or more of them, speculating and fixing up and then flipping. But now several million Americans may lose their homes, and tens of millions more have only their credit cards to live on and are reaching the outer limits of what they can spend. As consumer spending shrinks, companies will reduce production and cut payrolls. That has already begun to happen. It's called recession.

How much worse can it get? As I said before, the housing bubble drove home prices up 20 to 40 percent above historic averages relative to earnings and rents. So now that the bubble is bursting, you can expect prices to drop by roughly the same amount, and new home construction to contract. The latter plunged last month to its lowest point in more than 16 years. A managing partner of a large Wall Street financial house told me a few days ago the scenario could get much worse. He gave a 20 percent chance of a depression.

Even if a stimulus package were precisely targeted to consumers most likely to spend any money they received, the housing slump could overwhelm it. …

In reality, the crisis is both a credit crunch and the bursting of the housing bubble. Wall Street is in terrible shape and Main Street is about to be in terrible shape. And there's not a whole lot that can be done about either of these problems -- because they are the results of years of lax credit standards, get-rich-quick schemes, wild speculation on Wall Street and in the housing market, and gross irresponsibility by the Fed, the Treasury and the Comptroller of the Currency.

As a practical matter, our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad -- some major U.S. financial firms have already gotten key cash infusions from foreign governments buying stakes in them -- combined with export earnings as the dollar continues to weaken. But this is something no politician wants to admit, especially in an election year. …

Meanwhile Paul Krugman opines that the recession is likely to be deep and long. And, the Fed may not have enough ammunition to properly play out its role. He hints that a Japan-style Liquidity Trap may await us. Finally, Krugman remembers Greenspan's 2001 surprise inter-meeting rate cut:

On January 3, 2001 the Greenspan Fed announced a surprise, inter-meeting rate cut (50 basis points, compared with 75 yesterday.)

The markets went wild with joy. The Nasdaq rose 14 percent that day.

It didn’t last.

Comments

[bailey]

I'm way our of my realm but I've thought for a long time PK's liquidity trap thinking is nobel consideration worthy. On Reich, he's certainly a an astute social observer & commentator but he must have driven Ceccheti nuts while they shared space at Brandeis. I love it that non-Economists enjoy sprinkling Economics over their arguments for emphasis, especially when so many Economists abuse their academic pinnings. But, Reich takes PK's term, "airport Economist", to a new dimension.
I Hope retirement is doing well for you. I've been scouring the countryside (via the web of course) for an idyllic lake, habitable year round, for my wife & I to nest under until the SoCal r.e. carnage subsides.

[Dave Iverson]

Hi Bailey.

Retirement is a bit wierd, but then again so was "government work" which was/is as much an oxymoron as it sounds.

Hope you find your "idyllic lake". "Habitable year round" is the hard part. We own a patch of brushland overlooking lovely Bear Lake astride the UT/ID border. Problem is that it gets warm up there about late June and gets very cold beginning in Nov. Good skiing nearby, however.

Some people are thinking it to be "habitable" year round, but I dunno. So far we are looking at our little "stake" up there as, at best, a second home possibility. And I have serious reservations (environmental, financial, and workload) about owning two homes.

So we go up there for a week each summer to camp near the lake, and stop by to look at our patch of brushland--and watch it go up in value. My guess is that within a year or two (maybe later this year) I'll be crying the blues over seeing my real estate "paper gains" disappear as rapidly as they appeared (both at Bear Lake and here along the N. Utah Wasatch Front).

It won't be much different from what my Apple stock has been doing the last couple of weeks.

Oh well.. Easy come, easy go. As my favorite sci fi author Robert Heinlien said, "Surely the game is rigged. But if you don't bet you can't win."

I don't bet much, and therefore won't lose much. But sometimes it is very hard watching savings being slowly eroded away as others bet and win (lose) in the speculative frenzy, on-purpose inflation-oriented system we call capitalism.