Ten Trillion and Counting!

Tuesday, PBS Frontline will investigate what it means to add, in the next five years, 10 trillion dollars more debt to the American banking, political and social systems. See Ten Trillion and Counting. In the meantime we experience each day an ever-weakening US dollar, and ever-shrinking job/income picture for middle-class Americans, and an ever-more-anemic US consumption engine for the world economy.

What are to make of it?  One view, see Brad DeLong for example, paints this as a Keynesian economists dream.  DeLong see this as a chance to flood the world with money just in time to avert a total system collapse.  And then a chance to monitor the situation closely to ward off any hyperinflationary consequences that might accrue from the move. (Or maybe I'm putting words/ideas into DeLong's mouth?)

On the left, Paul Krugman sees the situation more darkly. Krugman believes that the Obama Administration, following the lead from the Fed (Ben Bernanke) and the Treasury (Tim Geithner)  continues to dither

…[I]f you think that the banks really, really have made lousy investments, this won't work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that's the Swedish solution, it's what we eventually did with our own.

On the right, Doug Noland sees this as hopelessly misguided as well:

…Washington fiscal and monetary policies are completely out of control.  Apparently, the overarching objective has evolved to one of rejuvenating the securities and asset markets and inciting quick economic recovery.  I believe the principal objective should be to avoid bankrupting the country … our policymakers and pundits are operating from flawed analytical frameworks … completely oblivious to the risks associated with the current course of policymaking.

There is indeed great hope policymakers will succeed in preserving the current economic structure.  On the back of massive stimulus and monetization, the expectation is that the financial system and asset prices will stabilize.  The economy will be, it is anticipated, not far behind.  And the seductive part of this view is that unprecedented policy measures may actually be able to somewhat rekindle an artificial boom — perhaps enough even to appear to stabilize the system.  But seeming "stabilization" will be in response to massive Washington stimulus and market intervention — and will be dependent upon ongoing massive government stimulus and intervention.  It's called a debt trap.  …Hyman Minsky would view it as the ultimate "Ponzi Finance."

… [O]ur highly inflated and distorted system requires $2.0 TN or so of Credit creation to hold implosion at bay.  It is my belief that this will ONLY be possible with Trillion-plus annual growth in both Treasury debt and Federal Reserves liabilities.  Private sector Credit creation simply will not bounce back sufficiently to play much of a role.  Mortgage, consumer, and business Credit — in this post-Bubble environment — will not re-emerge as much of a force for getting total system Credit near this $2 TN bogey.  In this post-Bubble backdrop, only government finance has a sufficient inflationary bias to get Trillion-plus issuance.  But the day that policymakers try to extract themselves from massive stimulus and monetization will be the day they risk an immediate erosion of confidence and a run on both government and private Credit instruments.  Also as I've written, once the government "printing press" gets revved up it's very difficult to slow it down.  This week currency markets finally took this threat seriously.

I don't know.  For some strange reason, given what I've written here on this blog the last few years, I am still pinning my hopes on Bernanke and Geithner.  I hate the idea of $10 trillion more debt, but I hope that it serves as a systems stabilization mechanism while the longer-term deals are worked out to reset our financial systems (see Ken Rogoff interview noted below.)

For those who want a very good refresher as to why we got into this mess, see Joseph Stiglitz, 'Capitalist Fools', Vanity Fair, Jan 2009  Here is a timeline of events, drawn from Stiglitz that ought to be (hope springs eternal) the subject of an upcoming Congressional hearing:

• 1987 - Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place … "Volcker … understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand. … Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble."
• 1993 – "When I [Stiglitz] was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives [credit-default swaps, and so forth] posed a danger. We didn't put it as memorably as Warren Buffett —who saw derivatives as 'financial weapons of mass destruction'—but we took his point. And yet, for all the risk, the deregulators in charge of the financial system—at the Fed, at the Securities and Exchange Commission, and elsewhere—decided to do nothing, worried that any action might interfere with "innovation" in the financial system.
• 1998 - Brooksley Born, head of the Commodity Futures Trading Commission called for derivatives regulation—"a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition."
• 1999 (November) - Congress repealed the Glass-Steagall Act. "Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest."
  … "The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking."
• 2001 (June) - "[W]ith a follow-on installment two years later, [President bush] and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches."
  … "The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement."
• 2002 (July 30) - "[I]n the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act. … "[I]n the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are 'incentive pay' in name only. If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
  "The incentive structure of the rating agencies also proved perverse. Agencies such as Moody's and Standard & Poor's are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. The rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds."
• 2004 (April) - the Securities and Exchange Commission "allowed big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process."
• 2008 (October 3) - The Bush administration's response to the crisis itself. "Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America's banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not. The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, 'cash for trash,' buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
  "The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up."

If such a Congressional hearing were to happen, I'd like to see some name-economists, Administration supporters and detractors from left and right, as well as US government officials past and present, asked at each point along the timeline:What were you thinking? Why were you thinking it? And how would you now rethink it?

For perhaps the best insights as to where this may go, see the Ken Rogoff video interview on PBS NOW, Mar 14 (23 min)

Comments

[TalithaTwoBlade]

Tiny Tim Geithner and Helicopter Ben Bernanke are going to ruin this country. They both need to GO!

http://fargoneworld.blogspot.com

[Joannah]

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Joannah