A Solution?
By Paul Craig Roberts / October 10, 2008
Readers have been pressing for a solution to the financial crisis. But first it is necessary to understand the problem. Here is the problem as I see it. If my diagnosis is correct, the solution below might be appropriate.
Let’s begin with the fact that the financial crisis is more or less worldwide. The mechanism that spread the American-made financial crisis abroad was the massive US trade deficit. Every year the countries with which the US has trade deficits end up in the aggregate with hundreds of billions of dollars.
Countries don’t put these dollars in a mattress. They invest them. They buy up US companies, real estate, and toll roads. They also purchase US financial assets. They finance the US government budget deficit by purchasing Treasury bonds and bills. They help to finance the US mortgage market by purchasing Fannie Mae and Freddie Mac bonds. They buy financial instruments, such as mortgage-backed securities and other derivatives, from US investment banks, and that is how the US financial crisis was spread abroad. If the US current account was close to balance, the contagion would have lacked a mechanism by which to spread.
One reason the US trade deficit is so large is the practice of US corporations offshoring their production of goods and services for US markets. When these products are brought into the US to be sold, they count as imports.
Thus, economists were wrong to see the trade deficit as a non-problem and to regard offshoring as a plus for the US economy.
The fact that much of the financial world is polluted with US toxic financial instruments could affect the ability of the US Treasury to borrow the money to finance the bailout of the financial institutions. Foreign central banks might need their reserves to bail out their own financial systems. As the US savings rate is approximately zero, the only alternative to foreign borrowing is the printing of money.
Financial deregulation was an important factor in the development of the crisis. The most reckless deregulation occurred in 1999, 2000, and 2004. See Roberts, “The End of American Hegemony.”
Lax mortgage lending policies grew out of pressures placed on mortgage lenders during the 1990s by the US Department of Justice and federal regulatory agencies to race-norm their mortgage lending and to provide below-market loans to preferred minorities. Subprime mortgages became a potential systemic threat when issuers ceased to bear any risk by selling the mortgages, which were then amalgamated with other mortgages and became collateral for mortgage-backed securities.
Federal Reserve chairman Alan Greenspan’s inexplicable low interest rate policy allowed the systemic threat to develop. Low interest rates push up housing prices by lowering monthly mortgage payments, thus increasing housing demand. Rising home prices created equity to justify 100 percent mortgages. Buyers leveraged themselves to the hilt and lacked the ability to make payments when they lost their jobs or when adjustable rates and interest escalator clauses pushed up monthly payments.
Wall Street analysts pushed financial institutions to increase their earnings, which they did by leveraging their assets and by insuring debt instruments instead of maintaining appropriate reserves. This spread the crisis from banks to insurance companies.
Finance chiefs around the world are dealing with the crisis by bailing out banks and by lowering interest rates. This suggests that the authorities see the problem as a solvency problem for the financial institutions and as a liquidity problem. US Treasury Secretary Paulson’s solution, for example, leaves unattended the continuing mortgage defaults and foreclosures. The fall in the US stock market predicts a serious recession, which means rising unemployment and more defaults and foreclosures.
In place of a liquidity problem, I see an over-abundance of debt instruments relative to wealth. A fractional reserve banking system based on fiat money appears to be capable of creating debt instruments faster than an economy can create real wealth. Add in credit card debt, stocks purchased on margin, and leveraged derivatives, and debt is pyramided relative to real assets.
Add in the mark-to-market rule, which forces troubled assets to be under-valued, thus threatening the solvency of institutions, and short-selling, which drives down the shares of troubled institutions, thereby depriving them of credit lines, and you have an outline of the many causes of the current crisis.
If the diagnosis is correct, the solution is multifaceted.
Instead of wasting $700 billion on a bailout of the guilty that does not address the problem, the money should be used to refinance the troubled mortgages, as was done during the Great Depression. If the mortgages were not defaulting, the income flows from the mortgage interest through to the holders of the mortgage-backed securities would be restored. Thus, the solvency problem faced by the holders of these securities would be at an end.
The financial markets must be carefully re-regulated, not over-regulated or wrongly regulated.
To shore up the credibility of the US Treasury’s own credit rating and the US dollar as world reserve currency, the US budget and trade deficits must be addressed. The US budget deficit can be eliminated by halting the Bush Regime’s gratuitous wars and by cutting the extravagant US military budget. The US spends more on military than the rest of the world combined. This is insane and unaffordable. A balanced budget is a signal to the world that the US government is serious and is taking measures to reduce its demand on the supply of world savings.
The trade deficit is more difficult to reduce as the US has stupidly permitted itself to become dependent not merely on imports of foreign energy, but also on imports of foreign manufactured goods including advanced technology products. Steps can be taken to bring home the offshored production of US goods for US markets. This would substantially reduce the trade deficit and, thus, restore credibility to the US dollar as world reserve currency. Follow-up measures would be required to insure that US imports do not greatly exceed exports.
The US will have to set aside the racial privileges that federal bureaucrats pulled out of the Civil Rights Act and restore sound lending practices. It the US government itself wishes to subsidize at taxpayer expense home purchases by non-qualified buyers, that is a political decision subject to electoral ratification. But the US government must cease to force private lenders to breech the standards of prudence.
The issuance of credit cards must be brought back to prudent standards, with checks on credit history, employment, and income. Balances that grow over time must be seen as a problem against which reserves must be provided, instead of a source of rising interest income to the credit card companies.
Fractional reserve banking must be reined in by higher reserve requirements, rising over time perhaps to 100 percent. If banks were true financial intermediaries, they would not have money creating power, and the proliferation of debt relative to wealth would be reduced.
Does the US have the leadership to realize the problem and to deal with it?
Not if Bush, Cheney, Paulson, Bernanke, McCain and Obama are the best leadership that America can produce.
The Great Depression lasted a decade because the authorities were unable to comprehend that the Federal Reserve had allowed the supply of money to shrink. The shrunken money supply could not employ the same number of workers at the same wages, and it could not purchase the same amount of goods and service at the same prices. Thus, prices and employment fell.
The explanation of the Great Depression was not known until the 1960s when Milton Friedman and Anna Schwartz published their Monetary History of the United States. Given the stupidity of our leadership and the stupidity of so many of our economists, we may learn what happened to us this year in 2038, three decades from now.
Source / Information Clearing House
Well for the first time, PCR doesn’t have it right (and I’m an admirer of his).
One of the most glaring errors is only 7% of the loans that were made; and DEFAULTED ON, were to minorities.
The majority of mortgage loans came from the promotion of how to buy up properties with ‘no money down’; then the trend was to RENT the property out TO THOSE LOW-INCOME individuals as well as transient individuals, and individuals OF ALL COLORS/RACES/CREEDS who didn’t have the most ‘glowing’ credit ratings.
Case-in-point: In the towns of Laughlin, Nevada and Henderson, Nevada, the majority of those who live in free-standing homes, RENT THEM. The owners? They are the mid to upper-income INDIVIDUALS who bought up at least 10 homes at a time, WITHOUT A DOWN PAYMENT – their income status allowed them to carry these mortgages, and the MAJORITY of those who bought these homes were from San Diego County, Los Angeles County, Orange County, CA Maricopa County, and Orange County, FLA.
The concept was that the casino and hospitality industry was ‘booming’, but most who work as laborers in this industry do not make a large wage; they often don’t work a full 40 hours, so they don’t have benefits. They move about frequently (the U-Haul and Ryder franchises have made millions as they transfer person from house to house). At the same time, there are multi-millions of immigrants (legal and illegal) from Korea, Japan, and Mexico who often work as house-keepers and cooks/dishwashers in this industry. From valet services to prostitution services, still these people needed HOMES, and that ‘fed’ the need for housing.
To top it off, the highest number of ‘crack houses’ and apartment buildings/houses where the drugs are broken down; moved, shared and sold are in these VERY REGIONS and STATES. Each and every individual, ‘needed a home’.
They’ve raided in our community; moved out drugs, and seen $300,000 homes go into foreclosure after those same houses were pick-up selling points for drugs.
Often gambling winnings were used to ‘buy a home’ – or at least put a down-payment to the bank or lending institution. There were a number of shady lending institutions that were NOT banks; they added fuel to this ‘fire’ because they could use IRS reports that showed a sufficient annual income, failing to note that 40 to 60% of the INCOME WAS FROM GAMBLING WINNINGS.
After this all reached a frenzy peak, the casinos tightened the odds; installed ‘ticket’ machines that were software-based (electronic), and from 2001 until now, the winnings people were enjoying (and using as part of their income record to acquire homes), were sharply REDUCED. When that happened; along with the high cost of fuel so air-line travel became expensive; cost to run expensive hotels rose, and tourism fell off substantially, it was ‘their gambling house of cards’ that started tumbling.
The ‘owners’ holding the mortgages tried raising rents; people moved elsewhere. Real estate taxes went up; home-owner fees that were doubled (as they were in our gated community) increased the need for the mortgage-holder to increase the rent. People received massive lay-offs; just remember, the hardest hit states include California, Arizona, and Nevada where the highest cost of living; the inflated value of homes, and the number of ‘slum lords’ and ‘land lords’ who didn’t own their rental properties OUT-RIGHT, all suffered when those in the labor industry where suddenly laid off.
Notice too, California, Nevada, and Arizona are all with a budget deficit; California being the largest! Notice also where the need for water is becoming a serious problem (due to over-building, over-populating, and abuse).
Notice Florida – another hard-hit state and check out the same type of conditions; again, very few in that state are minority OWNERS, but are minorities RENTING FROM GREEDY MORTGAGE HOLDERS.
Absentee owners on a grand scale who exploited people who otherwise would have rented an apartment rather than having tried to live the American Dream by living in an expensive single-family home they couldn’t afford, meant they were evicted; often leaving thousands of dollars in repairs and damage, so the land-lords had to invest MORE money to clean up for re-rent or re-sale.
Further, there were many who sold their mortgages to low-income individuals on LEASE/OPTIONS and LAND CONTRACTS. The ‘appearance’ of ownership was there, until the ‘buyer’ had to default on the contract or didn’t exercise their option. Those same people were able to generate other loans such as cars and credit cards with sizeable lines of credit because they could show on their application they were ‘owners’ (not noting they were buying on a land contract or lease/option agreement). All they had to do was produce that land contract agreement, and the banks and finance companies were on it like shit.
So, those same people who lost jobs; got loans and credit cards, then chose NOT TO BUY, ran up the CREDIT CARD INDUSTRY and that’s how it also worked in tandem with the mortgage industry – sub-prime or not!
When public news papers told about ‘high growth’ areas, I know at least 50 families and probably 25 investors who ‘fell for the story’. They created the ‘illusion’, and ‘filled it’. So, to compound the problem, investors were banging around in those ‘growth areas’ – buying houses (some with 3% down); again renting, and then starting up I-net businesses and other ‘service businesses’ that created a redundancy in many of those populated areas.
There were those who were ‘work-at-home’ people; many fell for the myriad of ‘make money’ schemes offered on the I-net, and (again) the I-net has played a key roll in putting up dreams that people could even make money just with their WEB-SITE.
Now attribute that to the likes of GOOGLE who will pay people for their ads, and tout that you can ‘make money’ as a supplement or as your primary income.
People BOUGHT THE SMOKE, THE MIRRORS, THE RABBITS THAT APPEARED TO BE POPPING OUT OF HATS, and used every available source of disposable income to ‘start a business’ that would allow them to ALSO GET SMALL BUSINESS LOANS AND GRANTS.
Enter then the small business owners; living on lines of credit and often times not paying payroll, but using it for their own PERSONAL EXPENSES. Add to that the costs of medicare; insurance – increase in fuel, clothing, and food costs; this adds another ‘facet’ to this ‘multi-faceted’ dilemma that is America-based.
The one thing that is true that Roberts has said, is the IMBALANCE OF IMPORT VERSUS EXPORT, but if the American buying public weren’t vain, lazy, and greedy, the IMPORTS would have gone ‘begging’, and had we not been a nation of unintelligent consumers, this imbalance would not have reached such high proportions.
You can also thank the EPA people; they shut down businesses that were PRODUCTIVE because the businesses didn’t ‘conform’ to the EPA standards and/or the business itself couldn’t afford to make those changes.
The high cost of FICA; more small businesses had to quit PRODUCING.
The high cost of renting commercial and industrial buildings; a myriad of licenses – fees, property taxes; sales taxes – franchise fees and taxes, and many were so loaded with taxes they failed.
We were loaded with the FDA demands; people who once could run a restaurant in a small town were ‘investigated and closed’ by that particular agency.
FEDERAL AGENCIES AND INTERVENTION/MANIPULATION that oversaw/oversee businesses have compounded the problem and have FORCED companies to go ‘off-shore’.
Companies like GE and GM/Ford/the ‘old stand-by’ businesses can’t afford to pay the HIGH WAGES, MEDICARE, INSURANCE, FICA, AND THE PENSION AND VACATION FUNDS that have been part of the standard ’employee perk’ for so many years.
Top it off with the SUPER RICH WANTING TO GET RICHER, and EXPLOITING this nation, is just another ‘card’ in the deck of disaster.
There are other factors I could detail, but suffice to say my comment has turned into an ‘article’ of its own……./ds
I agree with many of the things that Roberts says, but his economic analysis and prescriptions are suspect. Its a political essay. For one thing, any economic analysis that has no numbers to underline its points is nothing to get very excited about when planning the path forward.
If you want a better deeper analysis of our current plight with lots of numbers and details go here:
http://www.atimes.com/atimes/Global_Economy/JJ07Dj01.html
…As we are witnessing today, the issue is not some manageable amount
of new “capital” to replenish banking system losses. Instead, the
predicament is the massive and unmanageable amount of new credit
necessary to, on the one hand, sustain a mal-adjusted bubble economy
and, on the other, the trillions more required to accommodate a
gigantic speculative de-leveraging. I have a very difficult time
seeing a way out of this terrible mess….
No minorities were not the cause of the financial crisis.
http://mediamatters.org/items/200810100022?f=h_top
And corporations were not forced to move their factories overseas – they chose to move out of greed and ruling members of our government allowed them to because they were and are fascists.